1 Will irretrievable cash contributions made by Company A to the Trustee to fund the acquisition of ordinary fully paid shares in Company A (Shares) by the Company A Employee Share Trust (Trust) under the ESS Plan (Plan) be assessable income of the Trust under section 6-5, 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) or Division 6 of the Income Tax Assessment Act 1936 (ITAA 1936)?
No. Question 2 Will any capital gain or capital loss made by the Trustee of the Company A Employee Share Trust (Trust) arising as a result of CGT event E5 happening in respect of Shares allocated to a Participant be disregarded under section 130-90 ITAA 1997, if the Participant acquires the Shares for the same or less than the cost base of the Shares in the hands of the Trustee? Answer Yes.
Background Company A carries on a business in the retail and wholesale of X in Australia and Country B. Company A is the head company of the Company A tax consolidated group (Company A TCG). Description of the Plan Company A has established the Plan to encourage Eligible Participants to share in the ownership of Company A and to promote the long-term success of Company A as a goal shared by all. The Board (Company A's board of directors) will administer the Plan. The Plan states that the Board may designate some or all executive Directors or Employees as an Eligible Participant for the purposes of the Plan. Offer The Board at its discretion, may from time to time offer Shares to one or more Eligible Participants on the terms the Board decides by giving the Eligible Participants an Offer, subject to the Plan and any applicable law. An Offer must state the following: • the name and address of an Eligible Participant to whom an Offer is made • the maximum number or value of Shares that an Eligible Participant may accept • the date of the Offer and the anticipated closing date of the Offer
• the Issue Price (which will be nil or a discount to the market price of Shares, as set by the Board) • that the Offer is subject to the Eligible Participant directing the Shares be held by the Trustee on the terms of the Employee Share Trust Deed • any other terms of the Shares or the offer of Shares, and • any matters required to be specified by the Corporations Act . To accept an Offer an Eligible Participant must complete, sign and return the Acceptance Form and any other document required by the Board in accordance with the Offer. If Company A determines to cause the transfer or allocation of Shares to a Participant, the Shares may be acquired in such manner as Company A considers appropriate, including through allocation by the Trustee. Upon issue or transfer of Shares under the Plan Rules and/or the Trust Deed, each Participant agrees to become a member of the Company A and to be bound by its' Constitution. Share Rights Shares issued in accordance with the Plan carry the rights set out in the Constitution. Shares will be issued to the Trustee to be held for the benefit of the Participant in accordance with the terms of the Trust Deed.
Company A may, at its discretion, require that the Shares be transferred out of the Trust to a Bare Trustee nominated by Company A. If it does so, the Plan Rules continue to apply to those Shares. Participants who have acquired Shares will be entitled to dividends declared or determined by Company A where the record date for the dividend is after the date the Shares are acquired. Company A intends to declare and pay annual dividends, if it has sufficient funds for the anticipated capital expenditure and working capital required by Company A and can lawfully do so in compliance with the Corporations Act , its Constitution and applicable law. Restrictions on disposal of Shares An Offer may specify disposal restrictions that will apply to Shares issued pursuant to that Offer and other Plan Shares. A Participant must not instruct the Trustee or any Bare Trustee to Transfer their Shares to anyone, including the Participant, or agree to Transfer their Shares until any disposal restrictions specified in the Offer cease to apply, except with the written consent of the Board, which may be withheld at its absolute discretion.
