The Federal Court has dismissed a taxpayer’s appeal and upheld a 2012 AAT decision in AAT Case [2012] AATA 815, Re Watsford and FCT that a taxpayer was required to include as assessable income a discount from the market value of shares he acquired on the exercise of options under an employee share scheme (ESS) in the 2007 year. The Commissioner increased the taxpayer’s assessable income by $525,600 for that year. The Tribunal had also upheld the Commissioner’s decision to impose a 25% shortfall penalty of $61,101 for failure to take reasonable care.

The taxpayer commenced employment with a company in 1 May 2006. As a part of his employment conditions, he was granted 3 million options under an ESS able to be exercised in 3 tranches 6, 12, and 18 months from the commencement of employment. The taxpayer’s employment was subsequently terminated on 27 April 2007 at which time he had not applied to exercise his first tranche of options. After legal negotiations between the taxpayer and the company regarding the termination of his employment, both parties signed a deed of release on 12 October 2007, which permitted the taxpayer to exercise 2 million options in total. The Commissioner audited the taxpayer’s affairs for the 2007 year and contended that the discount from market value received in relation to the exercise of the options should be included in the taxpayer’s assessable income.  The relevant provision was the now repealed Div 13A of the ITAA 1936. The AAT agreed with the Commissioner’s decisions and the taxpayer appealed to the Federal Court.

The Court said the Commissioner’s argument (which the Tribunal upheld), was that the share options were issued in May 2006 and, by reason of the application of s 139B(3) of the ITAA 1936, read with the applicable definition of “cessation time” in s 139CB(1)(b), the “cessation time” was 27 April 2007, when the taxpayer’s employment was terminated. Accordingly there was, the Commissioner contended, a tax liability in the year ended 30 June 2007. The taxpayer did not declare the options in his return for that year. The taxpayer argued that the share options were new options granted to him in Deed of Release in October 2007, in relation to the termination of his employment, and so should have been included in his assessable income for the year ended 30 June 2008.

The Tribunal said only one question in the appeal constituted a question of law (regarding the construction of a term of the Options Terms and Conditions, which formed part of the taxpayer’s contract), and that question “should be answered adversely” to the taxpayer. Accordingly, it dismissed the taxpayer’s appeal.

(Watsford v FCT [2013] FCA 1389, Federal Court, Mortimer J, 20 December 2013.)

[LTN 3, 7/1/14]