The Australian Taxation Office recently released Draft Taxation Ruling TR 2014/D1. The draft ruling explains the tax consequences for employers, trustees and employees who participate in an employee remuneration trust (ERT) arrangement.
Whilst quite a number of law and accounting firms have already provided their perspective on the draft ruling, we have tried to identify the key points relevant to deductibility of employer contributions and briefly discuss the implications from a remuneration perspective.
For employer contributions to an ERT to be deductible, the primary purpose of the contribution has to be applied “within a relatively short period” to the direct provision of remuneration of employees. Further, it must also be intended, with “great certainty”, that the contribution will be “substantially diminished” in providing the employee remuneration (Paragraphs 14 and 15).
The Commissioner will generally accept “a relatively short period” to be up to five years from the date of the contribution. This will be extended to seven years where the contribution is made pursuant to Division 83A employee share scheme arrangements (Paragraph 178).
Additional complexity is, however, introduced (as with most tax laws). The existence of an “absolute discretion in the trustee to pay remuneration” would count against the certainty of diminution. Further any shares acquired by the trustee using the contribution must not be “on-sold to third parties” at the time or “shortly thereafter” they are transferred to employees within the relatively short period (Paragraphs 179 and 182).
Whilst the five-year period above (or seven in the case of Division 83A arrangements) would appear to accommodate almost all current long term incentive (LTI) schemes, there is a risk that deductibility may be deferred or even denied for non-Division 83A LTI schemes with performance periods longer than five years.
Further, for options-based LTI schemes where an extended exercise period is in place once options vest, there is a similar risk where the combined vesting and exercise period exceeds five or seven years. In respect of Division 83A arrangements, it would be a strange outcome for deductibility to the employer to be deferred past seven years (or denied!) when employees are taxed at that time (the latest taxing point under the relevant provisions).
For an increasing number of LTI schemes with absolute discretion reserved for the trustee (in essence providing the Board with discretion not to vest LTI entitlements), there is the additional risk that deductibility may be in question. Finally, there is no guidance as to what “shortly thereafter” means in the context of the on-sale of shares by employees and how the Commissioner can make such an assessment at the time of the transfer of the shares to employees.