1 Will the irretrievable cash contributions made to the Trustee to fund the subscription for, or acquisition of, shares by the Trustee in accordance with the Plan Rules and the Trust Deed be assessable income of the Trust under sections 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?
No. Question 2 Will either of the following CGT events result in an assessable capital gain or allowable capital loss arising to the EST when Company P shares are allocated and then transferred to a Participant pursuant to the Plan Rules in satisfaction of an Award: 2.1 CGT Event E5: beneficiary becomes entitled to a CGT asset; 2.2 CGT event A1: disposal of a CGT asset? Answer 2.1 No, section 130-90 will apply to disregard any capital gain or capital loss made. 2.2 No, CGT event A1 will not happen to the EST pursuant to section 106-50. Question 3 Will the Trustee be entitled to franking credits under Subdivision 207-B of the ITAA 1997, attached to franked distributions on Unallocated Shares? Answer Yes. Provided the Trustee is a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the Income Tax Assessment Act 1936 . This ruling applies for the following periods : The scheme commences on:
All legislative references are to provisions of the ITAA 1997 unless otherwise indicated. Background Company P is an Australian listed company. Company P aims to maintain a remuneration policy where employee reward is aligned with the achievement of the company's overall strategic objectives, outcomes and creation of value for shareholders. Company P rewards key employees with a mix of remuneration commensurate with their position and responsibilities. Remuneration structures are reviewed regularly to ensure that: • remuneration is competitive by market standards • rewards are linked to strategic goals and performance, and • accountabilities and deliverables are clearly defined to minimise potential conflicts of interest and • promote effective decision-making. Remuneration of employees is evaluated against comparative positions in similar companies and industries. The remuneration of key employees comprises the following elements: • Fixed remuneration, which includes base pay and other benefits • Performance linked remuneration, which consists of performance rights or options, and
• Employee share ownership, through the grant of ordinary shares subject to dealing restrictions granted under a salary sacrifice, tax exempt or tax deferred arrangement. Company P Employee Incentive Plan (the Plan) The Plan is an employee incentive plan operated by Company P for employees. The objective of the Plan is to: • align the interest of Eligible Employees with those of shareholders; • provide incentives to attract, retain and motivate Eligible Employees for the long term benefit of Company P; and • provide Eligible Employees with the opportunity to acquire Share Rights, and ultimately Shares, in accordance with the Plan rules. The Plan allows Company P to offer a right to acquire a fully paid share in Company P (Share Right) to an Eligible Employee subject to the terms of the particular offer and the Plan. An Eligible Employee becomes a participant of the Plan (Participant) on issue of a Share Right and is taken to have accepted the offer to acquire and hold the Share Rights by completing an acceptance form. There have been several separate grants of Share Rights made under the Plan to date. Share Rights
Share Rights do not carry dividend or voting rights. Certain grants (i.e. the long-term incentive and short-term incentive deferral grants, listed above) carry notional dividend equivalent payments for vested awards which are granted as Share Rights (with a nil exercise price) that vest immediately. Once vested, the Board must procure the transfer of Shares to the Participant in satisfaction of the vested Share Rights. No interest in Shares will arise until the relevant vesting conditions are met and a Share Right has vested. All unvested Share Rights will generally lapse immediately upon the Participant's cessation of employment, except in special circumstances details in the Plan. Company P Employee Share Trust (the Trust ) The Trust was established to facilitate the acquisition, holding of and allocation of Shares to Participants in accordance with employee equity plans, including the Plan. The Trustee of the Trust is not a related entity of Company P. Company P's reasons for using an employee share trust arrangement for the existing and any future equity based incentive plans include:
• a company is unable to hold its own shares. The Trust is a vehicle which will enable Company P to effectively acquire and hold its own Shares for the purpose of fulfilling its obligations resulting from new and existing grants under the Plan; • the Trust will facilitate the acquisition of Shares either on-market or by new issue of Shares by Company P; • the Trust provides an arm's length vehicle for acquiring and holding Shares in Company P, either by way of new issue or acquiring on-market, i.e. providing flexibility relating to capital management; • the Trust will be an efficient structure for giving effect to vesting conditions. As the Trustee is the legal owner; employees have no ability to deal in the Shares; • contributing to the Trust to acquire Shares before Share Rights vest may enable Company P to hedge against a potential increase in costs to satisfy Share Rights due to share price growth, as well as the potential for insufficient Shares being available on-market immediately prior to vesting;
• the Trust provides the flexibility to acquire and hold Shares that will be allocated to employees under the Plan. When vesting conditions are not met, Share Rights are forfeited, and the Trust enables Shares held for such forfeited Share Rights to be 'recycled' to satisfy other grants of Share Rights; and • the Trust establishes independent records and accounts for Participants. Company P states the Trust broadly operates as follows: • The sole activities of the Trustee will be acquiring Shares for the purpose of providing them to Participants on vesting of their Share Rights under the Plan and the administration of the Trust. The Trustee will acquire Shares at market value and will either acquire them on-market, by way of off-market transaction or subscribe for new. • Under the terms of the Trust Deed, Company P will instruct the Trustee to subscribe for, purchase or allocate a number of Shares specified in the notice. This instruction may occur at any time Share Rights are granted or at a later time depending on Company P's capital management strategy.
