Income tax: employee share schemes - when a dividend equivalent payment is assessable to an employee as remuneration

This Determination sets out when a dividend equivalent payment is assessable as remuneration, and therefore ordinary income, under section 6-5 of the Income Tax Assessment Act 1997 [1] (ITAA 1997) to an employee [2] (you) as an Australian resident participant of an employee share scheme (ESS) and beneficiary of a trust. [3]

A 'dividend equivalent payment' is a cash payment paid by a trustee of a trust to you. That cash payment is funded from dividends (or income from other sources) on which the trustee has been assessed [4] in previous income years because no beneficiary of the trust was presently entitled to the income. The amount of the dividend equivalent payment is ordinarily calculated by reference to the amount of the dividends (or other income) received by the trustee during a specified period, less the amount of tax paid by the trustee on that income.

A dividend equivalent payment is assessable to you as remuneration (and therefore ordinary income) under section 6-5 when you receive such a payment for, or in respect of, services you provide as an employee, or similarly, where the payment has a sufficient connection with your employment.

A Co is an Australian resident company that carries on a business.

A Co establishes a trust for the purpose of providing shares (ESS interests) under an ESS to eligible Australian resident employees.

A Co makes a contribution to the trustee of the trust so the trustee can purchase and hold shares in A Co under the terms of the trust deed, plan handbook and invitation to the employees (together ESS agreement).

Under the terms of the ESS agreement an eligible employee is a beneficiary of the trust and has an interest in the trust that is a right to acquire the shares being held by the trustee. This interest does not entitle the employee to any income generated by the shares over the course of the ESS until such time as the employee satisfies certain conditions set by A Co that are specific to the employee's performance and their continuous employment with A Co being three years (performance conditions). [5]

Upon satisfying the performance conditions the employee is entitled to own the shares held by the trustee of the trust. In addition, the employee is entitled to receive from the trustee an amount reflecting the dividends (post-tax) the employee would have earned had the employee owned the shares from the day the employee received their interest in the trust. The trustee funds this payment from trust capital. According to the ESS agreement, this payment can be made by the trustee or the employer.

As the dividend equivalent payment will be made to the employee because the employee has satisfied certain performance conditions, these payments are made to the employee for, or in respect of, services provided by the employee (they are, in substance, a reward for performance). They are assessable to the employee under section 6-5. While the quantum of the payment reflects a dividend equivalent that may have been received had the employee acquired the shares at the outset of the arrangement, this is merely a calculation mechanism and does not reflect the character of the payment in the recipient's hands. The character of the payment in the employee's hands is remuneration.

Assume the same facts as Example 1. However, separate to the terms and conditions in the ESS agreement, the trust deed also confers an absolute power on the trustee to make a dividend equivalent payment to a beneficiary at the trustee's discretion. The trustee takes no recommendation from A Co and has no regard to the continuing service of an employee, or the satisfaction of any performance conditions, before it makes such a payment. However, the trustee is only able to make such a payment once certain vesting conditions are satisfied. A beneficiary can receive the payment even if they are no longer an employee. The payment can only be made by the trustee.

If the trustee makes a dividend equivalent payment in exercising its discretionary power under the trust deed [5A] , the payment will not be assessable to an employee as remuneration under section 6-5. This is because the payment is received in their capacity as a beneficiary of the trust. The payment would have only a distant causal connection to an employee's employment and, therefore, would not be remuneration.

This Determination applies to dividend equivalent payments where they are paid under the terms and conditions attached to ESS interests [6] granted on or after 1 January 2018. However, this Determination will not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of this Determination (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10).

If you are granted an ESS interest (including a right that later becomes a right to acquire a beneficial interest in a share for the purposes of section 83A-340 [7] ) prior to 1 January 2018, and the terms and conditions attached to your ESS interest include eligibility to receive a dividend equivalent payment, the Commissioner's general administrative practice will be to treat any such dividend equivalent payments paid to you as not assessable to you as ordinary or statutory income. This is conditional on the dividends or other income (that the dividend equivalent payment is calculated on) being assessed to the trustee under section 99A of the ITAA 1936 in the income year the dividends (or other income) were received.

