House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 3 Employee share schemes and stapled securities

Outline of chapter

3.1 Schedule 3 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936), the Income Tax Assessment Act 1997 (ITAA 1997), the A New Tax System (Goods and Services Tax) Act 1999 (GST Act), the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) and the Taxation Administration Act 1953 (TAA 1953) to extend the employee share scheme (ESS) concessions and related capital gains tax (CGT) treatment to stapled securities that include an ordinary share, and that are listed for quotation on the official list of the Australian Securities Exchange.

Context of amendments

3.2 Stapled securities are created when two or more different securities are contractually bound together so that they cannot be traded separately. For example, a property trust may have its units stapled to the shares of a company with which the trust is closely associated.

3.3 When a company does not have any unstapled ordinary shares on issue (because all of the company's ordinary shares have been stapled to other interests) it is difficult to provide employees with access to the ESS concessions because the components of the stapled security will need to be treated separately - the ordinary share under Division 13A of the ITAA 1936, and the other securities subject to fringe benefits tax (FBT).

3.4 Extending the ESS concessions to stapled securities that include an ordinary share and that are listed for quotation on the official list of the Australian Securities Exchange will allow more employers to offer ESS to their employees, and reduce the associated complexity and cost.

Summary of new law

3.5 Where an employee is provided with shares or rights under an ESS, any discount that the employee receives from acquiring the shares or rights below their market value is assessable as income.

3.6 If the shares or rights provided to an employee are qualifying, then the employee may be eligible to access one of two tax concessions in relation to the discount: the tax upfront concession, or the tax deferred concession. Special CGT rules contained in Subdivision 130-D of the ITAA 1997 also apply to ESS shares or rights.

3.7 These amendments ensure that stapled securities are generally treated in the same way as qualifying shares or rights for the purposes of Division 13A and Subdivision 130-D, with some minor modifications.

3.8 These amendments also introduce two 'cessation times' (taxing points) for stapled securities - when a component of the stapled security is unstapled, and when the stapled security ceases to be listed for quotation on the official list of the Australian Securities Exchange. When either of these events occur, deferral of the tax on the discount on the stapled securities will cease.

3.9 These amendments also make several other consequential changes to the ITAA 1936, the ITAA 1997, the FBTAA 1986, the GST Act and the TAA 1953 to allow a stapled security or a right to acquire a stapled security to be broadly treated in the same way as a qualifying share or a qualifying right.

Comparison of key features of new law and current law

Detailed explanation of new law

3.10 These amendments allow the ESS concessions in Division 13A to apply to stapled securities that include an ordinary share, and that are listed for quotation on the official list of the Australian Securities Exchange, and to rights to acquire such stapled securities. [Schedule 3, item 2, section 139DSA ]

Basic conditions

3.11 These amendments achieve this by treating a stapled security in the same way as a share in a company, and by treating a right to acquire a stapled security in the same way as a right to acquire a share in a company, but only for Division 13A (except Subdivision DB) and with some modifications. It also treats a stapled security as an ordinary share, and a right to acquire a stapled security as a right to acquire an ordinary share. Therefore, a stapled security or right that meets the basic conditions will meet any ordinary share requirement in Division 13A. [Schedule 3, item 2, subsection 139DSB(1)]

3.12 For the purposes of Division 13A, a security will be a stapled security only if it is:

•

a security consisting of an ordinary share in a company, and one or more interests in a company or a unit trust. A stapled security can consist of two or more interests [Schedule 3, item 6, paragraphs 139GCD(1)(a) and (b)] ;

•

a security where the ordinary share and every other interest are stapled together. Broadly, stapling is an arrangement under which different securities are contractually bound together. This has the effect that the interests stapled together cannot be traded separately as they are treated as one security [Schedule 3, item 6, paragraph 139GCD(1)(c)] ; and

•

a security that is listed for quotation in the official list of the Australian Securities Exchange as a stapled security. In order to be listed for quotation as a stapled security on the official list of the Australian Securities Exchange, a stapled security must satisfy the listing rules for that exchange [Schedule 3, item 6, paragraph 139GCD(1)(d)] .

