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the reference to 'shares' includes a reference to stapled securities, as acquisition by employees of stapled securities in their employer are treated in the same way as acquisition of a share, provided that at least one of the ownership interests that are stapled is a share (see section 83A-335 of the Income Tax Assessment Act 1997^[1]), and

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the reference to 'employee' includes a reference to an individual covered by column 1 of the table in section 83A-325 (being the extended definition of employee for the purposes of Division 83A).

The context of the case law arising in respect of charitable institutions is significantly different to the context of the EST legislation. In considering whether a body is a 'charitable institution', the phrase 'merely incidental' has simply been used by the courts as a means of examining relevant objects of the body under consideration, as opposed to being a specific requirement in a relevant Act. Similarly, the courts in those cases are examining broad objects relating to a particular body, as opposed to links to specific, prescribed activities.

The Government's intent with ESTs was that they were designed to be little more than bare trusts, to just acquire, hold and pass on shares/ employee share scheme (ESS) interests to employees.

See also our response to Issue 8 of this Compendium.

However we have included additional explanation at paragraphs 32 to 40 of the final Determination to more clearly show the connection between the activities listed and the legal principles.

Paragraph 6 of the final Determination refers to 'actual activities', because the test in subsection 130-85(4) refers to the trust's 'sole activities'. So we must look to what the trustee actually does rather than what it could do under the trust documents.

However, 'merely incidental' is defined by reference to the two primary purposes outlined in paragraphs 130-85(4)(a) and (b):

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obtaining shares or rights in a company, and

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ensuring that ESS interests in the company are provided under the ESS to employees.

That is, any other activities of the trust must be merely incidental to these two activities. Paragraphs 12 and 13 of the final Determination provide examples of activities that the Commissioner considers would and would not be merely incidental to those two primary activities, regardless of the type of trust or the particular facts and circumstances.

Paragraph 11 of the final Determination notes that an activity will be merely incidental if it is a natural incident or consequence of the trust obtaining, holding and providing shares or rights under an ESS. It also makes it clear that an activity will not be merely incidental if it is undertaken for, or follows from, some other purpose.

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exercising voting rights

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participating in rights issues

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dealing with bonus shares

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the trustee becoming party to, and complying with any obligations imposed on it by, a shareholder's agreement of the company

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borrowing money - from the company group or elsewhere (and what expenses they can pay on such loans, for example, interest)

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purchasing derivatives - may be done to hedge against price increases without committing to the purchase of all the shares (allows them to manage price risk and capital going into the trust).

We have also clarified at paragraph 12 of the final Determination (see dot point 4) that borrowing money to purchase shares or rights in the employer company will be merely incidental, where no security is provided over trust assets and the interest payable is no more than arm's length commercial rates. Borrowing money for another purpose, where security is provided over the trust assets, or where the interest payable is more than arm's length commercial interest rates would not be merely incidental (see dot point 5 in paragraph 13 of the final Determination).

Where a derivative is a right to acquire a share in the employer company (for example, a physically settled call option), it will fall within paragraph 130-85(4)(a). Given the broad variety of types of derivatives that exist, it is not feasible to consider and provide public guidance on all forms a derivative may take.

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dealing with rights and bonus issues in respect of shares held

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default winding up beneficiaries

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payments of dividend equivalents before rights to shares/shares vest or shares become unrestricted.

Rights issues are discussed in our response to Issue 9 of this Compendium.

Footnote 16 of the final Determination notes that a trust's failure to satisfy the requirements of an employee share trust on the transfer of trust income and capital to a default beneficiary on the winding up of the trust would have no practical implications, since the trust will cease at that time.

Dividend equivalent payments are dealt with in dot point 6 in paragraph 12 and dot point 2 (together with footnote 15) in paragraph 13 of the final Determination. If the arrangement falls outside these parameters, it should be assessed against the general principles in paragraphs 9 to 11 of the final Determination and advice can be sought from the Commissioner if required.

Example 2 in TD 2017/26 mentions a dividend equivalent payment paid as a result of a broad discretion the trustee has in the trust deed. There is no mention in the example that the trust would not be an EST if it acted in that manner, so it gives the impression that such a clause is acceptable for an EST.

In Example 1 of the draft Determination, reference is made to an after-tax dividend equivalent payment for Megan, but no mention is made of the amount being assessable to her.

It would be helpful to clarify the interaction between the two Determinations and, in particular, the examples.

Similarly, the focus of Example 1 of the draft Determination is on the activities of the trust. It does not deal with the tax treatment of the payment in the hands of the employee. To avoid potential confusion, we have inserted a footnote in Example 1 of the final Determination to clarify that the payment is assessable income in Megan's hands, with a cross-reference to TD 2017/26.

The trustee should distribute the shares as quickly as possible. However, the Commissioner recognises that, in some circumstances, the trustee may be prevented from immediately distributing or disposing of shares under a demerger or other corporate actions. Whether the distribution or disposal of the shares will be considered merely incidental in those situations will depend on the facts and circumstances of the particular case, including the reasons why the trustee is unable to distribute the shares immediately, the expected timeframe for distribution/disposal and what may happen in relation to the share in the intervening period.

The action of the trustee in making a payment or transfer of trust income and capital to a default beneficiary on the winding up of the trust will breach the requirements of subsection 130-85(4). However it will have no practical implications, since the trust will cease at that time.