• In determining whether to request the Trustee to subscribe for or purchase Shares on-market, the Company P Board will consider the following: o Company P's current capital management strategy; o the dilution impact any issue of new Shares will have; o the liquidity (trade volume) of Company P Shares; o the Board's expectations regarding Company P's Share price movements and volatility over the short and longer term; and o trading restrictions or anticipated activity that may prompt restrictions in trading of Company P shares. • The Trustee will, in accordance with instructions received pursuant to the Plan Rules, acquire, allocate and deliver Shares to Participants, provided the Trustee receives sufficient payment from Company P to subscribe for or purchase Shares and/or sufficient unallocated Shares are available in the Trust. Contributions to the Trust
The Trust will be funded by Company P through irretrievable contributions to the Trustee, as required. All funds received by the Trustee will constitute accretions to the corpus of the Trust contributed by Company P will be used to acquire Shares and those Shares will be provided to the relevant Participants within one day of Company P initially making the contributions to the Trust. Any funds contributed to the Trust (other than funds contributed for fees or reimbursement of expenses incurred by the Trustee in accordance with the Trust Deed) cannot be refunded, repaid or returned to Company P (or any Group member) other than by way of the Trustee paying the issue price where it subscribes for Shares. The Trustee must carry out the objects of the Trust in a manner consistent with the definition of 'employee share trust' in section 130-85. The Trustee is not permitted to acquire any Share or deliver any Share to any Participant if to do so would contravene applicable law.
Funds to the Trust are transferred immediately prior to vesting in order to fund the acquisition of shares on market, so effectively the funds are provided at vesting. No contributions are made to the trust in advance of vesting. Shares will be provided to employee participants within one day of the contributions being made to the Trust.
All legislative references are to provisions of the ITAA 1997 unless otherwise indicated. Question 1 Will the irretrievable cash contributions made to the Trustee to fund the subscription for, or acquisition of, shares by the Trustee in accordance with the Plan Rules and the Trust Deed be assessable income of the Trust under sections 6-5 or 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? Summary The irretrievable cash contributions made by Company P to the Trustee in accordance with the Plan Rules and the Trust Deed to fund the subscription for, or acquisition on-market of, Company P shares will not be assessable income of the Trust pursuant to sections 6-5 or 6-10. Detailed reasoning The net income of a trust estate means the total assessable income of a trust estate calculated as if the trustee were a resident taxpayer in respect of that income (subsection 95(1) of the Income Tax Assessment Act 1936 (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 XXXX to the Trustee will therefore not be included in the assessable income of the Trustee under section 6-10. The contributions made by Company P 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. (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 Will either of the following CGT events result in an assessable capital gain or allowable capital loss arising to the EST when Company P shares are allocated and then transferred to a Participant pursuant to the Plan Rules in satisfaction of an Award: 2.1 CGT Event E5: beneficiary becomes entitled to a CGT asset;
2.2 CGT event A1: disposal of a CGT asset? Summary Any capital gain or loss that arises under CGT event E5 (section 104-75) for the EST, at the time when a Participant becomes absolutely entitled to a share pursuant to the Plan Rules in satisfaction of an Award, will be disregarded under section 130-90. CGT event A1 (section 104-10) will not happen when shares vest in a Participant pursuant to section 106-50. Detailed Reasoning CGT event E5 Pursuant to section 102-20, an entity can make a capital gain or loss if, and only if, a CGT event happens. 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 of the ITAA 1997 applies) as against the trustee. The time of the event is when the beneficiary becomes absolutely entitled to the asset. [1] If CGT event E5 happens, the trustee may make a capital gain if the market value of the asset, at the time of the event, is more than its cost base. The trustee makes a capital loss if that market value is less than the asset's reduced cost base. [2]
In the present case, the Trust is neither a unit trust nor a deceased estate to which Division 128 applies. 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 (TR 2004/D25) 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. [3]
