The ATO has stated that a dividend equivalent payment made under an employee share scheme (ESS) is assessable to an employee as remuneration when they receive the payment in respect of services they provide as an employee, or where the payment has a sufficient connection with the recipient's employment (Determination TD 2017/26).
The term "dividend equivalent payment" refers to a cash payment made by a trustee of a trust to an employee participant of an ESS (who is also a beneficiary of the trust), where the payment is funded from dividends (or income from other sources) on which the trustee has been assessed in previous income years because no beneficiary of the trust was presently entitled to the income. See below for an example taken from the determination.
A trustee that makes such a dividend equivalent payment is required to withhold an amount from the payment (even though the trustee is not an employer of the employee who receives the payment).
The ATO regards the following factors as indicative of a dividend equivalent payment being for, or in respect of, services as an employee:
- it is agreed that the payment is consideration for services rendered by the employee;
- the payment arises from a contract, an arrangement or a plan established by the employer to enable or facilitate the delivery of employment benefits (eg ESS interests) to the employee;
- the employer is able to make the payment;
- the payment is conditional on the employee meeting individual or specific employment-related targets;
- the payment depends on the employee's continued employment with the employer and is forfeited on cessation of employment; or
- the payment is provided at the discretion of the employer or trustee (based on the employer's direction or recommendations).
However, the determination offers a safe harbour from such payments being treated as remuneration where all of the following conditions apply:
- the trustee is not an associate of the employer;
- the payment is made because the employee is a beneficiary of the trust;
- the trustee exercises its power under the trust deed to make the payment, independent of any direction or wishes of the employer;
- the payment is not made in relation to:
- the employee's continued employment with the employer;
- the employee meeting individual employment-related targets; or
- termination, redundancy or retirement;
- the payment does not arise from a contractual agreement to which the employee and employer are party;
- the payment cannot be made by the employer, in lieu of the trustee making the payment; and
- the trustee was assessed on the dividends (or other trust income) that the payment is calculated on in the income year the dividends or other income were received.
A Co is an Australian resident company that carries on a business.
A Co establishes a trust for the purpose of providing shares (ESS interests) under an ESS to eligible Australian resident employees.
A Co makes a contribution to the trustee of the trust so the trustee can purchase and hold shares in A Co under the terms of the trust deed, plan handbook and invitation to the employees (together ESS agreement).
Under the terms of the ESS agreement an eligible employee is a beneficiary of the trust and has an interest in the trust that is a right to acquire the shares being held by the trustee. This interest does not entitle the employee to any income generated by the shares over the course of the ESS until such time as the employee satisfies certain conditions set by A Co that are specific to the employee's performance and their continuous employment with A Co being three years (performance conditions).
Upon satisfying the performance conditions the employee is entitled to own the shares held by the trustee of the trust. In addition, the employee is entitled to receive from the trustee an amount reflecting the dividends (post-tax) the employee would have earned had the employee owned the shares from the day the employee received their interest in the trust. The trustee funds this payment from trust capital. According to the ESS agreement, this payment can be made by the trustee or the employer.
As the dividend equivalent payment will be made to the employee because the employee has satisfied certain performance conditions, these payments are made to the employee for, or in respect of, services provided by the employee (they are, in substance, a reward for performance). They are assessable to the employee under s 6-5 of the Income Tax Assessment Act 1997. While the quantum of the payment reflects a dividend equivalent that may have been received had the employee acquired the shares at the outset of the arrangement, this is merely a calculation mechanism and does not reflect the character of the payment in the recipient's hands. The character of the payment in the employee's hands is remuneration.
Before TD 2017/26 was issued, it had been industry practice to treat the employee as not being assessable on a dividend equivalent payment, on the basis that the trustee had borne the tax under s 99A of the Income Tax Assessment Act 1936 (ITAA 1936). The ATO apparently considers that this practice was adopted on the basis of an inappropriate reliance on Class Ruling CR 2013/151. While noting that CR 2013/151 applied only to the entities specified in that ruling, the ATO has effectively conceded that TD 2017/26 constitutes a change in its view on the issue, and has allowed limited grandfathering in its application.
The determination applies to dividend equivalent payments paid under the terms and conditions attached to ESS interests granted on or after 1 January 2018. Where a taxpayer is granted an ESS interest before that date and the terms and conditions attached to the interest include eligibility to receive a dividend equivalent payment, the ATO's general administrative practice will be to treat such dividend equivalent payments as not assessable as ordinary or statutory income. This is conditional on the dividends or other income (that the dividend equivalent payment is calculated on) being assessed to the trustee under s 99A of ITAA 1936 in the income year when the dividends (or other income) were received.