3.13 These amendments are limited to stapled securities listed on the Australian Securities Exchange. They do not extend to stapled securities listed on other stock exchanges because they do not have the same requirements which need to be satisfied before a stapled security can be listed. The listing rules for the Australian Securities Exchange ensure, amongst other things, that the components of a stapled security cannot be dealt with separately.

3.14 A 'stapled entity' is a company or unit trust that has its shares or units included in the stapled security. [Schedule 3, item 6, subsection 139GCD(2)]

3.15 For the purposes of Division 13A, a reference to a company is a reference to all of the entities (the stapled entities) involved in a stapling arrangement as though they are one notional company. [Schedule 3, item 2, subsection 139DSB(2)]

3.16 This means that an employee of any of the stapled entities is considered to be employed by the notional company. It also means that the notional company can be a holding company of another company if sufficient interests are owned by the stapled entities.

Example 3.1

Stapled Security X comprises an ordinary share in Company A, and a unit in Trust B. Both Company A and Trust B are stapled entities. Company A and Trust B are a notional company for the purposes of Division 13A.

Company A has a 40 per cent ownership interest in Company C. Trust B has a 20 per cent ownership interest in Company C. Company C is not a stapled entity.

Neither Company A nor Trust B is a holding company of Company C. However, the notional company has a 60 per cent (40 per cent and 20 per cent) ownership interest in Company C. Therefore, the notional company is a holding company of Company C.

Qualifying conditions

3.17 In order for a stapled security, or a right to acquire a stapled security to be a qualifying share or qualifying right, a stapled security must meet the qualifying conditions in section 139CD of Division 13A, subject to the following modifications.

3.18 The first modification relates to the requirement in subsection 139CD(5) that at least 75 per cent of the permanent employees of the employer had been entitled to participate in an ESS of the employer. The modification means that the 75 per cent requirement is only applied to the stapled entity that is the employer of the taxpayer, rather than to all of the stapled entities or to the notional company. [Schedule 3, item 2, subsection 139DSE(1)]

3.19 The stapled entities are treated together and can be a notional holding company of an employer, where that employer is not a stapled entity. [Schedule 3, item 2, subsection 139DSE(2)]

Example 3.2

Continuing Example 3.1, 80 per cent of the employees of Company A are entitled to participate in an ESS. Forty per cent of the employees of the trustee of Trust B are entitled to participate in an ESS. Company A will satisfy the requirement in subsection 139CD(5). Trust B will not.

Ninety per cent of the employees of Company C are entitled to participate in an ESS that provides employees with Stapled Security X. The 75 per cent requirement is fulfilled for Company C, and the notional holding company arrangement means that Stapled Security X is treated as a security in the holding company of the employer (Company C).

3.20 A modification related to the first modification is that for the purposes of working out when a taxpayer ceases to be employed, each stapled entity is taken to be part of the original employer. Therefore employment does not cease merely because an employee transfers employment between stapled entities. [Schedule 3, item 2, subsection 139DSE(3)]

Example 3.3

Continuing Example 3.2, assume an employee is employed by Company A and participates in Company A's ESS and receives Stapled Security X. The employee then leaves Company A for Trust B, and continues to participate in their employer's ESS. Later, the employee leaves Trust B to work for Company Z. The employee only ceases employment when they move to Company Z. The employee did not cease employment when they moved from Company A to Trust B.

3.21 The second modification relates to the requirement in subsection 139CD(6) that a taxpayer cannot legally or beneficially hold more than 5 per cent of the interests in the company. The modification means that a taxpayer satisfies this requirement if they do not hold more than 5 per cent of the shares in any company that is a stapled entity, and more than 5 per cent of the units in any unit trust that is a stapled entity of the stapled security. [Schedule 3, item 2, section 139DSF ]

Example 3.4

Continuing Example 3.3, assume the employee holds 4 per cent of the shares in Company A and 4 per cent of the units in Trust B. The employee is taken to have satisfied the 5 per cent requirement. It does not matter if the employee holds more than 5 per cent of the shares in Company C as it is not a stapled entity.

