1 Will a depositary receipt issued by Entity A (the Foundation) constitute a beneficial interest in shares in Entity B, for the purposes of section 83A-320 ITAA 1997?
1 Yes. Question 2 Will the option/right to acquire a depositary receipt as held by employees or associates of employees (including past or prospective employees) of Entity B or its subsidiaries in relation to their employment in the Foundation, constitute an 'ESS interest' in Entity B which is provided under an 'employee share scheme', for the purposes of section 83A-10 ITAA 1997? Answer 2 Yes. This ruling applies for the following periods: Income Tax year ending 30 June 20XX Income Tax year ending 30 June 20XX Income Tax year ending 30 June 20XX Income Tax year ending 30 June 20XX Income Tax year ending 30 June 20XX The scheme commenced on: XX June 20XX
Entity B is a private company with limited liability incorporated in Country A. Entity C is an Australian resident private company and a wholly owned subsidiary of Entity B. The Foundation Entity B established Entity A (the Foundation). The Foundation has limited liability but no shareholders or share capital. The Foundation was established by execution of a notarial deed with the sole object of facilitating an employee incentive and growth participation plan (Plan). The Foundation is administered by a board of administration (Board) and, the Board is granted power to administers the Foundation through two documents, being the Articles and the Trust Conditions. The Articles set out the object of the Foundation as follows: • To acquire shares and to issue depositary receipts to employees (or other contractors) of Entity B and/or legal entity connected to Entity B. • To promote a proper spreading of control in Entity B.
• Everything that is directly related to the above or may be conducive thereto, including the entering into a shareholder's agreements at the level of Entity B and adhering to the provisions thereof and entering into related documentation. The ordinary activities of the Foundation in carrying out the objectives are as follows: • The Foundation acquires and administers ordinary shares in Entity B. • The Foundation then issues a depositary receipt for every share that is transferred to it. • The depositary receipts are then transferred through an intermediary company to Entity B so that Entity B is able to act as a grantor of the depositary receipts. • The Depositary receipts are linked directly to respective ordinary shares. The Foundation is obligated to distribute any amounts it receives with respect to the shares (such as dividends) to the holders of the depositary receipts. The depositary receipts do not grant the participating employees any voting rights in Entity B.
The Trust Conditions state that holders of depositary receipts may only be natural persons employed by Entity B and/or with a legal entity connected to Entity B pursuant to a labour, cooperation, management, contracting or other similar agreement; or otherwise as approved by the Foundation to acquire and hold depositary receipts. The Plan The Plan operates as follows: • Participants receive an option agreement to participate in the Plan which outlines the following: the number of options to purchase depositary receipts offered, the exercise price, any vesting conditions, the expiry date of the option(s), and any additional restrictions on the disposal of depositary receipts once granted. • Entity B issues an equivalent number of shares to the Foundation before the options are granted to participants. • The Foundation is required to issue the participant with depositary receipts corresponding to each individual share once the participants exercise their options.
• The Foundation will receive all dividends and further distributions from the shares and is required to immediately make available a corresponding dividend or other distribution on the depositary receipts. • Once options have been exercised, the shares held by the Foundation can only be transferred to or repurchased by Entity B or other third party with written permission from the depositary receipt holder. • Participants may choose to exercise vested options at any standard exercise round prior to their expiry. A vested and unvested option lapses or expires at the earliest of either the expiry date of the options or the occurrence of good/bad leaver scenarios set out in the option agreement. • After the exercise of the vested options, i.e. acquisition of the depositary receipts, the consequences of an employee being designated as a good leaver are as follows:
The good leaver, on first demand of Entity B, will be required to offer to Entity B irrevocably and unconditionally (or a designated third party connected to Entity B) all of its depositary receipts for a purchase price equivalent to the higher of: o the exercise price made by the good leaver to acquire the depositary receipts, or o the fair market value. Entity B may decline this offer, in which case the good leaver may retain its depositary receipts. • The consequences of an employee being designated as a bad leaver are as follows: The bad leaver, on first demand of Entity B, will be required to offer to Entity B irrevocably and unconditionally (or a designated third party connected to Entity B) all of its depositary receipts for a purchase price equal to the lower of: o the exercise price made by the bad leaver to acquire the depositary receipts, or o the fair market value. • The board of Entity B may agree with a leaver to terms that are different than those set out in the Trust conditions. Vesting Period for options The default vesting period for the options is X years.
