There has been a noticeable trend in recent Australian tax legislation to draft rules using notions like ‘rights’ and ‘obligations’ rather than ‘amounts’ earned or incurred. Obvious examples are the debt and equity rules and TOFA but there are others. The recent High Court judgment in Blank is a nice example of the kind of problems that this focus on rights and liabilities (rather than cash flows) can pose: in which cases is the assessable thing the right to something, and in which cases is the assessable thing the receipt which the right yields? And if the assessable thing is the right that was conferred, what is the treatment of the receipt when subsequently collected? Does the cash have the same character as the right which generated it, or is the cash now a different thing with its own character? And in a country with a tax on fringe benefits, will the right be liable to FBT or is it the cash, or both, or neither?
but in essence the question which the High Court faced was whether and how to tax Blank with regard to his involvement in various certificate-based profit participation plans which Glencore operated for its employees. Much of the complexity of the case arose because Blank had been employed by Glencore entities since 1991 while living and working overseas; he arrived in Australia in 2002 and worked here for 4 years leaving Glencore in 2006; he started receiving cash payments in 2008. If the thing which was assessable to him was the rights he was accumulating, and the rights were assessable while he was accumulating them, then 20 years’ worth of what he earned had nothing to do with Australia. If he entered Australia holding these rights and then sold them, presumably the amount collected would be gain from a sale rather than income from employment. On the other hand, if the assessable thing was the cash he collected, and the cash was assessable when he collected it, Australia now claims tax on everything.
People speak of share plans and ‘phantom plans’ as if those terms have a concrete and unambiguous meaning. The tax community accepts that under share plans the item of income is the share (or ‘ESS interest’) and, prima facie, it is derived at the time the interest is granted, unless the explicit deferral mechanism is triggered; under phantom plans the item of income is the cash and it is derived when the taxpayer receives cash; and an ‘indeterminate right’ can result in shares or cash (or both!) being delivered. But how is the distinction drawn? Or to put this another way, did Blank participate in a share plan or in a phantom plan? The relevant documents referred to him being granted a ‘Genusscheine and a contractual claim’ but that does not advance matters much for those of us unfamiliar with the Swiss Code of Obligations.
The judgment in the High Court confirmed the majority judgment in the Full Federal Court, namely, that Blank was assessable on the cash, not the rights, as ordinary income from employment, and because he was a resident when he received the cash, he was assessed on the entire amount. This outcome depends critically on the conclusion that the rights were not the income, just the cash.
The High Court based its conclusion largely on the text of the Plan and Swiss law. Because the documents referred to Blank as having a right to ‘deferred compensation’ and his involvement was ‘in consideration of the services to be rendered by’ Blank, the High Court took the view that this was just additional employment income albeit paid in a lump sum, as a result of ceasing (rather than performing) employment, and by an entity which wasn’t his employer.
Blank argued he entered Australia with rights akin to a shareholder but the Court said he had lacked rights a shareholder would be expected to have – no claim on the company’s assets, no rights to vote, no rights to call for or attend meetings, no right to examine the company’s books, no right to dividends or a return of capital (except as calculated under the incentive contract) and so on. The Court concluded, ‘any analogy with the rights of a shareholder’ was inapt.
Instead, the Court said what he had was, ‘an executory and conditional promise to pay an amount calculated by reference to [the company’s] profits …’ So be it, but why weren’t those rights the income or the fringe benefit? The High Court took the view that Blank did not actually hold any rights until the termination of his employment, and so whatever it was he held, it was ‘merely executory’ and not ‘vested nor accrued.’ This is the language of property law. Clearly Blank had been given something of value – after all, it would generate over $200m for him – but whatever that was, the High Court based its judgment on the view that it wasn’t yet quite enough to amount to ‘income.’ Blank’s rights did not have a sufficiently ‘proprietary nature.’
The point is subtle but the logic must be correct. The Court stated that to conclude otherwise would mean that ‘every employee would be rendered an accruals-based taxpayer taxable on their wages and salary before they received it.’ And, although this wasn’t discussed in the case, it would also mean that FBT would apply to the right to receive salary and wages even if the salary or wages when received would not be a fringe benefit – the ATO has been alive to this point for some time.