3.22 The third modification relates to the requirement in subsection 139CD(7) that a taxpayer cannot control more than 5 per cent of the voting rights in the company. The modification means that a taxpayer satisfies the requirement if the taxpayer is not in a position to control the casting of more than 5 per cent of the maximum number of votes that might be cast at a general meeting of each company that is a stapled entity. The requirement is only imposed on the employee's interest in stapled entities that are companies with ordinary shares. [Schedule 3, item 2, section 139DSG ]

Example 3.5

Continuing Example 3.4, assume that the employee's shareholding entitles them to 4 per cent of the voting rights in Company A. The employee is taken to have satisfied the voting rights requirement. The employee could hold more than 5 per cent of the voting rights in Company C as it is not a stapled entity.

Application of ESS provisions to a qualifying stapled security

3.23 If a stapled security or right to acquire a stapled security meets all of the basic conditions and all of the qualifying conditions, it is treated as a qualifying share or qualifying right for the purposes of Division 13A. Any discount on the acquisition of the stapled security or right is included in assessable income, subject to the two concessions available under Division 13A.

3.24 It is not necessary to amend the definition of 'qualifying share' because the definition refers to section 139CD of Division 13A, which includes stapled securities because of these amendments.

3.25 The definitions of 'employee share scheme' and 'qualifying right' are amended to include a right to acquire a stapled security. [Schedule 3, items 35 and 36, definitions of ' employee share scheme' and ' qualifying right' in subsection 995-1(1)]

3.26 If a stapled security is treated as a qualifying share, the provisions will not apply to the separate components of the stapled security. In other words, Division 13A cannot apply to both a stapled security and to a share that is a component of the stapled security. [Schedule 3, item 2, subsection 139DSD(1)]

Deduction for providing qualifying stapled securities or rights

3.27 If a stapled security is provided by one of the stapled entities and the conditions in subsection 139DC(1) are satisfied, the entity may be entitled to the current deduction under section 139DC, which is capped at $1,000.

3.28 If a stapled security is jointly provided by two or more of the stapled entities, each of the taxpayers (ie, the stapled entities) may be entitled to the deduction. [Schedule 3, item 2, subsection 139DSI(1)]

3.29 The amount of the deduction must be worked out under subsection 139DC(2) in respect of the stapled security, and must be apportioned between the taxpayers on a reasonable basis. One reasonable basis would be to have regard to the portion of the value of the stapled security that each taxpayer provided. [Schedule 3, item 2, subsection 139DSI(2)]

Example 3.6

An employee of a company is issued a stapled security which consists of an ordinary share in their employer valued at $1, and a unit in a trust valued at $4. In working out the deduction available to each taxpayer (ie, the stapled entities), it would be reasonable for the company to receive a deduction of $1, and for the trust to receive a deduction of $4, on the basis that this is the portion that each taxpayer provided.

What happens if the conditions are not met?

3.30 A stapled security or right to acquire a stapled security that is not qualifying (and thus cannot access the ESS concessions), will get the same treatment that it would previously have received. The securities in the stapled security and rights to acquire the stapled security will be treated separately either under Division 13A (eg, shares) or FBT (eg, units in a unit trust, rights to acquire non-qualifying stapled securities). [Schedule 3, item 2, subsection 139DSD(2)]

3.31 This is achieved by excluding an amount from assessable income, rather than excluding the stapled securities from Division 13A, to avoid a circular definition - that a stapled security is only acquired under an ESS if it is qualifying, and to be qualifying, it must be acquired under an ESS. [Schedule 3, item 2, section 139DSC ]

Example 3.7

Assume an employee of a company is issued a stapled security which consists of an ordinary share in the company which is stapled to a unit in a trust. The ESS is offered to 50 per cent of the employees of the company. As less than 75 per cent of the employees of the company are entitled to participate in the ESS, the security is not a qualifying stapled security. The ordinary share component of the security will be subject to Division 13A. The unit component of the security will be subject to FBT.