Pursuant to the Trust Deed, a Participant is the beneficial owner of their Allocated Plan Shares. An Allocated Plan Share is a Plan Share that is credited to the relevant Participant in the books of the Plan Trustee. Upon the transfer of a Plan Share to a Participant (i.e. the beneficiary), a Participant will become absolutely entitled to the Allocated Share (i.e a CGT asset of the EST) as against the Trustee. Accordingly, CGT event E5 happens pursuant to subsection 104-75(1). Section 130-90 ITAA 1997 If CGT event E5 happens, any capital gain or loss that the Trustee makes is disregarded if section 130-90 applies. Section 130-90 provides as follows: (1A) Disregard any *capital gain or *capital loss made by an *employee share trust to the extent that it results from a *CGT event, if: (a) immediately before the event happens, an *ESS interest is a *CGT asset of the trust; and (b) either of the following subparagraphs applies: (i) 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;
(ii) the event is CGT event E7, and the event happens because the trustee *disposes of the ESS interest to a beneficiary of the trust; and (c) Subdivision 83A-B or 83A-C (about employee share schemes) applies to the ESS interest. (1) Disregard any *capital gain or *capital loss made by an *employee share trust, or a beneficiary of the trust, to the extent that it results from a *CGT event, if: (a) the CGT event is CGT event E5 or E7; and (b) the CGT event happens in relation to a *share; and (c) the beneficiary had acquired a beneficial interest in the share by exercising a right; and (d) the beneficiary's beneficial interest in the right was an *ESS interest to which Subdivision 83A-B or 83A-C (about employee share schemes) applied. (2) Subsection (1A) or (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. For section 130-90 to apply, there must be an 'employee share trust' and an 'ESS interest'. Employee share trust Subsection 130-85(4) defines an employee share trust as a trust whose sole activities are:
(a) obtaining shares or rights in a company; and (b) ensuring that ESS interests in the company that are beneficial interests in those shares or rights are provided under the employee share scheme to employees, or to associates of employees, of: (i) the company; or (ii) a subsidiary of the company; and (c) other activities that are merely incidental to the activities mentioned in paragraphs (a) and (b). ESS interest An ESS interest in a company is defined in subsection 83A-10(1) as either a beneficial interest in a share in the company, or a beneficial interest in a right to acquire a beneficial interest in a share in the company. Shares that are purchased by the Trustee to satisfy its obligation under the Plan, and subsequently allocated to Participants pursuant to the Plan, are ESS interests for the purposes of section 83A-10(1). An 'employee share scheme' is defined in subsection 83A-10(2) as a scheme under which ESS interests in a company are provided to employees, or associates of employees (including past or prospective employees) in relation to the employee's employment.
The Plan constitutes an 'employee share scheme' because it is a scheme under which ESS interests in Company P are provided to the employees of Company P in relation to their employment with it. Therefore, paragraphs 130-85(4)(a) and (b) of the definition of an employee share trust are satisfied because: a. The Trust acquires shares in a company, namely Company P; and b. The Trust ensures that ESS interests as defined in subsection 83A-10(1) are providedunder an employee share scheme by allocating those shares to the employees of Company P in accordance with the Trust Deed and the Plan. Paragraph 130-85(4)(c) of the definition of an employee share trust provides that a trustee can engage in activities that are merely incidental to those described in paragraphs 130-85(4)(a) and (b). 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'? (TD 2019/13).
However, whilst the relevant trust documents may include powers and/or duties that are broad reaching, the mere existence of those powers or duties in the trust document does not, of itself, mean that the trustee has breached the requirements to be an employee share trust. In examining whether the requirements of subsection 130-85(4) are met, it is necessary to examine the actual activities that the trustee has undertaken. [4] The Trust Deed contains only powers and/or duties that are merely incidental, as required by subsection 130-85(4)(c). Therefore, the Trust established pursuant to the Trust Deed satisfies the definition of an employee share trust in subsection 130-85(4). As the rights granted under the Plan will be acquired by the employees at a discount, they are ESS interests to which subdivision 83A-B applies. Conclusion for CGT Event E5
As such, a capital gain or capital loss that arises for the Trustee of the Trust established pursuant to the Trust Deed at the time when CGT Event E5 happens in relation to Company P shares held by the Trustee will be disregarded under section 130-90, if the employees acquire the shares for the same or less than the cost base of the shares in the hands of the Trustee. CGT Event A1 Subsection 100-20(1) provides that a capital gain or a capital loss can only result from a CGT event happening. Subsection 104-10(1) provides that CGT event A1 happens if you dispose of an asset. You dispose of a CGT asset under subsection 104-10(2) if a change of ownership occurs from you to another entity. Section 106-50 provides that where a beneficiary is absolutely entitled to a CGT asset as against the trustee of a trust, the CGT provisions apply to an act done by the trustee in relation to the asset as if the beneficiary had done it.
