Private ruling: Bonus payments and capital gains tax (CGT)
Date of advice: 4 April 2019
Published: May 2019
Ruling period: Year ended 30 June 20XX | Year ending 30 June 20XX
Date scheme commenced: 5 June 20XX

Ruling: Q1: Is there a CGT event D1 happened to the Employee when the Employee has received a payout as a result of an agreement entered on between Employer and Employee? | A1: No. | Q2: Can the Employee apply further 50% Capital Gains Tax Discount on the payout due to the sale of business is a going concern? | A2: Not Applicable. | Q3: Is the amount proposed to be paid to you under the deed an employment termination payment as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A3: No.

Relevant facts and circumstances: You previously owned a business which you sold to the Employer. You no longer have any ownership interest in the business of the Employer. You commenced employment with the Employer when you entered into a contractual agreement with them (the agreement). Clause 5 of the agreement provides: (1) The Employer shall pay to the employee the initial base salary as specified in Item 6 of the Schedule, or, in the event this base salary is not specified, a salary equivalent to the minimum base salary legally payable for a position of this type in this State as may be specified or declared from time to time. (2) On each anniversary of the Commencement Date the Employer shall pay to the employee an amount equal to X% of the net profits of the business being conducted by the Employer after payment of all expenses, such net profits to be determined by the accountants of the Employer from time to time whose determination shall be final. In the event that this Agreement is terminated by the employer the Employee shall be entitled to be paid a sum equivalent to X% of the net profit as referred to above for the preceding two (2) years or part thereof in full and final settlement of any claim and/or entitlements that the Employee may have herein. (3) In the event that the Employer sells the business at any time during the course of employment of the Employee and provided that the employment agreement has not previously been terminated, the Employer shall pay to the Employee a sum equivalent to Y% of the price received by the Employer for the good will portion of the sale price provided the Employee is still employed by the Employer. The value of the good will portion shall be determined by the Employer’s accountants whose decision shall be final. The following parties entered a transaction bonus deed (the deed): 1. Company A signed by Director and Director/Secretary; 2. Company B signed by Director and Director/Secretary; 3. The Employer signed by Director and Director/Secretary; 4. Director in their personal capacity; 5. Yourself. Clause 1.1 of the deed titled Definitions provides: Group means Company A, Company B, the Employer, and the Director in their personal capacity; Promisors means Company A and Company B; Related Party means, in respect of a person: (a) anyone who is an associate of that person under sections 11 to 15 (inclusive) of the Corporations Act; and (b) an associate of that person as defined in section 318 of the Income Tax Assessment Act 1936 ; Successful Transaction means a sale by the Group to a Third Party Purchaser of: (a) all of the shares in, or substantially all of the assets of, Company A; and (b) all of the shares I, or substantially all of the assets of, Employer; and Third Party means a person who is not a Related Party of any member of the Group; and Transaction Bonus means an amount. Clause 2.1 of the deed titled Payment of Transaction Bonus provides: The Promisors must pay to the Employee the Transaction Bonus as follows: (a) 50% of the Transaction Bonus no later than 30 days after completion of the first Successful Transaction (‘ First Payment Date’ ); and (b) 50% of the Transaction Bonus on the date that is 18 months after the First Payment Date (‘ Second Payment Date’ ). Clause 3.1 of the deed titled Release provides: Subject to clause 3.3, with effect on and from the first payment date the Employee releases and forever discharges: (a) Each member of the Group; and (b) All of the current, former and future directors, agents, officers, employees, Related Parties of any member of the Group (collectively, ‘ Representatives ’), from and against all Claims of whatever nature and howsoever arising which it now has or at any time in the future may have, or but for the execution of this deed, could or might have against any member of the Group or of their Representatives, in connection with, incidental or in any way related to: (a) a Successful Transaction; (b) the Transaction Bonus; or (c) any contracts, arrangements, understandings, discussions or negotiations between the Employee and any member of the Group or their Representatives regarding a bonus payment following completion of a sale or other transaction of any nature involving any member of the Group (or the businesses conducted by any of them). The shares in the Employer were acquired by another entity as a going concern. You were issued a new employment contract on this date and the employing entity remains the Employer. You expect to receive the payout that was detailed on a transaction bonus deed after the Employer sold the business and there was no separation agreement.