Employee share schemes: The ATO denies deduction for recharge payments

3 April 2023

In a recent private binding ruling (PBR) (Authorisation Number: 1052071465515) the Australian Taxation Office (ATO) has concluded that a share based payment (SBP) recharge paid by an Australian subsidiary company (“Company A”) to its overseas parent Holding Company (“Holding Co”) was not deductible for Australian tax purposes. 

The recharge is related to the application of Division 83A of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) in relation to tax deferred employee share scheme (ESS) interests (in this case, restricted stock units (RSUs)) granted by Holding Co, to the employees of Company A. Broadly, the recharge was calculated by reference to Holding Co’s reported accounting expense in relation to the RSUs provided to Company A’s employees. 

Company A seemingly had limited involvement in the grant of awards – it did not request the grants, was not involved in determining vesting conditions and did not determine to which employees awards were granted. 

The decision

The ATO concluded that no deduction was available to Company A for the proposed recharge to be paid to Holding Co. The ATO’s reasoning largely related to the lack of nexus between the recharge and Company A’s business or production of assessable income. 

Specifically, the ATO concluded that the object of the recharge was to “retain the co-operation and goodwill of the global offshore parent… and to facilitate the payment of money by subsidiaries to the global offshore parent”.

Further, it was concluded that there was no readily apparent operational benefit to Company A’s business in making the recharge, and that the object of the recharge was not to remunerate employees. On this basis, the ATO concluded that the requirements for deductibility were not satisfied.

In addition, it was concluded that the recharge payment lacked the necessary association or connection with Company A’s business and therefore was not ‘in relation’ to Company A’s business for the purposes of the “black-hole” deduction provision (section 40-880). This section allows a Company to claim a deduction for certain business-related capital expenditure over five income years.

The key factors that the ATO considered were informative in reaching its conclusion were, broadly:

• whether or not the Australian entity itself was a party to the employee share scheme award agreements;
• whether the Australian entity has a liability to the employee to which the payment of the recharge amount relates;
• whether or not the Australian entity has the power to request the parent to provide awards to the Australian based employees, whether the Australian entity has the power to request which Australian employees can participate and whether the Australian entity can determine the conditions of the awards; and
• what would occur to the future issue of employee awards in the event that the intercompany recharge agreement was terminated, or the Australian entity did not pay the amounts owing under the intercompany recharge agreement.

Key takeaways

Our key takeaways follow:

• Whilst this PBR is binding only on the applicant taxpayer (and not on any other taxpayer), and noting the facts and circumstances of each case will often be determinative, the PBR provides us with some good insight into the factors the ATO now considers to be relevant when determining the deductibility (or not) of these recharges. 
• Critically, the PBR reiterates the importance of properly considering the tax deductibility of recharges and, given the ATO’s conclusions, it would be wise to consider in detail all current and proposed recharge arrangements.
• To support the continued deductibility of any current recharge arrangement, we recommend a review of agreements between Australian subsidiaries and their offshore group company that ultimately issues equity to employees of the Australian subsidiary; as well as review of the award agreement; to determine any risk of non-deductibility. 
• Where detailed consideration of the facts and circumstances provides that a recharge should be tax deductible, we recommend a review of the evidence available to support deductibility, including documentation on file.
• We note that the PBR is consistent with the ATO’s recent attention to the Australian tax deductibility of recharges paid (or credited) to offshore group companies that ultimately issue equity interests to employees of an Australian entity. 
• The nexus tests under the relevant tax law include only some of the considerations relevant to the tax deductibility of recharges. For example, broader corporate tax and transfer pricing considerations are critical and should not be forgotten.

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