If no disposal restrictions are specified in the Offer, a Participant must not instruct the Trustee or any Bare Trustee to Transfer their Shares to anyone, including the Participant, or agree to Transfer their Shares until the later of a Listing or a date that is 5 years after the date on which the Shares were issued, except with the written consent of the Board, which may be withheld at its absolute discretion. Where Shares are issued for nil value, the Participant must not direct the Trustee to transfer the Shares for until the earlier of 3 years after they are issued, or the date the Participant ceases to be employed by Company A TCG. Terms of the Trust Deed Company A established the Trust under a deed entered into between Company A and the Trustee. The recitals of the Trust Deed state that the sole activities of the Trust will be acquiring, holding and transferring Shares for the benefit of Participants in accordance with an Employee Share Plan on the terms of the Trust Deed. The Trust has been established to be an 'employee share trust' as defined in subsection 130-85(4) of the ITAA 1997. The Trustee's powers include the ability to:
• enter into and execute all agreements, deeds and documents • subscribe for, purchase or otherwise acquire and to sell or otherwise dispose of Shares • open bank accounts and retain on current or deposit account at any bank any money which it considers proper • take and act upon the advice or opinion of any legal practitioner or other professional • do all acts, matters or things which it may deem necessary or expedient for the purpose of giving effect to, and carrying out, the trusts, powers and discretions conferred on the Trustee by the Trust Deed or the law. The Trustee's powers are limited to those that would not result in the Trust ceasing to satisfy the definition of 'employee share trust' for the purposes of subsection 130-85(4) of the ITAA 1997. The Trustee and Company A must not grant a Security Interest over any Shares or Plan Shares held by the Trustee, or otherwise use any Shares or Plan shares as security.
Nothing in the Trust Deed confers or is intended to confer that Company A has proprietary right or interest, charge or lien in the Shares acquired by the Trustee under the Trust Deed. Company A nor any of its subsidiaries has, or is able to acquire, a beneficial interest in the Shares held by the Trust. Acquisition and transfer of Shares The Board may, by notice in writing to the Trustee, instruct the Trustee to subscribe for, acquire and/or allocate a number of Shares specified in the notice, to be held by the Trustee as Plan Shares in respect of an identified Participant or Participants. The Trustee will not acquire Shares already on issue from existing shareholders. The Board may also by notice in writing instruct the Trustee to subscribe for or acquire a number of Shares as specified in a notice, to be held by the Trustee on an unallocated basis on trust for Participants generally. Shares subscribed for or acquired are to be registered in the name of the Trustee on subscription or acquisition and are general Trust property to be held subject to the terms of the Trust Deed. The Trustee must transfer or dispose of Plan Shares in accordance with the Plan Rules and any Offer.
For the duration of any Restriction Period, the Trustee and the Participant must not assign, transfer, sell, or grant a Security Interest in or over, or otherwise deal with, a Plan Share, except with the express consent of the Board in accordance with the relevant Plan Rules. Where a Restriction Period applies, and the Trustee receives notice from the Company that it has ceased, the Trust must notify the Participant and transfer the legal title in those Plan Shares to the Participant if directed. Where no Restriction Period applies, the Trustee must notify the Participant and transfer the legal title in those Plan Shares to the Participant if directed; and may, at its discretion or if directed by Company A, transfer the legal title in those Plan Shares to a third party trustee to hold on bare trust for the Participant. If it does so, it must promptly notify the Company A and the Participant of the transfer and provide the name and contact details of the new trustee. Funding Company A may, from time to time, provide to the Trustee amounts for the purposes of funding the acquisition of Shares by the Trustee according to Trust Deed for the benefit of the Participants.
The Company A does not have any right to the income or capital of the Trust. Company A must pay to the Trustee such fees and reimburse such expenses incurred by the Trustee as Company A and the Trustee agree. All funds received by the Trustee from Company A in the form of contributions will constitute accretions to the capital of the Trust and no participant will be entitled to receive a distribution of or from such funds. The funds will not be repayable to Company A except where they are used for subscribing for Shares in Company A. Additional funds that are derived through unallocated Shares may be applied to acquire Shares and allocate them to Participants or to pay administration costs of the Trust. Unallocated Shares The balance of the Net Income of the Trust for a Financial Year to which no Participant is presently entitled must be accumulated by the Trustee as part of the capital of the Trust. Rights in respect of Allocated Plan Shares Subject to the Plan Rules, a Participant is presently entitled to so much of the Net Income of the Trust for a Financial Year which is attributable to: • the Plan Shares held by the Trustee on behalf of the Participant
• the proceeds of sale arising from the sale of Plan Shares by the Trustee on behalf of the Participant • transactions or events related to the Plan Shares or property related to or arising from Plan Shares held by the Trustee on behalf of the Participant.
