Will Company X have reporting obligations for a financial year under paragraph 392-5(1)(b) of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953), in relation to options granted to Australian-resident employees of Company Y or Company Z under the employee share plan of Company X (the Plan), if an ESS deferred taxing point occurs during the year?
No This ruling applies for the following periods: 1 July 20XX to 30 June 20YY The scheme commenced: In a particular income year
Background 1. Company X was incorporated overseas and is a private company limited by shares. Company X is not a tax resident of Australia. 2. Company X carries on business through subsidiaries in different jurisdictions. Neither Company X nor its subsidiaries are in the business of acquiring, selling or holding shares, securities or other investments. 3. Company Y and Company Z are Australian tax resident private companies limited by shares, who are subsidiaries of Company X. 4. Company Y and Z employ Australian resident individuals in their business. Share structure of Company X 5. Under the governing documents of Company X, Company X's share capital consists of different classes of shares, including 'D Shares'. 6. Each class of shares have their own characteristics and varying degrees of rights/entitlements in relation to Company X. 7. Key features of D Shares include: a. No right to a distribution of dividend. b. No right to vote at a general meeting of Company X or on any resolution in writing of Company X.
c. Non-transferrable, except in limited circumstances. d. Ranked last in the distribution of share capital upon the occurrence of a liquidity event and only if there is any balance remaining after the other shareholders of Company X receive their capital entitlements. 8. D Shares are only issued to employees of Company X (or its' subsidiaries) who participate in the Plan. Employee Share Plan 9. Company X intends on establishing the Plan to deliver a new incentive arrangement aimed at rewarding its worldwide employees and aligning their interests with its current shareholders. 10. Under the Plan, Australian resident employees of Company Y and Company Z will be granted options, which are rights to acquire a D Share in the capital of Company X (Option). 11. Subject to satisfaction of exercise conditions and other prescribed plan rules, Options may not be exercised before an exit event. 12. Company X will allot and issue D Shares (or, as appropriate, procure their transfer) within 30 days after a valid exercise of Options.
Section 15AA of the Acts Interpretation Act 1901 Paragraph 392-5(1)(b) of Schedule 1 to the TAA 1953 Division 83A of the Income Tax Assessment Act 1997 (ITAA 1997) Subdivision 83A-C of the ITAA 1997 Subsection 83A-45(2) of the ITAA 1997 Paragraph 83A-105(1)(b) of the ITAA 1997
All legislative references below are to provisions of the ITAA 1997 unless otherwise indicated. 13. Paragraph 392-5(1)(b) of Schedule 1 to the TAA 1953 requires a provider to give a statement to the Commissioner and to the employee if ESS interests have been provided to the employee (whether during the current or a prior year) to which Subdivision 83A-C applies and the ESS deferred taxing point for the interests occurs during the year. 14. For Subdivision 83A-C to apply to an ESS interest, one of the conditions that need to be satisfied is the condition in subsection 83A-45(2) (paragraph 83A-105(1)(b)). 15. Subsection 83A-45(2) requires that the ESS interest must only relate to ordinary shares. Definition of ordinary share 16. The term 'ordinary share' is not defined in the ITAA 1997, the Income Tax Assessment Act 1936 or the Corporations Act 2001 . Therefore, in the context of Division 83A, 'ordinary share' takes its ordinary meaning. 17. In Norman v Norman
(1990) 19 NSWLR 314, McLelland J stated at 316 that an ordinary share has the meaning in ordinary usage and that, in ordinary usage, ordinary shares mean shares other than preference shares. His Honour noted that different contexts may yield different interpretations. The decision should therefore not be read as proposing an inflexible dichotomy between ordinary and preference shares. 18. In construing 'ordinary shares' for the purposes of subsection 83A-45(2), it is appropriate to have regard to the purpose of Division 83A and, more specifically, the purpose of the requirement that the ESS interest offered under the employee share scheme must relate to ordinary shares. The interpretation which best serves those purposes is to be preferred (section 15AA of the Acts Interpretation Act 1901 ).
19. The Explanatory Memorandum to the Tax Laws Amendment (2009 Budget Measures No. 2) Bill 2009 explains at paragraphs 1.85 and 1.86 that providing tax concessions to employees participating in employee share scheme arrangements recognises the economic benefits derived from those arrangements and that participation will help foster better working relationships and increase productivity by aligning the employee and employer interests. Paragraphs 1.120 and 1.121 explain that ESS interests must relate to ordinary shares because shares other than ordinary shares may have less risk associated with them such that they are less likely to align the employees' interests with those of the company. 20. In the Explanatory Memorandum to the Tax Laws Amendment Bill (No.5) 1988, which introduced the requirement in the predecessor to Division 83A that all rights available for acquisition under an employee share scheme must relate to ordinary shares, it is explained that this requirement was to ensure that the voting rights of shares under an employee share scheme are not disadvantaged against any similar shares offered by the company.
21. Whether or not a share is an ordinary share must ultimately be determined by reference to the rights which attach to it. If the rights attaching to a share are insufficient to achieve the purpose of subsection 83A-45(2) and bear little resemblance to a share as traditionally conceived ( Sydney Futures Exchange Ltd v Australian Stock Exchange Ltd & Anor [1995] FCA 86, National Mutual Life Association of Australasia Limited v Commissioner of Taxation [2008] FCA 1871 at [46]), it is less likely to meet the meaning of 'ordinary share'. 22. The rights of an ordinary shareholder must be ascertained by having regard to the legal framework provided by the company's rules for internal management. In Australia, these rules are found in the Corporations Act 2001 , the company's constitution and the company's replaceable rules. Where the company is incorporated in another jurisdiction, regard must be had to similar governing provisions of the company. Application to Company X 23. The features that indicate that the D Shares are not ordinary shares include: a. The D Shares do not carry any right to a distribution of dividend.
b. The D Shares do not confer the right to vote at a general meeting of Company X or on any resolution in writing of Company X. c. The D Shares are not transferrable. d. The D Shares only have a right to a distribution of share capital upon the occurrence of a liquidity event and only if there is any balance remaining after the other shareholders of Company X receive their capital entitlements. e. The D Shares are only issued to employees of Company X (or subsidiaries of Company X) who participate in the Plan. f. Options may not be exercised before an exit event. 24. The features of the D Shares bear little resemblance to the traditional concept or ordinary meaning of an ordinary share.
25. The policy intent of subsection 83A-45(2) is ultimately to ensure that the interests of employees are suitably aligned with those of the company. As a matter of practicality, the holder of the D Shares will only ever receive a distribution in the event that Company X ceases to operate as a going concern, and even then, the right to share in Company X's capital is limited to any balance remaining after the other shareholders of Company X receive their capital entitlements. The manner in which the Options are exercised do not ensure that the interests of employees are suitably aligned with those of Company X. 26. If it is indeed in Company X's interests for employees to be remunerated upon its dissolution, this alignment of interests is less than that would be achieved if the ESS interest related to ordinary shares as that expression is normally understood. Ordinary shares which pay dividends and facilitate participation through shareholder votes more obviously provide for the intended alignment of interests insofar as they reward employees for working towards the long-term prosperity of their employer company.
27. Therefore, the D Shares are not ordinary shares for the purposes of subsection 83A-45(2). Conclusion 28. As subsection 83A-45(2) is not satisfied, Subdivision 83A-C will not apply to the Options granted under the Plan. 29. Consequently, Company X will not have reporting obligations for a financial year under paragraph 392-5(1)(b) of Schedule 1 to the TAA 1953.