However, if the money forms part of the trust funds generally available to the trust, it is expected that the trustee uses those funds for activities that satisfy paragraphs 130-85(4)(a), (b) or (c) (for example, to purchase additional shares for the ESS, pay relevant expenses etc). It would not be a merely incidental activity for the trustee to distribute its funds to a charity. See paragraph 35 of the final Determination.

In our view, dividend waivers should be allowed on the following alternative bases:

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The agreement to waive a dividend is not an activity.

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If it is an activity, it is part of 'obtaining shares in a company.'

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If it is an activity, it is an activity that is merely incidental to those described in paragraphs 130-85(4)(a) and (b).

A trustee should not properly take all the benefits of share ownership for shares held in respect of an ESS. For example, the Australian Securities and Investment Commission requires that, if the trustee is the listed body or an associate of the body, 'the trustee does not, at its own discretion, exercise any voting rights attaching to any of the underlying eligible products that it holds on trust' (ASIC Class Order [CO 14/1000]).

Given the purpose of the EST acquiring and holding shares is to manage (and minimise) the cost of acquiring shares to satisfy ESS obligations, the receipt of dividends for unallocated shares is an unwanted side-effect and complication, potentially over-funding the trust. In disclaiming the dividends, the trustee is essentially seeking to ensure it more precisely meets its funding needs from time to time.

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allowing an EST to waive or relinquish dividend entitlements, and/or

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providing more tailored guidance regarding the application of Division 16K of the Income Tax Assessment Act 1936 (ITAA 1936) to an ESS buy-back.

The application of Division 16K of the ITAA 1936 is beyond the scope of this Determination.

We do not believe that the extent of sales of securities should impact the outcome. We believe it is consistent with the sole activity test that in certain circumstances, securities may be sold. If the securities are acquired by the EST to deliver to employees, any sale of securities is incidental to the activity of acquiring shares for employees.

It flows from this view that, where multiple ESS are administered by a single trust, if any of the trust's activities do not fall within paragraphs 130-85(4)(a), (b) or (c) then the trust will fail to meet the requirements of an EST for all ESS arrangements as the relevant trust (see paragraph 7 and Example 3 of the final Determination).

In addition, the word 'are' in the phrase 'whose sole activities are' is a reference to a point in time test. Any non-incidental activity should mean no more than the EST fails for that year only, and the trust should be able to again qualify as an EST in later years where its activities can be properly confined to sole activities or incidental activities for those following years.

The definition of an EST looks at the activities of the trust on an ongoing basis. The text of the legislation itself does not limit the examination of the trust's activities to a particular time or period. The limiting factor in the legislation is 'sole', and that prevents activities that happen in the past from being disregarded.

It would not be a sensible drafting style to include that the activities 'are and always were...', as such additional words would be superfluous in the context of the use of the word 'sole'.

The provisions have been drafted in a way that requires the trust to be restricting its activities to those described in subsection 130-85(4) on an ongoing basis, and to interpret the provision otherwise would be inconsistent with the context and purpose of the provision. See paragraph 14 of the final Determination.

As a practical matter, the Commissioner always considers the most effective and efficient use of the ATO's resources when assessing risks and determining where the ATO will apply compliance resources.

The Commissioner has outlined in Appendix 2 of the final Determination that compliance resources will not be applied to investigate whether activities a trustee may have undertaken prior to 1 January 2020 do not satisfy the requirements of subsection 130-85(4). See paragraphs 41 to 43 of the final Determination.

However, see the compliance approach in paragraphs 41 to 43 of the final Determination in relation to activities undertaken by a trustee prior to 1 January 2020.

Whether the ESS continues in the same trust or is transferred to a new trust is a decision for the relevant entities.

On a go-forward basis, for those pre-existing trusts the following could be required:

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an undertaking by the company/trustee to not apply provisions that permit not incidental activities. Of course, the not incidental activities will need to be clearly enumerated in the final Determination.

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an annual declaration in the trust tax return that the EST has met the sole activities test, together with a statement that - if any additional activities - those activities are incidental. Again, sole activities and incidental activities will need to be clearly set out in the final Determination.

If, on audit, the ATO finds that the undertaking was not complied with or a statement is found to be false, then the trust as an EST will be invalidated and penalties in accordance with the tax laws may be applied.

This one-off 'grandfathering' approach was applied by the ATO when dealing with 'novated' car lease arrangements in the 1990s. See Taxation Ruling TR 1999/15 Income tax and fringe benefits tax: taxation consequences of certain motor vehicle lease novation arrangements.

Of course, for trusts set up after 1 January 2020, the requirements set out in the final Determination should be followed, perhaps together with an annual declaration as set out at the second bullet point above.

As the compliance approach only applies to activities undertaken prior to 1 January 2020, it will not apply to trusts that come into existence on or after 1 January 2020.

The Commissioner will not require an undertaking or annual declaration in the trust tax return. It is considered that the administrative penalty regime in Schedule 1 to the Taxation Administration Act 1953 will apply appropriately if false or misleading statements are made to the Commissioner.

The taxpayer can rely on paragraph 6 of the final Determination, that they will not be disqualified from being an EST merely because of the existence of those clauses in the trust deed.

The ability to conduct a self-audit would be very difficult especially in circumstances where administrators have changed over the life of the ESS, given that companies will select administrators via tender processes.

The Commissioner should draw a line in the sand in respect of past activities which could have occurred due to a mistake or receiving a positive private ruling, and allow entities to seek private rulings on a forward-looking basis.