A dividend equivalent payment made to you by a trustee out of an amount assessed to the trustee in an earlier income year is not an amount subject to tax under the trust assessing provisions.

Trust distributions which are not dealt with by the trust assessing provisions can be assessed as ordinary income to you if they bear that character in your hands. Division 6 of Part III of the ITAA 1936 is not an exclusive code in assessing distributions from a trust. [8]

Benefits (in the form of money or money's worth) that you receive for, or in respect of, services you provide as an employee, or, similarly, payments which have a sufficient connection with your employment, will be characterised as remuneration and therefore ordinary income. [9]

The character of the benefit must be determined in the hands of the recipient. [10] It is irrelevant whether: • it is paid in advance of the services to be performed or after [11] • the remuneration is paid by the employer or another entity [12] • it is paid from the income or the capital of a trust [13] , or • it is paid from an amount previously assessed to a trustee under the trust assessing provisions in an earlier year. [14]

It is not necessarily the case that a dividend equivalent payment will have the necessary connection with your employment just because you are an employee at the time you receive it. For instance, if you receive the payment other than in your capacity as an employee, the payment is unlikely to be for, or in respect of, services provided as an employee, as the consideration for the dividend equivalent payment is not your services. [15]

Factors that indicate a dividend equivalent payment is for, or in respect of, your services as an employee include the following: • it is agreed that the dividend equivalent payment is consideration for services rendered by you • the dividend equivalent payment arises from a contract, arrangement or plan established by your employer to enable or facilitate the delivery of employment benefits (such as ESS interests) to you • the dividend equivalent payment can be provided by your employer • the dividend equivalent payment is conditional on you meeting individual or specific employment-related targets • the dividend equivalent payment depends upon your continued employment with your employer and is forfeited on cessation of employment, or • the dividend equivalent payment is provided at the discretion of your employer or the trustee (based on your employer's direction or recommendations).

Factors that indicate a dividend equivalent payment is not for, or in respect of, services you provide as an employee include the following: • the dividend equivalent payment is consideration for an arm's length surrender, exercise or disposal of an asset (property or rights) [16] and that asset was acquired in return for valuable and arm's length consideration (or as remuneration and those rights were appropriately dealt with as such) • the dividend equivalent payment arises because you are a beneficiary of the trust and the trustee has exercised its power under the deed to provide those benefits to you independent of an arrangement or understanding with, or direction by, your employer • the dividend equivalent payment does not arise from a contractual agreement to which you and your employer are party • the dividend equivalent payment does not depend on your continuing employment • the dividend equivalent payment does not have regard to, and is not conditional upon you satisfying, your employment-related targets, or • the timing and amount of the dividend equivalent payment is identical in respect of all recipients who hold the same property or rights, regardless of their employment relationship with your employer.

The Commissioner will accept that a dividend equivalent payment is not for, or in respect of, services provided as an employee, and therefore is not assessable to you as remuneration under section 6-5, if all of the following are satisfied in relation to the payment: • the trustee of the trust is not an associate [17] of your employer • the dividend equivalent payment is paid to you because you are a beneficiary of the trust • the trustee exercises its power under the deed to pay you the dividend equivalent payment, independent of any direction or wishes of your employer • the dividend equivalent payment is not paid in relation to any of the following: - your continued employment with your employer - you meeting individual employment-related targets such as performance conditions - your termination of employment, redundancy or retirement • the dividend equivalent payment does not arise from a contractual agreement to which you and your employer are party • the dividend equivalent payment cannot be made by your employer, in lieu of the trustee making the payment, and • the trustee was assessed on the dividends (or other trust income) that the dividend equivalent payment is calculated on [18] in the income year the dividends or other income were received.