Private ruling: Employment termination payment
Date of advice: 23 December 2015
Published: March 2016
Ruling period: Income year ending 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Is the ETP/Severance payment, or any part of it, an eligible termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Is the ETP/Severance payment, or any part of it a, genuine redundancy payment under section 83-175 of the ITAA 1997? | A2: Yes | Q3: Is the ETP/Severance payment, or any part of it, a capital payment for restraint of trade in accordance with paragraph 82-135(j) of the ITAA 1997? | A3: No

Relevant facts and circumstances: Your client is not yet 65 years of age. Your client was employed as the Chief Operating Officer at the Employer. During the 20WW-XX income year, your client received a termination of employment letter stating that the role of Chief Operating Officer would no longer be required, effective immediately. The letter notes that under your client's contract, they will have a restraint of trade for the next 12 months. Your client received the following payments on termination in the 20WW-XX income year: • Accrued annual leave • Accrued long service leave • ETP/Severance payment The Contract of Employment (the Contract), provides the following in regards to the termination of employment: Termination of Employment - Notice of Termination In order to terminate your employment we will provide you with a period of notice set out in item 8 of schedule 1 of this contact. The term of notice is based on the seniority of your position and the nature of your duties being performed. We may elect to make a payment in lieu of the required notice period, or may continue your employment but not require you to work during that period. In the event that the notice period is four weeks and you have in excess of five years' service and are over forty-five (45) years of age you will be entitled to an additional week's notice. Restraint The provisions of this contract relating to Restraint are contained in Schedule 2 of this contract and the provisions of that schedule are an integral condition of this contract. Other conditions We may negotiate with you other specific terms of your contract of employment. If we do this we will specify those terms at item 9 of Schedule 1 of this contract. … Schedule 1 - Specified Variables Item 9 Other Conditions of your employment a. Should your employment be terminated for any reason other than serious misconduct you will be entitled to compensation for termination of a total of 12 months of your TRP at that time. This payment is for all purposes including but not restricted to any severance or redundancy payments, any expenses or allowances payable pursuant to your contract of employment with the specific exception of accrued Annual Leave and Long Service Leave entitlements. If you are required to work your notice period in line with clause 21 of this contract then you will be paid this payment at the end of that notice period. If you are paid in lieu of that notice period or are not required to work it then that payment will be included in this compensation payment. If this compensation payment is provided, the period of restraint set out in item 2 (a) of Schedule 2 will be extended to 12 months. Schedule 2 - Restraint … 2. Obligation In consideration of your remuneration and to protect our goodwill, you will not do or attempt to do the following while employed by us or after your employment with us ends: (a) For the duration of the notice of termination period given by you or us specified in Item 8 of Schedule 1 immediately following the date either you or we gave notice (unless otherwise specified in Item 9 of Schedule 1): - carry on or be engaged or interested in any business which competes with us. (b) For a period of twelve months immediately following the date either you or we gave notice (whichever occurred): - induce, encourage or solicit any of our employees to resign; - induce, encourage or solicit any of our members, clients or suppliers to end or restrict their trade relationship with us; - provide any information regarding trade secrets, connections with members, clients or suppliers, or other confidential information pertaining to our business to any member, client or supplier, competitor or to any other person who provides that information to the aforementioned parties. The Employer has classified the ETP/Severance payment as an employment termination payment (ETP).

