Edited version of private advice

Authorisation Number: 1052102074517

Date of advice: 29 March 2023

Ruling

Subject: CGT - shares

Question 1

Did the deferred taxing point in respect of the vested and unexercised Options under Grant B happen on the termination date?

Answer

Yes.

Question 2

Did the deferred taxing point in respect of the vested and unexercised Options under Grant A happen on the termination date?

Answer

No.

Question 3

Is the Taxpayer assessable in the residency income year in respect of the Options under Grant A that vested before the residency date?

Answer

No.

Question 4

Is the Taxpayer assessable in the residency income year in respect of the Options under Grant B?

Answer

Yes.

Question 5

Is the first element of the cost base of the Options under Grant A that vested before the residency date equal to their market value on that date?

Answer

Yes.

Question 6

Is the first element of the cost base of the Options under Grant B equal to their market value on the termination date?

Answer

Yes.

Question 7

Can the market value of the Options under Grant B be determined using the method outlined in Division 83A of the Income Tax Assessment Regulations 1997 (ITAR 1997)?

Answer

Yes.

Question 8

Can the market value of the Options under Grant A that vested before the termination date be determined using the method outlined in Division 83A of the ITAR 1997?

Answer

No.

Question 9

Did CGT event A1 happen due to the sale of the shares in the sale income year that had been acquired by exercise of the Options?

Answer

Yes.

This private ruling applies for the following periods:

20xx-xx income year

20xx-xx income year

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

The Taxpayer, (then an Australian resident) accepted a job offer some years ago to work as an employee overseas for a subsidiary of another company (the Company) that was incorporated overseas.

As part of the negotiated remuneration package, the Taxpayer was granted Stock Options to purchase ordinary shares (Common Stock) in the Company. The Plan was originally adopted by the subsidiary which became a wholly-owned subsidiary of the Company and the Company assumed the Plan.

The Taxpayer was granted two parcels of Options to acquire Common Stock in the Company pursuant to the Stock Option Agreement and Notice of Stock Option Grant.

At the time of the first grant of Options, the Taxpayer was an Australian resident.

The Options were granted at no cost to the Taxpayer. The Options had a market value of more than zero at the time of grant.

The details of the Options are as follows:

Table 1: Details of the Options

These Options would vest at the rate of 25% on the one year anniversary of employment, and an additional 1/48 of the total on each monthly anniversary thereafter over a four year period, subject to meeting the Continuous Service Status. Unvested Options will be forfeited on termination of employment with the Company or a group company.

Continuous Service Status means that the Taxpayer remains in continuous service with the Company or a group company through each vesting date. Continuous Service Status of an Employee or Consultant shall not be interrupted or terminated in the case of a change in status from an Employee to a Consultant or from a Consultant to an Employee.

The Options shall be exercisable during the term in accordance with the Vesting Schedule and with the relevant provision of the Plan (including any vesting requirements).

The Taxpayer did not own more than 5% of the shares in the Company if the Options were exercised to acquire shares in the Company at the time each parcel of the Options was granted.

Under the Plan rules and the Stock Option Agreements:

•         The Options may not be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner otherwise by will or by laws of descent or distribution.

•         The shares acquired by exercise of the Options may not be transferred to any person unless such transfer is approved by the Board prior to such transfer, which approval may be granted or withheld in the Board's sole and absolute discretion. Any stockholder seeking the approval of the Board of a Transfer of some or all of its shares shall give written notice to the Company.

•         Shares issued upon exercise of the Options prior to the date on which the Common Stock becomes a Listed Security shall be subject to a 'right of first refusal' in favour of the Company to which the Participant of the Plan will be required to offer shares to the Company before selling or transferring them to any third party. However, a transfer of the shares to the holder's immediate family or a trust for the benefit of the holder's immediate family shall be exempt from the provision of the 'right of first refusal'.

The Taxpayer was not aware of whether the Company's Board routinely approved requests to sell shares and whether there were fixed or objectively measured criteria applied by the Board for approval.

The Taxpayer was treated as an Australian resident for Australian tax purposes for the first income year and the income tax return was submitted on this basis as the Taxpayer intended for their relocation overseas to be temporary for about a year.

The Taxpayer continued working for the subsidiary overseas longer than initially anticipated. The Taxpayer became a non-resident of Australia from the start of the next income year. The Taxpayer's next two income tax returns were prepared on the basis that the Taxpayer was a non-resident of Australia.

The Taxpayer performed employment with the subsidiary after relocating overseas until the Taxpayer returned to Australia permanently on the residency date, at which time the Taxpayer re-assumed his Australian tax residency.

