It is not uncommon in new or small resources and start up technology companies to provide premium exercise price options to avoid an employee tax liability. Unfortunately this otherwise reasonable and sensible approach to conserve cash, and reward employees with the potential of still significant upside may backfire after a recent Australian Tax Office (ATO) determination.
In ATO ID 2012/68, the ATO has determined that a grant of premium priced options with a nil value under the employee share scheme tax regime set out in Division 83A of the Income Tax Assessment Act 1997 is nevertheless subject to fringe benefits tax (FBT). Employers who have made such grants need to be aware of their potential FBT liabilities as a result.
This result comes despite section 83A-5 stating that one of the two objectives of Division 83A is “to ensure that benefits provided to employees under employee share schemes are subject to income tax at the employees’ marginal rates under income tax law (instead of being subject to fringe benefits tax law)”.
Section 83A-10 defines an “employee share scheme” (ESS) as a scheme under which interests in a company are provided to employees (including past or prospective employees), or associates of employees, of the company or subsidiaries in relation to the their employment. There is no stipulation that an interest acquired under an employee share scheme can only be an ESS interest for the purposes of Division 83A if it has a positive value or has been acquired at a discount. However, the operative provisions contained in sub-divisions 83A-B – (immediate inclusion of discount in assessable income) – and 83A-C (deferred inclusion of gain in assessable income) only apply if ESS interests are acquired at a discount. The new provisions thus differ from those in the previous Division 13A, which specifically provided that a taxpayer does not acquire a share or right under an employee share scheme if the consideration for the acquisition is equal to, or more than, the market value of the share or right at the time that it is acquired (i.e. there is no discount – section 139C(3)).
The exclusion of ESS interests from FBT liability would seem to have even more validity in cases where the ESS interests have a nil value under the valuation methodology prescribed in the regulations.
Unfortunately, the ATO does not see it that way.
The ATO’s argument is that the exclusion of ESS interests from the definition of a fringe benefit contained in section 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) applies only to ESS interests that come within sub-divisions 83A-B or 83A-C, that apply where ESS interests are acquired at a discount. And the words of section 136, as amended when Division 83A replaced the previous Division 13A of the ITAA 1936 from 1 July 2009, support the ATO’s interpretation. But only if you ignore the clear legislative intent, as expressed in section 83A-5.
A solution may be at hand, however. Under the regulations, taxpayers have a choice as to whether they value grants of premium priced options as the market value of the right or the amount determined in the regulations to Division 83A. Electing to use the market value of the right should avoid any risk that FBT may be assessed, as ordinary notions of market value will always attribute some value, however small, to premium priced options. The disadvantage of this approach, of course, is that the very small value attributed to the premium priced options would have to be included in the taxpayer’s assessable income.
Our first reaction was that this situation was the result of an error in the drafting of the amendments supporting the 2009 replacement of the old Division 13A with the new Division 83A, but it turns out that a similar outcome may well have applied under the old provisions.
Section 136(1)(ha) of the Fringe Benefits Tax Assessment Act 1986 previously provided that a fringe benefit does not include a benefit constituted by the acquisition by a person of a share or a right to acquire a share under an ESS (within the meaning of Division 13A of Part III of the Income Tax Assessment Act 1936).
Under section 139C(3) of Division 13A, a taxpayer did not acquire a share or right under an ESS if the consideration for the acquisition is equal to or more than the market value of the share or right at the time it is acquired.
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