Employee remuneration trusts: what the Tax Commissioner thinks

It is, and has been, very common practice of listed and unlisted companies over many years to use a trust with their employee incentive arrangements. Listed companies, in particular, have used trusts with their employee share schemes for a range of reasons including administration, cash flow management, independence, tax deductibility, forfeiture and reapplication of shares, among others.


Others have used so-called employee remuneration trust (ERT) arrangements, particularly through the noughties, as a key component of their remuneration and incentive arrangements for employees. These arrangements were often promoted as being tax effective for both the employer and the employee, potentially providing capital gains rather than ordinary taxable income for the employee. And, at the same time, suggesting the employer’s contributions to the trust were tax deductible.


These latter arrangements were promoted by some accounting and “share scheme” firms, and sometimes supported by private rulings from the Australian taxation Office (ATO). Those earlier views of the Commissioner have now changed – do not expect ERT arrangements to deliver the outcomes that were promised in earlier days.


In March of 2014, the Commissioner of Taxation released a draft tax ruling on what he considered to be the tax implications when companies made contributions to employee remuneration trusts. The draft ruling was very long, complex and with some unexpected views on deductibility of the contribution and taxation of distributions and disposals.


The draft ruling caused quite some angst at the time because listed companies, and other companies, had been using employee share scheme trusts (ESS trusts) for many years, often with the approval of ATO private rulings. We did our best at the time to relieve some of that angst (see HERE).


The Commissioner sought consultation on the draft ruling and quickly heard from many about the concerns raised by the draft. Now, fast-forward more than three years to the Commissioner’s release of a revised draft ruling on the same issues, Draft Taxation Ruling TR 2017/D5. (Well, maybe just forward, rather than fast-forward).


The good news


The critical piece about this revised draft ruling is that the Commissioner has made it clear it does not apply to employee share schemes that are subject to Division 83A of the Income Tax Assessment Act 1997 (the ITAA). These are commonly referred to as the employee share scheme rules of the tax legislation. Listed companies, more than most, use the employee share scheme rules to provide employee share scheme interest to their employees. They also use trusts to manage and facilitate those structures. The Commissioner has confirmed these trust arrangements are outside the scope of this draft ruling.


What ESS trust arrangements does the draft ruling apply to?


The original and this draft ruling are targeted at employee benefits trust arrangements that have been promoted over the years as being effective in converting ordinary employment income into concessionally-taxed trust income and at the same time providing tax deductibility for the employer’s contribution to the trust.


These arrangements have been termed ERT arrangements (referring to employee remuneration trusts) by the Commissioner because they involve a trust being established to facilitate the provision of payments or benefits to employees of an employer.


Employers that have such arrangements or are considering them should be extra careful as a 74-page draft ruling is a warning the Commissioner is all over them. It is fair to say the ATO regard such arrangements as warranting close scrutiny.


So, what’s the ATO view?


There are a number of clarifying points.

  • An employer’s contribution to an employee remuneration trust should be deductible when:
    • the employer is carrying on business and makes an irrevocable payment of cash; and
    • the employer expects the contribution will have the effect of improving employee performance and thereby benefiting the business; and
    •  the contribution is intended to be permanently dissipated in remunerating employees within a reasonably short period of less than five years.
  • A contribution will not be deductible to the extent it secures a capital advantage for the employer. The draft ruling provides an example of a listed company getting a capital advantage when the contribution it makes to the trust forms the nucleus of a permanent investment fund to be held for employees.


Another example of concern for listed companies using ESS trusts is the ATO regarding a contribution to be of a capital nature to the extent it is applied in remunerating employees who are wholly engaged in affairs of capital of the business, like for instance working on a project to upgrade depreciating assets of the business.

  • The prepayment rules of the tax legislation may apply to apportion the deductibility of the contribution over the performance period.
  • The contribution may be a fringe benefit if the identity of each employee who will share in the benefit of the contribution is clear and known at the time the contribution is made.
  • If the arrangements are such that the contribution has the effect of being made at the instruction or direction of the employee, it will be assessable income of the employee at the time it is made.
  • A contribution made by a private company may be deemed to be a dividend under the deemed dividend rules in Division 7A of the ITAA. This means the contribution will not be deductible to the employer, and it will be assessable income of the employee.
  • If the employee remuneration trust makes a loan to an employee, the employer will be taken to have provided a taxable loan fringe benefit.

This latest draft ruling is a more simplified discussion of a range of complex issues. Employers contemplating the use of a trust in combination with their employee incentive arrangements are well advised to take care and seek specific advice, and not necessarily from those who have promoted these ERT arrangements.

The Commissioner has invited comments on the draft ruling. Closing date for submissions is 21 July 2017.

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