Taxing points for tax deferred stapled securities or rights

3.32 A taxing point for tax deferred stapled securities or rights to acquire stapled securities will occur when any of the basic conditions for a stapled security or the qualifying conditions stop being met.

3.33 A cessation time for a stapled security or a right to acquire a stapled security is the time when:

•

one of the stapled entities which makes up the stapled security is no longer stapled to the other stapled entities [Schedule 3, item 2, paragraph 139DSH(a)] ; or

•

the stapled security is no longer listed for quotation as a stapled security on the official list of the Australian Securities Exchange [Schedule 3, item 2, paragraph 139DSH(b)] ,

if that time is earlier than the cessation times outlined in section 139CA for a stapled security, or for a right to acquire a stapled security - the cessation times outlined in section 139CB [Schedule 3, item 2, paragraphs 139DSH(c) and (d)] .

3.34 A cessation time will usually not occur where a stapled security is subject to a trading halt or suspension. In such instances, the stapled security will still be considered to be listed for quotation on the official list of the Australian Securities Exchange.

3.35 Where a cessation time occurs because of a restructure, the restructure relief provisions in Subdivision DA of Division 13A may apply (see paragraph 3.38).

3.36 Some references to 'a company' or 'the company' are replaced with references to 'an employer' or 'the employer' to allow the correct operation of Subdivision DB as it applies to Division 13A. [Schedule 3, items 3 to 5, subsections 139GB(1) and (2)]

3.37 The definition of 'cessation time' is amended to refer to these additional cessation times in relation to a stapled security or right to acquire a stapled security. [Schedule 3, item 34, definition of ' cessation time' in subsection 995-1(1)]

Relief for restructures and 100 per cent takeovers

3.38 The existing restructure relief in Subdivision DA of Division 13A can apply to stapled securities and rights to acquire stapled securities. It can apply to the replacement of:

•

a share with a stapled security;

•

a stapled security with a different stapled security; and

•

a stapled security with a share.

3.39 Whether an asset is a share or a stapled security is not relevant in determining whether it is matching. The number of components in a stapled security is not relevant in determining whether it is matching.

Definitions

3.40 The index of definitions in Division 13A is updated to reflect the inclusion of definitions of 'stapled entity' and 'stapled security'. [Schedule 3, item 7, section 139GH ]

Application and transitional provisions

3.41 These amendments will apply retrospectively to acquisitions of stapled securities, and rights to acquire stapled securities, on or after 1 July 2006. These amendments were announced on 9 May 2006 as part of the 2006-07 Budget and are beneficial to taxpayers. Acquisition has the same meaning as given in Division 13A. [Schedule 3, item 39 ]

Consequential amendments

3.42 Several consequential amendments are made to various other taxation laws in order to allow a stapled security or a right to acquire a stapled security to be broadly treated the same as a qualifying share or a qualifying right.

CGT treatment of ESS stapled securities

3.43 Division 13A treats a stapled security as though it is a single share. However the CGT provisions treat each CGT asset separately and a stapled security is made up of two or more CGT assets. Therefore, it is necessary to modify the way that the CGT provisions apply to a stapled security acquired under an ESS, or that is a replacement under the restructure relief. [Schedule 3, item 21, subsection 130-97(1)]

3.44 Any relevant CGT provisions that refer to ESS shares and rights apply to each asset in a stapled security, and rights to acquire stapled securities, as though those assets are acquired under an ESS and are qualifying shares and rights. [Schedule 3, item 21, subsection 130-97(2)]

3.45 Any relevant CGT provisions that refer to an election being made under section 139E (an election to be taxed upfront on a qualifying share or right) apply as though the election was made in relation to each asset that makes up the stapled security. [Schedule 3, item 21, subsection 130-97(3)]

3.46 Any relevant CGT provisions that refer to a cessation time apply to each asset in a stapled security as though the cessation time for the stapled security was a cessation time for each asset. [Schedule 3, item 21, subsection 130-97(4)]

