ATO draft Tax Determination 2021/D5
Are your share plan rule disposal restrictions ‘genuine’?
The Australian Taxation Office recently released draft Tax Determination 2021/D5 regarding how the ATO proposes it will interpret ‘disposal restrictions’ placed on securities issued under employee share schemes/incentive plans (ESS Interests) for the purpose of compliance with the tax deferral provisions of Division 83A of the Income Tax Assessment Act 1997 (Cth).
What is the current lay of the land?
Essentially, current ATO guidance is that ‘genuineness’ with respect to disposal restrictions has focussed on discerning whether a participant practically has the ability to trade their ESS Interest by being able to easily manipulate a disposal restriction (eg by simply having to request a routine Board approval).
In light of this guidance and so as not to tie the Board’s hands unnecessarily, many plan rules provide the Board with fairly wide discretion and advisers have cautioned about Boards not lifting such restrictions as a matter of course.
What is changing?
As is usual, just as one area of tax law is fixed (cessation of employment ceasing to be a taxing point) another becomes more complicated. This time it is the ATO, clearly without enough to do now that JobKeeper payments are gone, expanding the scope of what the ATO will consider when assessing the ‘genuineness’ of a disposal restriction. In particular:
1. Need for objective criteria: If plan documentation gives the Board a broad discretion to lift a disposal restriction early without setting out objective criteria for when the Board will consider doing this, then the draft TD indicates that the ATO may consider this broad discretion in itself as an indication that the restriction is not ‘genuine’.
While one would have thought that the past practice of looking to when and how often a Board in fact lifted a disposal restriction early, (eg whether it was in fact in exceptional circumstances such severe financial hardship) would be enough, the ATO would now like ‘clear, fixed and objectively measured criteria to be applied by the Board’.
2. No nominee transfers while restricted: If a participant is able to transfer ESS Interests to a nominee while a disposal restriction otherwise applies, the draft TD states that the ATO may consider this ability as an indication that the restrictions are not ‘genuine’. This applies even if such a transfer is limited only to a related person/controlled entity of the participant.
Our reading of the draft TD is that this is separate to the participant directing the company to either grant the ESS Interest to a nominee (and then have it restricted) or to deliver Shares to a nominee on vesting/exercise of Options/Rights.
What are the implications?
Again most helpfully, the ATO draft TD is proposed to apply in interpreting the tax treatment of both new and previously granted ESS Interests. If the draft TD was finalised in its current form, this would mean that some companies may have been operating employee share schemes that may not have a genuine restriction using the ATO’s ‘new’ eyes.
The implication of this is the risk that tax may be determined to have attached to a participant’s ESS Interests at an earlier ‘taxing point’ (and at a different tax value) as the restriction which applied was not genuine. In some cases this may be quite a windfall for executives as if the determination that there was not a genuine restriction dates back to a point where the share price was much lower, the ATO may actually owe executives a refund of tax paid!
The draft TD does indicate that the ATO’s assessment is intended to holistically consider a company and participant’s specific circumstances in determining ‘genuineness’ of a disposal restriction, such that one indicator by itself shouldn’t cause a finding of ‘not genuine’.
What do you need to do?
Nothing – for now. The draft Tax Determination is still not final.
However, we suggest that you:
1. Review your company’s plan documentation (including invitations) as to whether they need amendment to better fit within the ATO’s view of genuine restrictions.
2. Consider where your Board has approved early release of disposal restrictions in the past and consider whether it might be helpful to develop a policy about when it will consider lifting restrictions early (noting the ATO would like the policy to include ‘clear, fixed and objectively measured criteria to be applied by the Board’).
3. Consider whether your plan rules allow, or allow the Board to approve, participants transferring their ESS Interests to related persons/controlled entities during periods when a disposal restriction is in place. If so, you may wish to amend those provisions.
As always, please reach out if you would like to discuss the implications of this change for your company’s employee share schemes/incentive plans.