The Taxpayer's residency year income tax return was submitted as an Australian resident taxpayer from this date.

As at the date of the Taxpayer becoming an Australian resident on the residency date, the Taxpayer held certain vested Options in Grant A and Grant B. The Taxpayer also held some unvested Options in both Grants at that time.

The Taxpayer continued to perform some consultancy work from Australia as a Consultant for the subsidiary for the remainder of the residency income year. During this period the unvested Options continued to vest as per the Vesting Schedule until the Taxpayer ended this work for the subsidiary on the termination date. At the time the Taxpayer ceased to be a Consultant of the subsidiary, the Taxpayer held vested Options. All unvested Options were forfeited at that time.

The Company undertook a share buyback. The Taxpayer was permitted to exercise a small number of the vested Options and sell the shares under the share buybacks. The Taxpayer exercised some Options held under Grant A and Grant B and sold the total of the shares upon exercise in the share buyback, and exercised more Options held under Grant A and sold them shares upon exercise in second share buyback. Foreign withholding tax was deducted from the sale proceeds on the sale of the shares in the second share buyback.

In the sale year the Company's shares were listed on a foreign Stock Exchange. The Taxpayer exercised all of the vested Options to acquire shares during that income year. The Taxpayer immediately sold most shares upon exercise of the Options. The Taxpayer received the proceeds from the sale of the shares.

The Taxpayer currently holds the remaining shares.

The Company did not issue any Employee Share Statements to the Taxpayer in respect of Options granted to the Taxpayer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Division 83A

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Division 134

Income Tax Assessment Act 1997 Division 855

Reasons for decision

Question 1

Summary

The deferred taxing point in respect of the vested and unexercised Options under Grant B happened on the termination date.

Detailed reasoning

The Options issued to the Taxpayer under Grant B are ESS interests because they provided the Taxpayer with the right to acquire a beneficial interest in a share in a company (the Company).

The Options issued to the Taxpayer under Grant B were issued under an employee share scheme (ESS) because they relate to the Taxpayer's employment with a subsidiary of the Company.

Subdivision 83A-B of the Income Tax Assessment Act 1997 (ITAA 1997) about upfront taxation notionally applies to the Options issued to the Taxpayer under Grant B because they were issued to the Taxpayer at a discount to their market value (calculated as at the issue date).

Subdivision 83A-C of the ITAA 1997 about deferred taxation applies to the Options issued to the Taxpayer under Grant B (and Subdivision 83A-B does not) because:

•         Subdivision 83A-B would apply to the Options but for the deferral conditions being satisfied

•         There is still a discount on the Options after applying section 83A-315

•         Section 83A-33 (about startups) does not apply to the Options

•         The Taxpayer was employed by a subsidiary of the Company when the Options were issued

•         The Options provided the Taxpayer with the right to acquire ordinary shares in the Company

•         The Company is not a share trading or investment company

•         The Taxpayer does not hold a beneficial interest in more than 10% in the Company and could not cast or control the casting of more than 10% of the votes that might be cast at a general meeting of the Company, and

•         The vesting conditions attached to the Options put them at a real risk of forfeiture

Deferred taxing point

The deferred taxing point happened in relation to the vested but unexercised Options under Grant B on the termination date because this was the date that the first potential deferred taxing point happened being the end of the Taxpayer's employment with the subsidiary.

None of the other potential deferred taxing points had occurred by the termination date. Specifically:

•         There were continuing genuine selling restrictions preventing the sale of the Options held by the Taxpayer

•         The 15 year maximum deferral limit had not been reached for the Options, and

•         The Taxpayer had not exercised the Options.

Question 2

Summary

The deferred taxing point in respect of the vested and unexercised Options under Grant A did not happen on the termination date.

Detailed reasoning

The process for determining whether or not ESS interests granted between 1 July 20XX and 30 June 20XX qualify for deferral are reasonably similar to the mechanism that applies to ESS interests granted from 1 July 20XX.

The main difference is that the ownership threshold was set at 5% rather than 10% before 1 July 20XX.

Deferred taxation applies to the Options issued to the Taxpayer under Grant A because the relevant deferral conditions that applied at the issue date were satisfied.

Deferred taxing point

The deferred taxing point did not happen in relation to the vested but unexercised Options under Grant A on the termination date because that was not the date that the first potential deferred taxing point happened being the end of the Taxpayer's employment with the subsidiary.

