On Wed 31.10.2018, the ATO issued Taxation Ruling TR 2018/7 on employee remuneration trust (ERT) arrangements that operate outside the employee share scheme rules in Div 83A of ITAA97 (which includes beneficial interests in employer shares held through trusts). The Ruling finalises draft Taxation Ruling TR 2017/D5.
This ruling is about arrangements established to facilitate the provision of benefits (eg payments) to employees. The benefits are provided at the direction of, or by arrangement with, the employer.
A typical ‘plain vanilla’ ERT, involves the employer paying a sum to a trustee, to be held for identified employee(s), and to later pay this sum (and any investment earnings) to those employees, at various defined times, if they continue to be employed and meet defined performance hurdles.
The ruling explains the tax consequences for
- the employer,
- employees and
- trustee, including the potential application of Div 7A where the employer is a private company.
The Ruling says that employer contributions are deductible – subject to to the following requirements [per para 9] –
- the contribution is an irrevocable payment of cash,
- made while the employer carries on a business;
- the employer reasonably expects the business to benefit from the contribution via improved employee performance etc; and
- the contribution is intended to be permanently and entirely dissipated in remunerating employees within a relatively short period (no more than 5 years). This feature is aimed at satisfying the requirement that a s8-1 ‘general deduction’ is not ‘capital’ in nature.
- The ATO says it will not apply compliance resources to further investigate whether a period is “relatively short” if the evidence indicates that the contribution will be permanently and entirely dissipated within 5 years and the arrangement is not part of an anti-avoidance scheme.
- A s8-1 general deduction may have to be spread over the life of the proposed benefits, to the employees, under the 13-month prepayment rule in s82KZMD of the ITAA36, unless it’s ‘excluded expenditure’ which includes expenditure under a ‘contract of service’ [para 22], which it is, because it is paid in satisfaction of a liability, that arises under that contract between the employer and the employee, for their services (eg. the employment contract requires the employer to make the payment to the trustee, for conditional payment to the employee, over time, where applicable). [para 22]
There ought be no FBT for the employer (in the plain vanilla example given above). [para 26]
- The employers payment, to the trustee, giving the employee a contingent, deferred benefit, might have created a a ‘fringe benefits tax’ (FBT) liability for the employer, except that the eventual payment, from the trustee to the employee, is effectively ‘salary and wages’ (albeit, via the trustee) – and is excluded from the pivotal definition of ‘fringe benefit’ under para (f) of the definition of that term in s136 of the FBT Act.
- Should the payment be a Div 7A deemed dividend (s109C of the ITAA36), then it’s also removed from the FBT regime (because it will be assessed to the recipient, under that regime).
Amounts the employee receives, from the trustee, are assessable as ‘salary and wages’ – when received (over the vesting period) – in the plain vanilla example above. This is only my conclusion (unsupported by the ruling – but I think correctly analysed). In the ‘plain vanilla’ example I mentioned above:
- The employee won’t be assessed ‘up front’ when the employer makes the contribution to the trustee.
- The ‘deemed derivation’ provision in s6-5(4) of the ITAA97 depends on the employee being entitled to the initial contribution, and then directing the employer to pay the contribution be paid to the trustee. The employee, however, won’t be entitled to any particular amount until the contingencies at each potential vesting point.
But the Commissioner does seem to rule [in para 30] that the employee is assessed on the whole contribution, to the trust, when made by the employer, on a deemed derivation basis (contradicting what I’ve just concluded) above [para 30].
- The example used is oblique.
- There is no analysis on facts closer to the ‘plain vanilla’ examples used elsewhere in the ruling.
- It is amazing to me that there is no other analysis than this.
Contributions ought not be Div 7A ‘deemed dividends’ – in the above ‘plain vanilla’ situation, even when the employer is a ‘private company’.
- The trustee for ‘arms-length’ employees, ought not be an ‘associate’ of any employer shareholder (under s317 of the ITAA36).
- And a trustee for employees, not at arm’s length, to the employer, are likely to be excluded from Div 7A (and thrown back into the ‘Fringe Benefits Tax’ regime, because of the operation of s109ZB(3) – which applies to the sorts of ‘payments’ assumed in this ‘plain vanilla’ situation).
BUT THIS IS ONLY THE ‘PLAIN VANILLA’ TREATMENT – the tax effect gets pretty ‘hairy’ outside this straight path.
DATE OF EFFECT: before and after its date of issue.
- The ruling notes that the ATO previously issued many private rulings which showed a more favourable general administrative practice on the deductibility of contributions than some of the views contained in TR 2018/7 and the withdrawn draft TR 2014/D1.
- In cases where a contribution would have been deductible under this prior practice, the ATO will not undertake compliance activities to apply the Commissioner’s current views to contributions made before 5 March 2014 (when draft TR 2014/D1 was issued).
[ATO Website: TR 2018/7; LTN 210, 31/10/18; Tax Month – November 2018]
FJM 16.11.18
CPD questions (answers available)
- Is this ruling about the tax effect of Div 84A Employee Share Scheme share trusts?
- Is a ‘plain vanilla’ version, of that this ruling is talking about, a payment to a trustee, for the benefit of an employee, to be paid at defined points over a vesting period, if they are still employed and have met defined employment related performance hurdles?
- Would the employer get a s8-1 deduction, for the whole contribution, at the time it is paid?
- In the ‘plain vanilla’ version of these trusts, would the employer be liable to FBT?
- If the employer were a ‘private company’ is it likely that the contribution to the trustee is treated as a Div 7A deemed dividend?
- Will this ruling apply prior to its issue?
- Did the Commissioner have a different practice, once?
- When did that change?