In this case, and under the Plan Rules and the Trust Deed, a Participant is absolutely entitled to a Plan Share when it is allocated to them by the Trustee in satisfaction of a Share Right. The Trustee must then, at times stipulated in the Plan Rules, transfer legal title to the Plan Shares of a Participant to that Participant. Paragraph 144 of TR 2004/D25 states: • no CGT event happens when the legal title in an asset to which a beneficiary is absolutely entitled as against the trustee is • transferred to the beneficiary. Conclusion for CGT Event A1 In this case when the Trustee transfers legal title to the Participant, the Participant is already absolutely entitled. Therefore, no CGT event will occur and further no capital gain or loss will arise under section 100- 20. Question 3 Will the Trustee be entitled to franking credits under Subdivision 207-B of the ITAA 1997, attached to franked distributions on Unallocated Shares? Summary Yes. Provided the Trustee is a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936. Detailed Reasoning
Division 207 deals with the effect of receiving franked distributions. Amounts to be included in assessable income As far as is relevant in this case, subsection 207-5(3) provides that if a franked distribution is made to a member that is a trustee of a trust, an amount equal to the franking credit on the distribution is included in the member's assessable income. However, subsection 207-5(4) provides that a tax offset in relation to that distribution is only available to an entity (who may be a trustee) if the distribution flows indirectly to it and does not flow indirectly through it to another entity. The tax offset is equal to its share of the franking credit on the distribution. Subdivision 207-B deals with the effect of receiving a franked distribution through certain partnerships and trusts. Section 207-25 explains, relevantly, that: This Subdivision deals with an entity that receives a benefit of a franked distribution where: (a) the distribution is made to a ... trustee of a trust; and (b) the benefit is received either directly or through other interposed partnerships or trusts. The distribution is regarded as flowing indirectly to the entity under this Subdivision.
Subsection 207-35(1) provides that if a franked distribution is made in an income year to an entity that is a trustee of a trust and the entity is not a corporate tax entity nor the trustee of a complying superannuation entity, then the assessable income of the trust for that income year includes the amount of the franking credit on the distribution. Pursuant to subsection 207-50(4), a franked distribution will be taken to flow indirectly to the trustee of a trust relevantly if: • the distribution is made to the trustee, and • the trustee is liable to be assessed on all or part of the trust's net income for that year under section 99A of the ITAA 1936 (subparagraph 207-50(4)(b)(ii)); and • the trustee's share of the distribution under section 207-55 is a positive amount, whether or not the trustee actually receives any of that share. Tax offset
Section 207-45 provides an entity that is the ultimate recipient of a franked distribution to whom a distribution flows indirectly is entitled to a tax offset for that income year equal to its share of franking credit attached to the distribution. The ultimate recipients of a franked distribution are the recipients that can use the tax offset and includes trustees that are liable to be assessed under section 99A of the ITAA 1936. The Trustee will be liable to be assessed under section 99A of the ITAA 1936 in relation to dividends on Unallocated Shares. However, where a franked dividend is paid to a person, subsection 207-145(1) denies a gross-up and tax offset where the person is not a qualified person for the purposes of Division 1A of the former Part IIIAA of the ITAA 1936. Qualified person Broadly, a person will be taken to be a qualified person in respect of a dividend paid on shares if the shares are held at risk for a period of 45 days and the person or an associate does not make a related payment in respect of the dividend (former section 160APHO of the ITAA 1936).
It is accepted that no related payment will be made by the Trustee. Therefore, the Trustee will be a qualified person if it has held the Unallocated Shares for a continuous period of not less than 45 days during the period beginning the day after the Trustee acquires the Unallocated Shares and ending on the 45th day after the Unallocated Shares become ex-dividend. Limit of tax offset Subsection 67-25(1) provides that where a tax offset is available under Division 207, that tax offset is subject to the refundable tax offset rules unless otherwise stated in the section. Subsection 67-25(1B) provides that the tax offset is only subject to the refundable tax offset rules if the trustee entitled to the tax offset is not liable to be assessed under section 98 or 99A of the ITAA 1936. As franked distributions flow indirectly to the Trustee, the Trustee is entitled to a franking tax offset under section 207-45. However, the Trustee is assessed on the distributions under section 99A of the ITAA 1936. Therefore the tax offsets available to the Trustee is limited to the amount of tax payable and any excess franking tax offset is not refundable. > [1] Subsection 104-75(2). [2]
Subsection 104-75(3). [3] Paragraph 41 of TR 2004/D25. [4] Paragraph 6 of TD 2019/13.