On 8 June, the ATO released 3 documents in relation to trusts used in conjunction with employee remuneration and employee share schemes (ESS):
- TR 2017/D5: Income tax: employee remuneration trusts (an updated draft from TR 2014/D1)
- TD 2017/D2: Income tax: when will a dividend equivalent payment, made by a trustee under an employee share scheme that delivers ESS interest taxed under Subdivision 83A-B or 83A-C of the Income Tax Assessment Act 1997, be assessable as remuneration under section 6-5?
- Draft Practical Compliance Guideline PCG 2017/D9: Dividend equivalent payments made by a trustee under an employee share scheme.
TR 2017/D5 sets out the Commissioner’s view on the deductibility of contributions made to employee remuneration trusts. The draft ruling specifically excludes employee share trusts used to deliver ESS interests subject to Subdivisions 83A-B or 83A-C (which is the subject of a separate ATO consultation). This should mean that a lot of the uncertainty and angst caused by TR 2014/D1 for listed company’s share trusts should not be repeated..
The updated draft ruling has simplified much of the ATO’s prior views whilst maintaining the substance of the views previously expressed. The updated draft also includes more examples to explain the ATO’s views.
The key points from the draft ruling remain the same:
- A contribution to an employee remuneration trust will be deductible to an employer if:
- An irrevocable payment is made when the employer is carrying on a business
- The employer reasonably expects the contribution to benefit their business through improved employee performance; and
- The contribution is intended to be permanently dissipated in remunerating employee within a relatively short period of time (less than 5 years).
- The contribution may need to be spread over the performance period under the prepayment rules in sections 82KZMA and 82KZMD
- To the extent that the amounts from the trust are not salary and wages for employees, a fringe benefit may arise if particular employees and share of the benefit can be established at the time of the contribution
- Division 7A may have application for private companies – a contribution or loan to a trust that is already a shareholder may be a deemed dividend.
TD 2017/D2 and PCG 2017/D9
A dividend equivalent payment is a payment made by the trustee of an employee share trust at or after the time that shares have vested for an employee. The payment reflects the dividends paid on the shares during the vesting period. The trustee of the employee share trust will likely have held the shares during this period and have received the dividends on the shares. As no beneficiary was presently entitled to the dividend income during the vesting period, the trustee pays tax on those amounts at the trustee tax rate (49% to drop to 47% in 2018) (less franking credit offsets).
Industry practice has been that the employee is not assessable on the dividend equivalent payment on the basis that the trustee has borne the tax under section 99A (in accordance with section 99B). In this circumstance there is no tax leakage (when compared to dividends being paid on shares)and tax has been borne at the highest marginal tax rate on the dividends.
The issue of TD 2017/D2 documents the Commissioner’s view has now changed.
The ruling states that the amount will be assessable as ordinary income under section 6-5 on the basis that they have the character of ordinary income or are remuneration.
The examples in the TD make it clear that any entitlement of an employee under an employee share plan to the dividend income during the vesting period of shares held in an employee share trust will result in the amount being assessable.
The end result is that double tax will be paid on dividend equivalent payments that are paid on shares held through an employee share trust arrangement.
The Draft PCG is intended to provide a safe harbour for when a payment will not be connected with an employee’s employment. However, it is difficult to see circumstances in which the safe harbour will practically apply. In effect, the trustee of the trust must have a discretion to pay the amounts to employees independently of their employment status or performance.
The ‘sole activities test’ that is critical for employee share trusts to qualify for concessional FBT and CGT treatment has not been considered as part of the draft TD or PCG. This needs to be rectified, particularly as example 2 (flood relief payments and example 3 (payments to employees and ex-employees) may not fall within the activities permitted to be carried out by employee share trusts.
The change in view will apply prospectively to interests issued after 1 October 2017. Employers will need to ensure that they review their employee share trust arrangements prior to this date to consider the implications of double tax being paid on dividends.
Submissions are due by 6 July 2017 in relation to the draft documents.