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 82-10(2) | Income Tax Assessment Act 1997 section 82-130 | Income Tax Assessment Act 1997 section 82-135 | Income Tax Assessment Act 1997 paragraph 82-135(e) | Income Tax Assessment Act 1997 paragraph 82-135(j) | Income Tax Assessment Act 1997 section 82-170 | Income Tax Assessment Act 1997 section 82-175

Reasons for decision: Summary: The ETP/Severance payment is an employment termination payment in accordance with section 82-130 of the ITAA 1997 apart from the amount excluded as the tax-free amount of a genuine redundancy payment. The ETP/Severance payment includes a genuine redundancy payment in accordance with section 83-175 of the ITAA 1997. As the total genuine redundancy payment amount your client received is more than the tax free amount, a portion of the payment will be an employment termination payment and is to be included as income in your client's tax return for the 20WW-XX income year under subsection 82-10(2) of the ITAA 1997. As the ETP/Severance payment cannot be dissected, the Commissioner considers it fair and reasonable to treat the entire severance payment accepted by your client under the Contract as an employment termination payment for income tax purposes, and not a capital payment for restraint of trade. | Detailed Reasoning - Employment termination payments: Subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that a payment is an employment termination payment (ETP) if: (a) it is received by you: (i) in consequence of the termination of your employment; or (ii) after another person's death, in consequence of the termination of the other person's employment; and (b) it is received no later than 12 months after that termination (but see subsection (4)); and (c) it is not a payment mentioned in section 82-135. To determine if a payment is an ETP, all the conditions in subsection 82-130(1) of the ITAA 1997 must be satisfied. Failure to satisfy any of the conditions under subsection 82-130(1) will result in the payment not being considered an ETP. Furthermore, any termination payments received more than 12 months after the termination are included in assessable income and taxed at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule. | Detailed Reasoning - Paid as a 'consequence of' the termination of your employment: For a payment to be treated as an ETP, the first condition that must be met is that the payment is made in ' consequence o f' the termination of employment of the taxpayer. The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Taking into account the courts decisions on the meaning of the phrase, the Commissioner's view on the meaning and application of the 'in consequence of' test are set out in Taxation Ruling TR 2003/13 (TR 2003/13). While TR 2003/13 considered the meaning of the phrase 'in consequence of' in the context of the eligible termination payments, TR 2003/13 can still be relied upon as both the former provision under the Income Tax Assessment Act 1936 and the current provision under the ITAA 1997 both use the term 'in consequence of' in the same manner. In paragraph 5 of TR 2003/13 the Commissioner states: … a payment is made in respect of a taxpayer in consequence of the termination of the employment of the taxpayer if the payment 'follows as an effect or result of' the termination. In other words, but for the termination of employment, the payment would not have been made to the taxpayer. Accordingly, it must be demonstrated that, but for the termination of employment, the payment would not have been made. Under the Contract, your client is entitled to receive a severance payment, representing 12 months of their total remuneration package (TRP) at the time their employment is terminated. In the present case, your client's employment was terminated by the Employer during the 20WW-XX income year. As a result of the termination, the Employer made the severance payment to your client in the 20WW-XX income year. In other words, but for the termination, the severance payment would not have been made to your client. Therefore, it is considered that the severance payment was made to your client in consequence of the termination of their employment with the Employer. Payment is received no later than 12 months after termination This condition is satisfied as your client received the severance payment within 12 months of the termination of their employment. Payment is not a payment mentioned under section 82-135 of the ITAA 1997 Based on the information provided, the only payments listed in section 82-135 of the ITAA 1997 which may be relevant in this case and thus require consideration are: • the part of a genuine redundancy or an early retirement scheme payment worked out under section 83-170 of the ITAA 1997. • a capital payment for, or in respect of, a legally enforceable contract in restraint of trade by you so far as the payment is reasonable having regard to the nature and extent of the restraint. | Detailed Reasoning - Genuine redundancy payments: In accordance with subsection 83-175(1) of the ITAA 1997, a genuine redundancy payment is so much of a payment that: • is received by an employee who is dismissed from employment because the employee's position is genuinely redundant; and • exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of their employment at the time of the dismissal. | Detailed Reasoning - Meaning of genuine redundancy: The requirements to be satisfied before any payment made to a person whose employment is terminated qualifies for treatment as a genuine redundancy payment under section 83-175 of the ITAA 1997 are discussed in Taxation Ruling TR 2009/2 Income tax: genuine redundancy payments (TR 2009/2). With regard to the first requirement set out in subsection 83-175(1) of the ITAA 1997, the Commissioner