3.47 Any relevant CGT provisions that refer to the market value of an ESS share that apply to a component of a stapled security are a reference to the amount of the market value of the stapled security that are reasonably attributable to the component. [Schedule 3, item 21, subsections 130-97(5) and (6)]

CGT trust relief

3.48 A capital gain or loss that is made when a beneficiary becomes absolutely entitled to a stapled security, or right to acquire a stapled security, that has been held in a employee share trust can be disregarded if it meets the existing conditions in section 130-90. This can also apply to stapled securities that are replacements under the restructure relief provisions in Subdivision DA. [Schedule 3, item 20, subsections 130-90(6) and (7)]

Goods and services tax

3.49 Imported services used to make input taxed supplies are generally subject to a goods and services tax (GST) reverse charge under Division 84 of the GST Act. A reverse charge means that the Australian recipient of the supply, rather than the overseas supplier, is liable for the GST on the imported service. However, under section 84-14 of the GST Act the reverse charge does not apply to the supply of an ESS:

•

if it is subject to Division 13A of the ITAA 1936; and

•

it is made by an overseas enterprise to an Australian branch or by an overseas entity to a subsidiary of the entity.

3.50 Consistent with the intention of extending ESS concessions to certain stapled securities, amendments are made to the reverse charge provisions to also exclude ESS under which qualifying stapled securities and rights to acquire qualifying stapled securities are issued. [Schedule 3, items 8 and 9, paragraphs 84-14(a) and (b) of the GST Act ]

3.51 An amendment is also made to the definition of an employee share scheme to clarify that it includes stapled securities and rights to such securities included by these amendments. [Schedule 3, item 10, definition of ' employee share scheme', section 195-1 of the GST Act ]

Fringe benefits tax

3.52 A stapled security or right to acquire a stapled security that has a discount included in assessable income or can access the concessions under Division 13A is excluded from the definition of 'fringe benefit'. [Schedule 3, item 12, subsection 136(1 ), paragraph (haa) of the definition of ' fringe benefit' of the GST Act ]

3.53 An amendment is made to the existing exemption for ESS shares and rights to clarify that a right is a right to acquire a share. [Schedule 3, item 11, subsection 136(1 ), paragraph (ha) of the definition of ' fringe benefit' of the GST Act ]

3.54 The acquisition by a trust of money or other property is excluded from the definition of fringe benefit where the sole activities of the trust are obtaining stapled securities or rights that are treated as qualifying shares or qualifying rights, where those shares or rights are provided to:

•

employees of a stapled entity that is part of the stapled security, or to associates of those employees [Schedule 3, item 13, subsection 136(1 ), subparagraph (hc)(i) of the definition of ' fringe benefit' of the GST Act ];

•

persons who are engaged in foreign service for a stapled entity that is part of the stapled security, or associates of those persons [Schedule 3, item 13, subsection 136(1 ), subparagraph (hc)(ii) of the definition of ' fringe benefit' of the GST Act ]; or

•

if the stapled entities, taken together as one notional company, is a holding company of another company, then to the employees or associates of employees of that other company [Schedule 3, item 13, subsection 136(1 ), subparagraph (hc)(iii) of the definition of ' fringe benefit' of the GST Act ]; or

•

if the stapled entities, taken together as one notional company, is a holding company of another company, then to persons who are engaged in foreign service for that company, or associates of those persons [Schedule 3, item 13, subsection 136(1 ), subparagraph (hc)(iv) of the definition of ' fringe benefit' of the GST Act ].

