On Wednesday last week the ATO finalised Taxation Determination TD 2016/17, which provides the ATO’s view on what is an indeterminate right under the ESS provisions.

This follows the ATO’s defeat in the Federal Court last year in last year in Davies.


The employee share scheme (ESS) provisions provide a framework for taxing equity provided to employees on either an upfront, deferred or exempt basis.

A central concept is that of an “ESS interest”, which is:

  1. a beneficial interest in a share in the company; or
  2. a right to acquire a beneficial interest in a share in the company.

The time at which an ESS interest is granted to an employee is important to the operation of the ESS provisions. For example:

  • tax deferral is only available if the employee is actually employed at the time the ESS interest is granted (ie, no tax deferral for prospective employees); and
  • any forfeiture conditions or disposal restrictions which facilitate tax deferral must be in place at the time the ESS interest is granted.

Whilst the time at which an ESS interest is granted will often be obvious, it can be complicated by the “indeterminate rights” rule.

The scope of the indeterminate rights rule

The indeterminate rights rule provides that if the employee acquires a right in Year 1 that is not a right to acquire a share; but which later becomes a right to acquire a share in (say) Year 3, the employee will be deemed to have acquired the ESS interest in Year 1.

A well-known example of an indeterminate right is a performance right that is able to be settled in either shares or cash on vesting. Until the company elects not to settle the right in cash then the right is not an ESS interest. Performance rights are commonly used by public companies to manage the taxing point that would otherwise immediately arise on cessation of employment. This is because there is technically no taxing point whilst the right remains an indeterminate right.

However, the precise scope of the rule has been uncertain.

Following the ATO’s defeat in Davies, Taxation Determination 2016/7 provides the ATO’s views on the scope of the indeterminate rights rule. In the ATO’s view the distinction between what is and is not an indeterminate right hinges on whether (i) a contractual right has been created; and (ii) whether satisfaction of any conditions attaching to that contractual right:

  • directly causes the employee to have a right to acquire a share (which will be an indeterminate right); or
  • may eventually lead to, or have a distant causal connection to the eventual acquisition of a right to acquire a share (which will not be an indeterminate right).

In this regard, the ATO relies on whether a condition is a condition precedent to performance (which will be an indeterminate right) and a condition precedent to formation (which will not).

The ATO acknowledges that the legislation enacting these provisions do not make any reference to ‘direct causation’ or ‘distant causal connection’ to determine what may or may not be an indeterminate right.

The Taxation Determination contains 4 examples.

Two of the examples turn on whether contractual rights have been created.

In Example 1, turning up to a presentation by the CEO on a potential scheme doesn’t result in an indeterminate right being created, as no contractual rights are created at that time. In contrast, in Example 4, accepting an offer to acquire a right to acquire shares that is subject to shareholder approval is an indeterminate right as a contractual right is created at the time of acceptance.

Example 2 highlights the difficulties in determining whether a contractual right directly causes an employee to have a right to acquire a share (an indeterminate right), or has a distant causal connection (not an indeterminate right). The reasoning of the ATO that an indeterminate right is not created when contractual rights first come into existence seems strained; particularly as the ATO states that the contractual right is not a fringe benefit because it was one of a series of steps to be issued shares.

Example 3 is the most helpful, as it deal with the problem of a contractual right coming into existence prior to employment. On the basis that the right to the ESS interest is conditional on employment commencing, the ATO determined that the earliest time that the indeterminate right can come into existence is when employment commenced. Thus, tax deferral can apply to the ESS interest.