On 17 August 2016, the Commissioner issued draft Determination TD 2016/D3, which is about a technical point to do with the employee share scheme (ESS) provisions in Div 83A of the Income Tax Assessment Act 1997 (ITAA97) and the Income Tax (Transitional Provisions) Act 1997 (Transitional Act).
The draft determination asks the question: in what circumstances does a contractual right, which is subject to the satisfaction of a condition, ‘become a right to acquire a beneficial interest in a share‘ for the purposes of subsection 83A 340(1) of the ITAA97? The same phrase appears in s83A-15 of the Transitional Act and the ruling proposes to take the same position for that provision too.
To understand this question, it is necessary to understand (relevantly) the ESS provisions in Div 83A. They are designed to bring to tax (as statutory income taxable at an individual’s marginal rates) discounts at which employees acquire ESS Interests under an a scheme in connection with their employment. This could occur on acquiring the ESS Interest (up-front) under Subdiv 83A-B (principally through s83A-25) or it could be at a later point in time known as a ‘deferred taxing point’ for acquisition of shares (s83A-115) or for acquisition of rights to acquire shares (s83A-120) – broadly, the earliest of ceasing employment, 15 years or there ceasing to be any ‘real risk’ of forfeiture or loss of right.
Section 83A-340 deals with ‘indeterminate’ rights that are not yet ‘a right to acquire a beneficial interest in shares’ (viz: an ESS Interest not yet taxable under Div 83A) that later becomes that sort of ESS Interest. This section deems the ‘indeterminate’ right to have always been that sort of ESS interest (a ‘rights or options’ interest). The section gives examples of what these so rights might be rights that might ‘become’ an ESS interest, but aren’t yet.
Section 83A-340 provides as follows:
83A-340(1) This section applies if:
(a) you acquire a beneficial interest in a right; and
the right later becomes a right to acquire a beneficial interest in a *share.
Example 1: You acquire a right to acquire, at a future time:(a) shares with a specified total value, rather than a specified number of shares; or(b) an indeterminate number of shares.
Example 2: You acquire a right under which the provider must provide you with either ESS interests or cash, whichever the provider chooses.
83A-340(2) This Division applies as if the right had always been a right to acquire the beneficial interest in the *share.
The Substance of the determination – The Commissioner will rule that the right must be capable of becoming a right to acquire a beneficial interest in shares and be enforceable (and then become a right to acquire a beneficial interest in shares) – para 2 of the draft Determination.
Date of effect
22. When the final Determination is issued, it will apply to schemes begun to be carried on or after 9 September 2015 (the date of withdrawal of Taxation Determination TD 2014/21). For schemes entered into before 9 September 2015, taxpayers may elect to apply Taxation Determination TD 2014/21 or this Determination, whichever produces the more favourable outcome.
Explanation – Davies case
27. In Davies v. FCT [2015] FCA 773; 2015 ATC 20-520 (Davies), the Federal Court described the requirements of subsection 83A-15(1) of the ITTPA in the following way (at paragraph 73):
[I]t is evident that ‘right’ in this context cannot be a right to acquire shares; otherwise the provision would be circular. Thus the requirements of subs (1) are three:
- (a) a right, which is not a right to acquire shares [is acquired]…;
- (b) which right [later] becomes another right…;
- (c) that latter right being a right to acquire shares.
28. The original right must be something less than, or other than, a right to acquire shares. However, this right must be capable of becoming a right to acquire a share, and must, in fact, become such a right.
29. In Davies, the taxpayer held contractual rights to acquire shares and rights to shares subject to shareholder approval. The Federal Court observed (at paragraph 74):
The contingent right to acquire shares is not itself a right to acquire shares…On satisfaction of the condition precedent the nature of that right changes so that it becomes a right to acquire shares.
30. The Commissioner argued that, although the terms of such a conditional right may be set out in the relevant contract or instrument, the right does not exist until the contingency is satisfied. In response, the Federal Court further stated (at paragraph 81):
I should think it a very unsatisfactory state of affairs if I were required to accede to this contention and to find that … [the] rights exhibited behaviour normally only observed in quantum mechanics. Fortunately, this is not necessary. Conditions precedent can be read either as conditions which must be satisfied before a contract comes into existence at all or as not affecting the existence of the contract but instead conditioning only performance of the obligations already arising under it. Generally, there is a preference for construing such conditions in the second way, that is to say, as going to performance rather than formation: Perri v. Coolangatta Investments Pty Ltd (1982) 149 CLR 537 at 552 (‘…unless the contract as a whole plainly compels this conclusion’ [that it goes to formation]; see also 541 and 545) (‘Perri’).
Explanation – Fowler’s case
35. In Fowler v. FCT [2013] FCAFC 69; 2013 ATC 20-398; (2013) 92 ATR 595 (Fowler), Gordon J held, in relation to a right conditional upon shareholder approval to acquire options over shares (at paragraphs 156-157):
156. … Mr Fowler enjoyed some rights in respect of the Options. …[T]he rights Mr Fowler enjoyed in respect of the Options prior to shareholder approval were limited to the relief available to him in equity. … Mr Fowler merely had the right to insist that Nexus put the issue of Options to him to its shareholders for their approval. …
157. … Mr Fowler’s conditional right to the Options … did not create an equitable interest in either the Options or the shares the subject of the Option (which were…yet to be issued). It is not possible to have a beneficial interest in future property : Norman v. Federal Commissioner of Taxation (1963) 109 CLR 9 at 16 and 24; Federal Commissioner of Taxation v. Everett (1980) 143 CLR 440 at 450-451.
[ATO website – TD 2016/D3] [LTN 158, 17/10/16]