considers that there are four necessary components within this requirement: • the payment must be received in consequence of an employee's termination; • the termination must involve the employee being dismissed from employment; • dismissal must be caused by the redundancy of the employee's position; and • the redundancy payment must be made genuinely because of a redundancy. Each of these requirements will be considered in turn below. Payment must be received in consequence of an employee's termination For the reasons stated above, it is considered that, in this case, the severance payment received by your client is in consequence of the termination of their employment. Termination must involve the employee being dismissed from employment The term 'dismissal' is not defined in the ITAA 1997 therefore, consistent with basic principles of statutory interpretation, its meaning must be determined according to the ordinary meaning of the words, having regard to the context in which they appear. Accordingly, the Commissioner's view, as stated in Taxation Ruling TR 2009/2, is that 'dismissal' means a decision to terminate employment at the employer's initiative without the 'consent' of the employee. This stands in contrast to employment that is terminated at the initiative of the employee, for example in the case of resignation. Furthermore, the loss of a particular position with an employer is not a dismissal for the purposes of subsection 83-175(1) of the ITAA 1997 unless all employment with the employer is severed (paragraph 16, TR 2009/2). In this case, in a letter to your client, the Employer notified them that their position will be made redundant effective immediately. Accordingly, the decision to terminate your client's employment was at the initiative of the Employer. Therefore this requirement is satisfied. Dismissal must be caused by the redundancy of the employee's position A position is redundant when the functions, duties and responsibilities formerly attached to the position are determined by the employer to be superfluous to the current needs and purposes of the organisation (paragraph 25, TR 2009/2). In this case, the Employer has deemed your client's position to be excess to requirements and ceased to exist in the 20WW-XXincome year. Therefore this requirement is satisfied. The redundancy payment must be made genuinely because of a redundancy Contrived cases of redundancy will not meet the conditions in section 83-175 of the ITAA 1997. The fact that an employer and employee have an understanding that a payment on termination is caused by redundancy, or that the employer treats the payment as a redundancy payment for tax purposes, does not of itself establish genuine redundancy (paragraph 32, TR 2009/2). Based on the facts of the case, we accept that the severance payment was made because of a genuine redundancy. | Detailed Reasoning - Exceeds the amount that could reasonably be expected: The severance payment that your client received must exceed the amount that could reasonably be expected to be received by them in consequence of the voluntary termination of their employment at the time of the dismissal. In this case, the Contract provides that if your client's employment is terminated for any reason other than serious misconduct, they will receive a termination payment of 12 months of your client's TRP. Had your client voluntarily resigned they would not have received the severance payment. As the amount that your client received is more than the amount that would have been reasonably expected had they voluntarily resigned, this requirement is satisfied. | Detailed Reasoning - Further conditions for a genuine redundancy payment: Further conditions must be satisfied in order for the severance payment to be considered a genuine redundancy payment (see subsection 83-175(2) of the ITAA 1997). The first condition requires that the taxpayer is dismissed before the earlier of the day the taxpayer turns 65 or the day they reach a particular age or completed a particular period of service that would have terminated the taxpayer's employment. This condition is satisfied as your client was dismissed before they turned 65 years of age. The second condition requires that if the dismissal were not at arm's length, that the severance payment does not exceed the amount that could be reasonably expected to be made if the dismissal were at arm's length. This condition does not apply as the dismissal is at arm's length. The third condition is that at the time of dismissal, there was no arrangement between the employee and the employer, or between the employer and another person, to employ the employee after the dismissal. This condition is satisfied as there is nothing to indicate that, at the time of dismissal there is an arrangement (written, verbal or implied) between your client and the Employer or between the Employer and another person, to employ your client after their dismissal. | Detailed Reasoning - Not a payment received by the employee in lieu of superannuation benefits: Subsection 83-175(3) of the ITAA 1997 provides that a genuine redundancy payment does not include any part of a payment that was received by the employee in lieu of superannuation benefits to which the employee may have become entitled at the time of the payment or at a later time. This condition is satisfied as the severance payment is not received in lieu of superannuation benefits. | Detailed Reasoning - Not a payment mentioned in section 82-135 of the ITAA 1997: Subsection 83-175(4) of the ITAA 1997 provides that a payment is not a genuine redundancy payment if it is a payment mentioned in section 82-135 (apart from paragraph 82-135(e)). Section 82-135 of the ITAA 1997 includes (among others): • superannuation benefits; • the payment of a pension or annuity; and • unused