The Australian High Court case of Blank v Commissioner of Taxation  HCA 42 considered the nature of a termination payment received by an employee from a series of incentive schemes.
The taxpayer was employed by the Glencore group of companies. He was party to various employee profit participation schemes. In particular, he entered into a Profit Participation Agreement (PPA 1999) which provided him with a right to the company’s profits in the form of a “Genussscheine” (GS) (or profit sharing certificate) as well as a contractual claim. The GS provided the taxpayer with a claim to a portion of the company’s profits upon the restitution of the GS to the company and not upon the issue of the GS to the employee. Under a related agreement, the taxpayer also subscribed for shares in the holding company of the group.
In 2005, the taxpayer entered into an Incentive Profit Participation Agreement (IPPA 2005) which terminated and replaced all prior profit participation agreements including the PPA 1999. The IPPA 2005 granted the taxpayer “deferred compensation” based on the group’s results and this was payable upon termination of employment. Under the new plan, the taxpayer no longer had an interest in the GS previously issued but the GS would still be used to calculate the “deferred compensation” payable.
The taxpayer resigned after entering into the IPPA 2005 and he became entitled to receive some US$160m (Amount) payable in instalments. The taxpayer contended that the Amount was the proceeds of the exploitation of interconnected rights that conferred on him a right to receive a portion of the company’s profits in the future and therefore was assessable as a capital gain.
The High Court held that the Amount was clearly deferred compensation in consideration of the taxpayer’s services under the terms of the IPPA 2005. The intention of the IPPA 2005 was that the company’s profits were to be distributed as deferred compensation to employees and not as a return on the shares of the company. Additionally, the IPPA 2005 recorded that the taxpayer did not acquire any right in or title to any assets, funds or property of GI, Glencore AG or any other subsidiary.
In contrast, the High Court referred to a situation where an employee had been granted an option to purchase shares in the company. The grant of the option itself would be the reward for services and any gains arising from the subsequent exercise of the option would not be assessable as employment income.
The fact that the taxpayer’s entitlement in this case was to be calculated by reference to the profits of the company did not indicate that such an entitlement was like that of a shareholder. As such, the Amount was taxable as employment income.
This is an interesting case to explore in structuring employee incentive schemes. If the taxpayer’s entitlement had been consistently crafted as a share option instead of deferred compensation, it is likely that the tax point would have come in earlier at the time of grant or vesting when the assessable amount would possibly have been much lower. Obviously, a share option must have been regarded as not feasible or advantageous in this case. An opportunity that may have been lost is the structuring of the transition from the GS scheme to the IPPA scheme. We wonder if the possibility of articulating the consideration for the award under the IPPA scheme as the surrender of the already accrued rights under the GS scheme was considered. This could be instead of the grant of “deferred compensation”. The surrender of the accrued rights would possibly have the effect of characterising the reward under the IPPA scheme as capital in nature.