All legislative references are to provisions of the ITAA 1936 or to provisions of the ITAA 1997, unless otherwise indicated. Question 1 Detailed Reasoning The total assessable income of a trust estate is calculated as if the trustee were a resident taxpayer in respect of that income (subsection 95(1) of the ITAA 1936) . The assessable income of a taxpayer includes income under ordinary concepts (section 6-5) or statutory income (section 6-10). None of the provisions listed in section 10-5 (list of provisions about assessable income that is not ordinary income) are relevant in the present circumstances. The irretrievable cash contributions made by Company A to the Trustee will therefore not be included in the assessable income of the Trustee under section 6-10.
The contributions made by Company A are irretrievable and non-refundable to it in accordance with the Trust Deed. The funds provided to the Trustee are used in accordance with the Trust Deed and the Plan Rules for the sole purpose of the employee share scheme. Therefore, the contributions constitute capital receipts to the Trustee, and are not assessable under sections 6-5 or 6-10 or Division 6. (ATO Interpretative Decision ATO ID 2002/965 Income Tax -Trustee not assessable on employer contributions made to it under the employer's employee share scheme ). Question 2 Detailed Reasoning Pursuant to section 102-20, an entity can make a capital gain or loss if, and only if, a CGT event happens. CGT event E5 Under subsection 104-75(1), CGT event E5 happens if a beneficiary becomes absolutely entitled to a CGT asset of a trust (except a unit trust or a trust to which Division 128 applies) as against the trustee. The time of the event is when a beneficiary becomes absolutely entitled to the asset according to subsection 10475(2).
If CGT event E5 happens, the trustee may make a capital gain or loss if the market value of the asset, at the time of the event, is more than its cost base or less than the asset's reduced cost base respectively (subsection 10475(3)). Draft Taxation Ruling TR 2004/D25 Income tax: capital gains: meaning of the words 'absolutely entitled to a CGT asset as against the trustee of a trust' as used in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 explains the principles set out in the leading English trust law case of Saunders v Vautier (1841) 49 ER 282 in relation to 'absolutely entitled' as follows: ... if a sole beneficiary's interest in the trust property is vested and indefeasible and they are of age then they can put an end to the trust by directing the trustees to transfer the trust property to them or at their direction, even though the trust deed contains a contrary intention. The basis of the principle is that a beneficiary is entitled now to that which will be theirs eventually anyway. In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 applies.
