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21 Nov 1212 Employee share scheme: discount properly included in assessable income - Watsford

The AAT has affirmed the Commissioner’s decision to include in a taxpayer’s assessable income the discount from market value the taxpayer received in relation to the exercise of options he had received from a former employer under an employee share scheme (ESS).

On commencing employment with his employer, the taxpayer was granted 3,000,000 options in three tranches. The first tranche was exercisable in November 2006, the second after 1 May 2007 and the third after 1 November 2007. His employment with the employer was terminated on 27 April 2007. Although the first tranche of options had become exercisable by that date, the taxpayer had not applied to exercise the options.

Under the terms and conditions of the issue of those options to the taxpayer, the agreement between the employer and the taxpayer was that they would expire on the date he ceased to be an employee of the employer. However, the term dealing with the expiry date of the options also provided that the directors of the employer could determine an expiry date which was after the date on which his employment was terminated.

After extensive negotiations following the taxpayer’s dispute with the employer regarding the termination of his employment, during which the exercise of the existing options was discussed, the parties entered into a Deed of Release on 12 October 2007, the terms of which permitted the taxpayer to exercise 1,000,000 of the options within five days of the employer receiving full payment for those options and a further 1,000,000 options before 30 November 2007. The AAT found that the deed clearly extended the expiry date of the existing 2006 options. The employer did not issue new options outside the ESS to the taxpayer.

Despite that, the taxpayer did not disclose in his 2007 income tax return as assessable income the discount from market value of the shares he acquired on the exercise of those options. The AAT found that he was required to do so as the cessation time in respect of those options occurred when the taxpayer’s employment with the employer terminated. That occurred in the 2007 income year. Therefore, the AAT found that the Commissioner correctly amended the taxpayer’s assessment for that income year to include additional taxable income of $525,600.

The Commissioner also assessed the taxpayer for an administrative penalty for failure to take reasonable care which resulted in a tax shortfall. The AAT found that the taxpayer failed to take reasonable care and therefore he was correctly assessed for an administrative penalty. There were no grounds for remitting that penalty.

Re Watsford and FCT [2012] AATA 815 (Egon Fice, Senior Member, 20 November 2012).

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