An earlier potential deferred taxing point happened as each tranche of the Options issued to the Taxpayer under Grant A vested because from that time:

•         There ceased to be a real risk of the Taxpayer forfeiting the Options (other than by disposing of them, exercising them or letting them lapse)

•         The Taxpayer became able to exercise the Options

•         The shares to be acquired by exercising the Options were not at a real risk of forfeiture, and

•         The shares to be acquired by exercising the options were not subject to genuine selling restrictions.

These vested Options had already transitioned from remuneration assets to investment assets by the termination date.

Question 3

Summary

The Taxpayer is not assessable in the residency income year in respect of the Options under Grant A that vested before the residency date.

Detailed reasoning

The income tax consequences for ESS discounts are worked out as at the time they are assessable under Division 83A of the ITAA 1997. That is at the deferred taxing point for ESS interests issued under a deferral scheme.

ESS discounts are only included in the assessable income of foreign residents to the extent that they have an Australian source.

ESS discounts are considered to have a foreign source to the extent they relate to employment outside Australia.

Rights to acquire shares that are subject to vesting conditions are generally considered to be earned between the date they are granted and the vesting date.

The Taxpayer's situation

For the reasons outlined above, deferred taxation applies to the Options issued to the Taxpayer under Grant A because it is a deferral scheme and the deferred taxing point for the Options that vested before the residency date happened when they vested.

The Taxpayer was a foreign resident between 1 July 20XX and the residency date, so the ESS discounts are only included in the Taxpayer's assessable income to the extent they have an Australian source.

The grant date for the Options issued under Grant A was before 1 July 20XX. The Taxpayer worked for the subsidiary exclusively overseas for the whole of the period between the issue date and the residency date giving the Options a foreign source exclusively.

It does not matter that the Taxpayer was an Australian resident when the Options were issued under Grant A. The work was performed outside Australia.

Consequently, the Options issued under Grant A that vested before the residency date are foreign source income derived by a foreign resident and therefore not assessable in Australia.

The same outcome would also apply to ESS discounts in relation to Options issued under Grant A where the deferred taxing point happened in earlier income years.

Question 4

Summary

The Taxpayer is assessable in the residency income year in respect of the Options under Grant B.

Detailed reasoning

The income tax consequences for ESS discounts are worked out as at the time they are assessable under Division 83A of the ITAA 1997. That is at the deferred taxing point for ESS interests issued under a deferral scheme.

Australian residents are assessable on their ESS discounts from all sources whether in or out of Australia.

The Taxpayer's situation

For the reasons outlined above, the deferred taxing point for the Options issued under Grant B happened on the termination date.

The Taxpayer was an Australian resident on the termination date.

As an Australian resident, the Taxpayer is not entitled to exclude any ESS discount from assessable income on the basis that it has a foreign source.

Question 5

Summary

The first element of the cost base of the Options under Grant A that vested before the residency date is equal to their market value on that date.

Detailed reasoning

Generally, the first element of the cost base of a CGT asset is equal to the sum of the money paid or payable to acquire it and the market value of any property given or required to be given in respect of acquiring it.

There are a number of instances where the market value of the CGT asset as at the acquisition date is used as the first element instead of what was paid.

The market value of an ESS interest calculated as at the date of the taxing point (which may be at the issue date or the deferred taxing point) is generally used as the first element of their cost base.

The market value of a CGT asset calculated as at the date the owner becomes an Australian resident is generally used as the first element of the cost base if it is not taxable Australian property or acquired before 20 September 1985.

The market value substitution rule that occurs last is used if more than one may apply to a particular CGT asset.

The Taxpayer's situation

The deferred taxing point for each tranche of Options under Grant A that vested before the residency date is before that date. Each of those earlier dates would be potential acquisition dates for CGT purposes.

The residency date being the date the Taxpayer became a resident of Australia is also a potential acquisition date for CGT purposes.

The exception to using the date that the Taxpayer became an Australian resident as the acquisition date of the vested Options under Grant A that is related to deferral schemes under ESS does not apply because the deferred taxing point had already happened in respect of all of these Options.

The Taxpayer becoming an Australian resident is the later potential acquisition date in relation to the vested Options under Grant A so it is used as the basis for applying the market value substitution rule.

Question 6

Summary

The first element of the cost base of the Options under Grant B is equal to their market value on the termination date.

Detailed reasoning

Generally, the first element of the cost base of a CGT asset is equal to the sum of the money paid or payable to acquire it and the market value of any property given or required to be given in respect of acquiring it.

There are a number of instances where the market value of the CGT asset as at the acquisition date is used as the first element instead of what was paid.

