The ATO has released Draft Tax Determination TD 2021/D5, which addresses the operation of the deferred taxing point rules for employee share scheme (ESS) awards.

Under division 83A of the Income Tax Assessment Act 1997, taxation of share and rights grants that meet certain conditions can be deferred to the earliest of a list of taxing points. One of those taxing points is the removal of a genuine disposal restriction.

This tax ruling provides principles for determining if a scheme’s disposal restrictions were “genuine” and, assuming they were, when the participant is no longer genuinely restricted by the scheme for the purposes of determining the ESS deferred taxing point. The ruling does not consider the “real risk of forfeiture” test.

Timing of imposition of disposal restrictions

Disposal restrictions that were added or imposed by the exercise of a discretion after the employee acquired the ESS interest are not relevant to determining the ESS deferred taxing point occurs.

When is a disposal restriction a genuine restriction?

Restrictions imposed by the exercise of a discretion are only relevant if that discretion was exercised in a way that meant the employee was genuinely restricted from immediately disposing the ESS interest at the time they acquired it.

According to the ATO:

“To be genuine, a scheme’s disposal restrictions must be sufficiently identifiable (real and objectively demonstrable), certain and legally enforceable (not spurious or hypothetical). There must be serious and enforced consequences when a breach of a scheme’s disposal restriction occurs. Conversely, a disposal restriction is not genuine if it is open to manipulation such that it does not in a real, practical sense limit the disposal.”

More specifically:

A requirement to make an application to the employer or a company discretion to allow trade does not necessarily constitute genuine disposal restrictions given that discretion often allows lifting of restrictions based on a variety of subjective considerations. According to the ATO, if a board routinely approves requests to trade, this discretionary power is not a genuine disposal restriction. On the other hand, if there are clear, fixed and objectively measured criteria to be applied by the board the restriction may be a genuine disposal restriction. A disposal restriction will still be considered a genuine disposal restriction if it is able to be lifted in exceptional and extraordinary circumstances, for example, severe financial hardship.

Company bureaucracy not a protection from taxation

A requirement to undergo a process (e.g., complete an application form) is not regarded as a restriction on disposing of the interest immediately.

Windows to trade however brief mean taxation

Regarding trading windows and possession of price sensitive information, the scheme’s rules may prevent an employee from disposing of an ESS interest when they possess price sensitive information, but the employee must have or be able to obtain objective evidence that reasonably shows how the information held prevented the employee from immediately disposing of the ESS interest and show that the employee held that information at all ties when they were otherwise able to dispose of the interest. Holding a particular position within a company is not sufficient. Proof that the employee actually possessed information is necessary. If a trading window is briefly lifted then reimposed, the restriction ceases at the commencement for the first trading window (i.e., when lifted prior to being reimposed).

Disposal

To be a genuine disposal restriction, the scheme’s restriction must control or limit the power or right to (voluntarily or compulsorily) sell, transfer, assign, deal with, make over or part with the ESS interest (whether legally or beneficially).

If the employee is able to participate in a share buy-back, or to gift or transfer the ESS interest to a spouse or family trust, they are not genuinely restricted from immediately disposing of the ESS interest. This may get some into trouble, based on the advice they received in the past by some advisors.

The ATO provides examples to illustrate the ruling. Once the final determination is issued, the ATO proposes it apply retrospectively to all grants unless it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Determination.

The Draft Taxation Determination can be found in full HERE.

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