A Participant will become absolutely entitled to the Shares in accordance with the Plan when those rights have vested and been exercised (if applicable) and the restrictions in respect of the Shares have ceased or no longer apply. Upon cessation of all the restrictions, the Participant has the right to request the Trustee to transfer the Shares into their name and deal with the Shares at their own will. At this point, the Participant will become absolutely entitled to the Shares as against the Trustee, and CGT event E5 happens pursuant to subsection 10475(1). However, any capital gain or loss that a Trustee makes from CGT event E5 is disregarded if section 130-90 applies. Shares held for future acquisition under employee share schemes: subsection 130-90(1A) Subsection 130-90(1A) applies to disregard any capital gain or loss made by an EST if: • immediately before the event happens, an ESS interest is a CGT asset of the trust (paragraph 13090(1A)(a)), and • either of the following apply:
the event is CGT event E5, and the event happens because a beneficiary of the trust becomes absolutely entitled to the ESS interest as against the trustee (subparagraph 130-90(1A)(b)(i)) the event is CGT event E7, and the event happens because the trustee disposes of the ESS interest to a beneficiary of the trust (subparagraph 130-90(1A)(b)(ii)), and • Subdivision 83A-B or 83A-C (about employee share schemes) applies to the ESS interest (paragraph 130-90(1A)(c)). Employee share trust In examining whether the requirements of an employee share trust in subsection 130-85(4) are met, it is the activities of the trustee in relation to a particular trust that are relevant. To qualify as an employee share trust, a trustee's activities must be limited to: • obtaining shares or rights in a company (paragraph 130-85(4)(a)) • ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the ESS to employees, or to associates of employees, of the company or a subsidiary of the company (paragraph 130-85(4)(b))
• other activities that are merely incidental to the activities mentioned in paragraphs 130-85(4)(a) and (b) (paragraph 130-85(c)). The Trust Deed provides: At all times the Trustee must manage and administer the Trust so that it satisfies the definition of "employee share trust" for the purposes of subsection 130-85(4) of the Tax Act. Paragraph 130-85(4)(a) is satisfied because the sole activities of the Trust include obtaining shares in a company, namely Company A (Recital A of the Trust Deed). Paragraph 130-85(4)(b) is satisfied because the Trust has been established to acquire Shares and to allocate those Shares to Participants to satisfy Share acquired by Participants under the Plan which subsequently vest and, if applicable, are exercised (with each Share constituting an ESS interest as defined in subsection 83A10(1)). The Plan is an ESS within the meaning of subsection 83A-10(2) as it is a scheme under which rights to acquire Shares are provided to employees, or associates of employees in relation to the employees' employment.
In respect of paragraph 130-85(4)(c), the phrase 'merely incidental' takes its ordinary meaning, with further guidance drawn from the context and purpose of the legislation in which it appears. 'Merely incidental' is not defined in the legislation and has not been judicially considered in the context of subsection 130-85(4). The Macquarie Dictionary defines 'merely' to mean 'only as specified, and nothing more'. 'Incidental' is defined as 'happening or likely to happen in fortuitous or subordinate conjunction with something else'. The Commissioner's views on the types of activities that are merely incidental and not merely incidental are set out in Taxation Determination TD 2019/13 Income tax: what is an 'employee share trust'? Activities that result in employees being provided with additional benefits (such as the provision of financial assistance, including a loan to acquire the shares) are not considered to be merely incidental.
In the present case, the Trust Deed provides that the Trust will be managed and administered so that it satisfies the definition of 'employee share trust' for the purposes of section 130-85(4), including paragraph 130-85(4)(c) as the other activities undertaken by the Trustee are merely incidental to managing the Plan. Paragraph 130-90(1A)(a) Paragraph 130-90(1A)(a) is satisfied as the shares held by the Trustee are ESS interests (as defined by subsection 83A(1)(a)) which are CGT assets of the Trust. Paragraph 130-90(1A)(b) CGT event E5 is the CGT event that will apply under the terms of the Plan at the time the Participant becomes absolutely entitled to the Shares as against the Trustee. Therefore paragraph 130-90(1A)(b) is satisfied. Paragraph 130-90(1A)(c) The Plan is an employee share scheme for the purposes of Division 83A as it is an arrangement under which an ESS interest is provided to a Participant in relation to their employment by Company A in accordance with the Trust Deed. Therefore, Subdivision 83A-B or 83A-C can apply to the Shares acquired under the Plan and paragraph 13090(1A)(c) will be satisfied.
Accordingly, all the conditions in subsection 130-90(1A) have been satisfied. Subsection 130-90(2) Subsection 130-90(1) does not apply if the beneficiary acquired the beneficial interest in the shares for more than its cost base in the hands of the employee share trust at the time the CGT event happens (subsection 130-90(2)). Provided a Participant does not acquire the beneficial interest in the Share for more than its cost base in the hands of the Trust at the time that CGT event E5 happens, subsection 130-90(1A) will apply to disregard any capital gain or loss that arises for the Trustee as a result of CGT event E5 happening.