Does Part IVA apply to this private ruling? Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement. If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax. We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidancerule for income tax'.
Question 1 Detailed reasoning 83A-320 states: (1) This section applies if, at a time: (a) you hold an interest in a trust whose assets include * shares; and (b) that interest corresponds to a particular number of the shares (even if the interest does not correspond to particular shares). (2) For the purposes of this Division, treat yourself as holding at that time a beneficial interest in each of a number of the * shares included in the assets of the trust equal to the number mentioned in paragraph (1)(b). (3) If there are 2 or more classes of * shares included in the assets of the trust, this section operates separately in relation to each class as if the shares in that class were all the shares included in the assets of the trust. (4) This section applies to rights to acquire beneficial interests in * shares in the same way it applies to shares. Therefore, we need to consider if the Foundation is a trust.
A 'trust' is not defined in ITAA 1936 or ITAA 1997. Whether an arrangement constitutes a trust for the purposes of tax law has been decided through numerous courts and these decisions help refine what is meant by the term. French J in Harmer & Ors v. Federal Commissioner of Taxation (1989) 20 ATR 1461; 89 ATC 5180 (Harmer) stated that a trust 'is notably a definition of a relationship by reference to obligations'. He went on to state that the four essential elements of a trust are: • the trustee who holds a legal or equitable interest in the trust property • the trust property which must be property capable of being held on trust and which includes a chose in action • one or more beneficiaries other than the trustee; and • a personal obligation on the trustee to deal with the trust property for the benefit of the beneficiaries, which obligation is also annexed to the property. In ATO ID 2008/2 an overseas pension fund was found to be a trust as it satisfied the four criteria in Harmer described above.
For the present case, the following characteristics are present in the Foundation, and relevant to the criteria described in Harmer: • the Board has legal authority to execute decisions on behalf of the property of the Foundation. • trust property exists in the form of Entity B shares. The property is registered to depositary receipt holders. Depositary receipt holder can reasonably assert a legal claim to the beneficial interests from trust property through their depositary receipts recorded in the Foundation's depositary receipt holder register. • Beneficiaries exist, identifiable as depositary receipt holders • obligations are placed on the Board to deal with the property on behalf of depositary receipt holders, through the Trust Conditions and Articles.
As reasonable evidence supports that the four criteria for establishing a trust (per Harmer) are met, we conclude that the relationship between the Foundation and its depositary receipt holders is one of a trust, with the Foundation (and Board) being equivalent to the trustee, the depositary receipt holders being the beneficiaries of the trust arrangement, and the property of the Foundation being the trust property. Additionally, the Foundations assets consists of Entity B shares and thereby the depositary receipt corresponds to these shares. On this basis the depositary receipt will constitute a beneficial interest in shares in Entity B for the purposes of section 83A-320. Question 2 Detailed reasoning An ESS interest in a company is a beneficial interest in a share in the company, or a right to acquire a beneficial interest in a share in the company (83A-10).
If at a time you hold an ESS interest in a trust whose assets include shares (or beneficial interests in shares) and that ESS interest corresponds to a particular number of the shares, 83A-320(2) provides that you treat yourself as holding a beneficial interest in that number of the shares (or beneficial interests) of the trust at that time (see analysis in Question 1). Options to acquire depositary receipts issued to eligible employees will be 'ESS interests' An Option issued under the scheme is a right to acquire a depositary receipt in the Foundation. A depositary receipt is itself a right to receive economic interests linked to a specific number of shares held in Entity B. Whether the Option is a right to acquire a depositary receipt under an employee share scheme for a company will therefore (per 83A-10(2)) depend upon whether the Option is provided to • Employees • Associates of employees (including past or prospective employees) of: The company; or Subsidiaries of the company in relation to the employees' employment. For the present case, Trust Conditions states that depositary receipt holders includes:
• natural persons who are employed by virtue of a labour agreement with the Company and/or with a legal entity connected to the Company; • natural persons who are engaged by the Company and/or by legal entity connected to the Company pursuant to cooperation agreements, management agreements, contracting agreements or other similar agreements; The Articles states a purpose of the Foundation. We accept as fact that the primary purpose of the Plan is to reward employees or other contractors as a result of their employment with Entity B or an entity connected to Entity B. A Depositary Receipt held by an employees or associates of employees in respect of the Holder's employment with Entity B, or a subsidiary of the Company (which includes Entity C), will be regarded as an ESS interest.