annual leave or long service leave payments. This condition is satisfied as the severance payment is not a payment mentioned in section 82-135 of the ITAA 1997 (apart from paragraph 82-135(e)). | Detailed Reasoning - The redundancy payment is a genuine redundancy payment under sections 83-170 and 83-175 of the ITAA 1997: As previously mentioned, all of the conditions set out in section 83-175 of the ITAA 1997 must be satisfied for the severance payment to qualify as a genuine redundancy payment. An examination of the information provided shows that in relation to the severance payment your client has satisfied all of the relevant conditions set out in section 83-175 of the ITAA 1997. Consequently it is considered that the severance payment constitutes a genuine redundancy payment for the purposes of section 83-170 of the ITAA 1997. | Detailed Reasoning - Tax treatment of this genuine redundancy payment: Section 83-170 of the ITAA 1997 provides that so much of the genuine redundancy payment that does not exceed the amount worked out using the prescribed formula is not assessable income and is not exempt income. The formula for working out the tax-free amount is: Base amount + (Service amount x Years of service) For the 20WW-XX income year: Base amount means $9,780; Service amount means $4,891; and Years of service means the number of whole years in the period, or sum of periods, of employment to which the payment relates. It should be noted that six months, eight months or even eleven months do not count as a whole year for the purposes of this calculation. The total genuine redundancy payment amount your client received (that is, the Tax-free Component and the Taxable Component ) is more than the tax-free amount calculated using the formula above. | Detailed Reasoning - Capital payment for restraint of trade: Some time ago, your client executed the Contract prepared by the Employer. Schedule 1 of the Contract provides that your client will receive a severance payment to compensate them for the termination of their employment to the value of 12 months of their TRP. Furthermore, Schedule 2 of the Contract provides your client is subject to restraints upon the termination of their employment. The Contract does not specify how much out of the gross sum of the severance payment was for the termination of employment and how much was the consideration for the restraint of trade. In Administrative Appeals Tribunal (AAT) Case 7/2005; 2005 ATC 162; AATA 583; 59 ATR 1161, the taxpayer entered into a deed of settlement in respect of claims the taxpayer made against the employer. Under the deed, part of the payment received by the taxpayer was represented as a termination payment. The taxpayer submitted that the characterisation of the payment as a termination payment was not determinative and that the payment was in fact compensation for wrong or injury suffered in the workplace hence free from tax. While agreeing that the characterisation of the payment in the deed was not determinative, the Commissioner disagreed that the payment was a CGT- exempt capital sum. Senior Member Ettinger, who heard the case, held at 2005 ATC 171 that: 47. I am mindful that whilst the judgments in Reseck, McIntosh and Le Grand, which are binding on this Tribunal, vary somewhat, they are not at odds in holding that termination need not be the dominant cause of the payment for there to be the conclusion drawn that a payment is made "in consequence upon" the termination of employment. At 2005 ATC 173, Senior Member Ettinger further noted that: 70. Mindful of the evidence and applying the case law as noted above, I was satisfied that the payment of $3,176,322 was "payment made in respect of the taxpayer in consequence of the termination of any employment of the taxpayer…", that there was not just a temporal connection but that the causal nexus had been established between the payment of $3,176,322 and the termination of employment of the Applicant. Accordingly, the payment must be taxed as an ETP pursuant to section 27A of the Act. If the amount received by your client were clearly stated in the Contract as comprised: (a) a specified amount compensating your client for the termination of their employment; and (b) another specified amount as the consideration for the restraint of trade undertaken by your client, the Commissioner would treat: (i) the amount in (a) above as an employment termination payment, since it was a payment made in respect of the Taxpayer in consequence of the termination of his employment, based on the AAT case just cited, and since it also met the other conditions stipulated in paragraphs 82-130(b) and (c); and (ii) the amount in (b) above as a payment for or in respect of a legally enforceable contract in restraint of trade by your client, which is not an employment termination payment by reason of paragraph 82-135(j) of the ITAA 1997. However, as noted before, the Contract does not specify the amount of the consideration paid to your client in respect of the restraint of trade agreed to by them. Schedule 2 of the Contract merely states that: In consideration of your remuneration and to protect our goodwill, you will not do or attempt to do the following while employed by us or after your employment with us ends… As the severance payment cannot be dissected, the Commissioner considers it fair and reasonable to treat the entire severance payment accepted by your client under the Contract as an employment termination payment for income tax purposes. As the total genuine redundancy payment amount your client received is more than the tax free amount, the portion above the tax free amount will be an employment termination payment and is to be included as income in your client's tax return for the 20WW-XX income year under subsection 82-10(2) of the ITAA 1997.