Deemed dividend provisions

3.55 A loan to a shareholder or an associate of a shareholder of a private company, that is solely for the purpose of acquiring a stapled security or right to acquire a stapled security that is treated as a qualifying share or a qualifying right, is not taken to be a dividend. [Schedule 3, item 15, subsection 109NB(1)]

3.56 An amendment is made to the relevant simplified outline to reflect this change. [Schedule 3, item 14, section 109H ]

Foreign investment fund losses

3.57 A new subsection is inserted to ensure that provisions relating to the reduction of foreign investment fund income because of ESS shares or rights, also apply in relation to a stapled security or right to acquire a stapled security that is treated as a qualifying share or qualifying right within Division 13A, the same way as they apply to a share or right. [Schedule 3, item 16, subsection 530A(3)]

3.58 Related to paragraph 3.57, the cessation time for a stapled security or right to acquire a stapled security are the cessation times listed for stapled securities or rights to acquire stapled securities in Division 13A. [Schedule 3, item 16, subsection 530A(4)]

Discount capital gains

3.59 An amendment is made to ensure that a replacement CGT asset (a component of a stapled security or a share) is treated for the purposes of item 8 in the table in subsection 115-30(1), as if it were a continuation of each CGT asset that was, or was a part of, the original asset. [Schedule 3, items 17 and 18, subsections 115-30(1A) and (1B)]

3.60 This ensures that for the purposes of the 50 per cent CGT discount (which requires an asset to be held for 12 months before the concession can be accessed), a CGT asset that forms part of a stapled security that is treated as a continuation of an old CGT asset, is treated as having been acquired at the time a beneficial interest in the old CGT asset was first acquired. [Schedule 3, items 17 and 18, subsections 115-30(1A) and (1B)]

CGT demerger relief

3.61 There is a requirement in the CGT demerger relief provisions that the same percentage interests be owned before and after the demerger. There is a limited exception for ESS holdings. This exemption is extended to ownership interests in a trust if the ownership interest forms part of a stapled security that is treated as a qualifying share. [Schedule 3, item 19, paragraph 125-75(3)(a)]

Franked distributions

3.62 For the purposes of the franking provisions, a share in a company that is acquired as part of a stapled security that is treated as a qualifying share satisfies the definition of an 'eligible employee share scheme'. [Schedule 3, items 22 and 23, section 208-215 ]

Consolidation

3.63 The special rule in the consolidation regime (which applies to ignore certain employee shares) is changed to ensure an entity can be part of a consolidatable group if it is only the presence of an ESS membership interest in an ESS entity that is preventing it from being part of that group. Without this rule, it is likely that the benefits of being in a consolidated group will be denied to an entity whose equity is effectively wholly-owned by a head company of a consolidatable group. [Schedule 3, item 24, section 703-35 ]

3.64 An ESS membership interest in an ESS entity can include a stapled entity provided the stapled security is treated as a qualifying share. [Schedule 3, item 26, subsection 703-35(7)]

3.65 A reference to 'the company' is replaced with a reference to 'a company' to allow the correct operation of these provisions. [Schedule 3, item 25, subsection 703-35(5)]

3.66 For the purposes of the multiple entry consolidated group provisions, in determining whether an entity is a wholly-owned subsidiary, certain employee shares (including stapled securities) are allowed to be held in a company without affecting the wholly-owned status of the company. [Schedule 3, item 28, subsection 719-30(2)]

3.67 A membership interest in an ESS entity can be part of a stapled security provided it is treated as a qualifying share. [Schedule 3, item 29, subsection 719-30(5)]

3.68 A reference to 'shares in a company' is replaced with a reference to 'membership interests in an entity' to allow the correct operation of these provisions. [Schedule 3, item 27, subsection 719-30(1)]

International ESS

3.69 A number of changes are made to note the CGT changes arising from these provisions. [Schedule 3, items 30 to 33 ]

Non-cash benefits

3.70 The TAA 1953 requires providers of non-cash benefits to pay an amount to the Commissioner of Taxation if the payment would have been subject to withholding if it had been cash. There are exceptions to this for certain benefits, including ESS shares and rights. The exceptions are extended to cover stapled securities and rights to acquire stapled securities. [Schedule 3, item 37, subsection 14-5(3)]

3.71 A new paragraph is inserted to ensure that an employer is not subject to withholding on the provision of a benefit that constitutes the acquisition by an employee of a stapled security or right to acquire a stapled security that is treated as a qualifying share or qualifying right. [Schedule 3, item 38, paragraph 14-5(3)(e)]