The market value of an ESS interest calculated as at the date of the taxing point (which may be at the issue date or the deferred taxing point) is generally used as the first element of their cost base.

The market value of a CGT asset calculated as at the date the owner becomes an Australian resident is generally used as the first element of the cost base if it is not taxable Australian property or acquired before 20 September 1985.

The market value substitution rule that occurs last is used if more than one may apply to a particular CGT asset.

The Taxpayer's situation

The residency date being the date the Taxpayer became a resident of Australia is a potential acquisition date for CGT purposes.

The deferred taxing point for the Options issued under Grant B is the termination date for the reasons outlined above. This is another potential acquisition dates for CGT purposes.

The deferred taxing point is the later potential acquisition date in relation to the Options issued under Grant B so it is used as the basis for applying the market value substitution rule.

Question 7

Summary

The market value of the Options under Grant B can be determined using the method outlined in Division 83A of the Income Tax Assessment Regulations 1997 (ITAR 1997).

Detailed reasoning

There is a continuum when ESS interests transition from being remuneration assets subject to the ESS provisions to becoming investment assets that are subject to the CGT provisions.

One element of this continuum is that the same market value calculation mechanism is used for consistency. So, the market value of the ESS interest that is used to calculate any ESS discount becomes the first element of the cost base of that ESS interest as a CGT asset.

The mechanism that achieves this outcome for CGT purposes is at section 83A-125 of the ITAA 1997 and it uses the market value definition in section 83A-315.

Section 83A-315 of the ITAA 1997 authorises the making of Regulations to calculate the market value of ESS interests and directs that they be used if they exist. There are such Regulations in Division 83A of the ITAR 1997.

Question 8

Summary

The market value of the Options under Grant A that vested before the termination date cannot be determined using the method outlined in Division 83A of the ITAR 1997.

Detailed reasoning

The market valuation calculation mechanism contained in Division 83A of the ITAR is only authorised to be used by section 83A-315 for purposes associated with the operation of Division 83A about ESS.

Those purposes are limited to:

•         Direct calculations of amounts to be included in assessable income for ESS purposes

•         In calculating the amount paid for ESS interests that are subject to upfront taxation (under Subdivision 83A-B of the ITAA 1997) for all other purposes beside ESS, and

•         In calculating the amount paid for ESS interests that are subject to deferred taxation (under Subdivision 83A-C of the ITAA 1997, the acquisition date is also changed)

Calculating the market value of the Options due to the Taxpayer becoming an Australian resident is not a permitted use of Division 83A of the ITAR.

The ATO provides guidelines for calculating market value for tax purposes.

Question 9

Summary

CGT event A1 happened due to the sale of the shares in the sale income year that had been acquired by exercise of the Options.

Detailed reasoning

A taxpayer can make a capital gain or loss if and only if a CGT event happens. The gain or loss is made at the time of the event.

CGT event A1 happens if there is a disposal of a CGT asset. That means there is a change of ownership from that taxpayer to another entity.

A capital gain from CGT event A1 is the difference between the capital proceeds received due to the event happening and the cost base of the CGT asset. A capital loss is the difference between the reduced cost base and the capital proceeds.

The capital proceeds are the money or (market value of) property received due to the event happening under the general rule about capital proceeds.

The first element of the cost base and reduced cost base of a CGT asset acquired by exercising an option is the sum of the cost base or reduced cost base of the option and the amount paid to exercise it.

CGT event C2 happens when an option is exercised, but any capital gain or loss on the option due to the exercise is disregarded.

The share is acquired when the option is exercised. There must be at least 12 months between the exercise date and the time that CGT event A1 happened if any capital gain from the sale of the share is to be a discount capital gain. Only discount capital gains are eligible for the 50% CGT discount.

The Taxpayer's situation

In the sale income year, the Taxpayer exercised all of the Options then held and then immediately sold most of the Company's shares for the sale price.

CGT event A1 happened in the sale income year to the shares that were immediately sold. The Taxpayer will be able to choose which of the Company shares were sold as they are identical to those still held but there is some variance in their cost bases.

The capital proceeds are the amount received for the sale of these Company shares.

The first element of the cost base and reduced cost base of the Company's shares that were sold is the sum of the exercise price and the cost base and reduced cost base of the Options that were exercised.

It is not possible to aggregate Options that have different attributes, so separate calculations will be required in such instances.

Any capital gain or capital loss due to CGT event C2 happening on the exercise of the Options is disregarded.

Any capital gains that arise due to the sale of the Company's shares in the sale income year will not be discount capital gains because the shares were not held for at least 12 months by the Taxpayer before the sale happened.

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