The Commissioner of Taxation has released a draft taxation determination TD 2021/D5 which contains the Australian Taxation Office’s (ATO) view of when shares contain genuine disposal restrictions.

Genuine disposal restrictions are an important factor in determining the deferred taxing point of an employee share scheme and therefore may have significant taxation implications for employees benefiting under employee share schemes.

The legislative requirements

In order for a genuine disposal restriction to result in further deferral of the taxing point, the following legislative conditions must be met:Disposal restrictions that were imposed by the exercise of a discretion after grant are not relevant unless those restrictions genuinely restricted you from immediately disposing of your ESS interest at the time you acquired it.

  1. The restriction must be in place at the time of acquiring the ESS interest. Disposal restrictions that were imposed by the exercise of discretion after the grant are not relevant unless those restrictions genuinely restricted you from immediately disposing of your ESS interest at the time you acquired it.
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  2. The disposal restriction must be “genuine”.
    In TD 2021/D5, the Commissioner goes on to state that it must be:
    • Sufficiently identifiable (real and objectively demonstrable);
    • Certain (i.e. not contingent)
    • Legally enforceable
    • Must have serious and enforced consequences when a breach of a scheme’s disposal restriction occurs.
  3. They must apply ‘immediately’ that is, not be imposed at some future date.
     
  4. The restrictions must prevent or prohibit you from disposing of your interest. The rules must control or limit your power or right to (voluntarily or compulsorily) sell, transfer, assign, deal with, make over or part with your ESS interest.

What does this mean for me?The requirement to obtain approval of the board will not amount to a genuine disposal restriction

The Commissioner provides a number of examples, which are common, in which the ATO will consider that no genuine disposal restrictions will apply.

I need to complete an application to the Board to dispose of my shares

In the Commissioner’s view, the mere requirement to obtain approval of the board will not amount to a genuine disposal restriction as this is a subjective requirement, unless the Board has clear, fixed and objectively measured criteria that it must judge the request against.

As such, if there was a vesting period (e.g. three years) and after that date only board approval was required to sell the shares, it is unlikely, in the Commissioner’s view, that the deferred taxing point will extend beyond that three year vesting period.

Similarly, if the board or administrator approval is routinely exercised or otherwise controlled by an affected employee, in the view of the Commissioner, the disposal restriction is illusory. Employee Shares and disposal restrictions

This will not result in a further deferral of taxation and the meeting of any vesting criteria will likely give rise to the taxing point.

However, a genuine disposal restriction that is lifted in exceptional and extraordinary circumstances (e.g. severe financial hardship) will be considered to be genuine.

Do blackout periods/holding locks impact the deferred taxing point?

Provided that there are serious consequences of purporting to dispose of ESS interests during blackout periods (e.g. forfeiture of the shares), a blackout period would likely extend the deferred taxing point.ASX holding locks (within the meaning of the ASX listing rules) will also be considered to be a genuine disposal restriction.

The example provided by the Commissioner is where an employee holds price-sensitive information in the lead-up to the release of the Annual Report of that company, and the company’s internal share trading policy prohibits trading in company shares.

In this example, the shares are administered by a third party who manage the employee’s disposals which effectively places a holding lock on the ability of the employee to dispose of those shares.

ASX holding locks (within the meaning of the ASX listing rules) will also be considered to be a genuine disposal restriction.

My shares are not transferrable, although I can transfer them to a related party?Are your disposal restrictions genuine?

Whilst the Commissioner does not provide a specific example on this, it is stated that the ability to participate in a share buy-back or to gift or transfer your ESS interests to your spouse or family trust means that you are not immediately restricted from disposing of your ESS interests at that point in time.

What implications are not specifically covered?

The Commissioner does not specifically cover in any examples when genuine disposal restrictions are applicable to the grant of options.One way for deferred taxation to be achieved is upon the issue of rights that are subject to genuine disposal restrictions and to which the scheme states that deferred taxation will apply.

One way for deferred taxation to be achieved is upon the issue of rights that are subject to genuine disposal restrictions and to which the scheme states that deferred taxation will apply.

Most option plans, at least for ASX listed companies, are in respect of unlisted options where the options are not transferrable (which has been ordinarily considered to be a genuine disposal restriction).

However, if there are no vesting criteria such that the options are immediately exercisable and the shares saleable, it could be interpreted that this ability to exercise and sell will not result in a genuine disposal restriction (in the same way that seeking board discretion is not a genuine disposal restriction).

Similarly, taking an example in which there is a vesting condition that has been satisfied and the employee now has an exercisable option that is out of the money.

As such, the employee waits for the remainder of their exercise period to determine whether to exercise.The fact that the employee is able to exercise and dispose of the share could be interpreted as the lifting of any genuine disposal restrictions.

The fact that the employee is able to exercise and dispose of the share could be interpreted as the lifting of any genuine disposal restrictions.

This would seem to be contrary to the intention of the legislation as enacted in 2015 in which the explanatory memorandum specifically states that the bill make various amendments to: “alter one of the taxing points for ESS interests that are rights so that it applies not at the point at which a right can be exercised but at the point at which it is exercised (…)”. It is hoped the Commissioner will clarify this position in respect of options in the final Taxation Determination.

Should you have any concerns about the impact of the Commissioner’s draft interpretation on your employee share scheme plans, please contact your local RSM tax adviser to assist.