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 15-2 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 104-35 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 section 115-5 | Income Tax Assessment Act 1997 section 115-25 | Income Tax Assessment Act 1997 section 118-20 | Income Tax Assessment Act 1997 section 82-130 Detailed Reasoning | Question 1 | A contractual right is an intangible CGT asset (Section 108-5 ITAA 1997). | CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity (subsection 104-35(1) ITAA 1997). | CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied (section 104-25 ITAA 1997). | A capital gain that you make from a CGT event is reduced if, because of the event, a provision of the ITAA 1997 outside Part 3-1 includes an amount (for any income year) in your assessable income (section 118-20 ITAA 1997). | The case of Sent v Federal Commissioner of Taxation (2012] FCAFC 187 involved the execution of a Share Issue Deed to replace the appellant’s accrued and contingent bonus entitlements under his employment agreement. The Full Federal Court found at paragraphs 28 to 32: | 28. Following the execution of the Share Issue Deed on 2 October 2001 and Primelife's shareholders' approval on 30 November 2001, the appellant's accrued and contingent bonus entitlements under his employment agreement had been replaced by an absolute entitlement to be issued with five million fully paid ordinary shares in Primelife. While the execution of the Deed and the shareholders' approval did not give rise to a derivation of assessable income by the appellant, had Primelife subsequently issued the shares to the appellant or, at his direction, to a nominee, such an event would have given rise to a derivation of income by the appellant as a reward for services rendered or to be rendered. | 29. It was argued, understandably not with great force, that the appellant's share entitlement was subject to the same contingencies as the bonus entitlements and that until these contingencies were satisfied by the appellant rendering the services under the employment agreement, there could be no derivation. We reject that. The share entitlement was, by the terms of the Share Issue Deed, free and clear of any contingency as to services provided or to be provided and was not defeasible or subject to any condition subsequent which could be described in the way of "claw back", whatever that encompasses. There would be nothing to deny derivation, in the sense of the shares "coming home", at the time they were issued. | 30. The derivation point aside, it is, in our view, beyond argument that the character of any such benefit in the form of the shares issued would be income; they would be as much a reward for services rendered or to be rendered as payment of the bonus entitlements. | 31. Why, it may be asked, should it be any different if Primelife, instead of issuing five million fully paid shares in its capital to the appellant or his nominee, pays the amount of $11,600,000 to the appellant or his nominee, as it did on or about 21 December 2001 by payment to the Trustee (see [20] above). Clearly, the answer is that it should make no difference. True it is that the payment is made to the Trustee, and not to the appellant, but on any view or level, the payment is made to the Trustee at the request/direction of the appellant such as to trigger the provisions of s 6-5(4) of the Income Tax Assessment Act 1997 (Cth) ("the 1997 Act"). | 32. The payment in the present case is not analogous to a payment by Primelife by way of contribution to a superannuation fund for the appellant's ultimate benefit (see Constable v Federal Commissioner of Taxation (1952) 86 CLR 402 at 418.5-418.9 per Dixon CJ, McTiernan, Williams and Fullagar JJ). The payment here was in substitution for the appellant's absolute entitlement to be issued with five million fully paid ordinary shares in Primelife and that itself was in substitution for his bonus entitlements, both accrued and contingent. The payment was undoubtedly a reward for services rendered and to be rendered and, as such, income of the appellant. Moreover, it was derived by the appellant in the year of income it was paid because it was paid, free and clear of the contingencies to which the bonuses were subject at the time they were substituted by the share entitlement. | And further at paragraphs 33 to 39: | 33. It was argued on behalf of the appellant that the payment of the $11,600,000 was capital in the hands of the appellant on the basis that the right to be issued the shares in Primelife was a capital asset and the payment in lieu partook of the same character. With respect, the argument is misconceived. It is as much an error to characterise a receipt by reference to a "juristic classification of the legal rights, if any, secured, employed or exhausted in the process" as it is to characterise an outgoing as being on revenue or capital account by reference to such matters: Hallstroms Pty Ltd v Commissioner of Taxation (1946) 72 CLR 634 at 648.10 per Dixon J. | 34. The payment of $11,600,000 was in substitution for the appellant's entitlement to his right to receive remuneration for his services in the form of the issue to him or his nominee of five million shares in Primelife. The appellant accepted that payment as the performance of Primelife's obligation under the Share Issue Deed to pay him for his services by the issue of those shares. The arrangement under which the appellant gave up his right to the five million shares and accepted the money in its place could be not characterised as converting a receipt of an income character (the right to be issued the shares) into one of a capital character (the payment of the money in substitution for the right to receive the shares). From a "practical and business point of view" ( Hallstroms 72 CLR at 648.10), both forms of receipt were intended to reward the appellant for his service to Primelife. | 35. If an employer is obliged to furnish an employee remuneration in one form, the fact that the parties treat the employer's obligation as having been discharged because the remuneration is furnished in a different or substitute form, does not alter the character of the receipt in the employee's hands. | 36. Here, the appellant was content to have Primelife pay his nominee (the Trustee) the money in substitution for his absolute entitlement to the issue of the shares. But the whole purpose of the arrangements was to remunerate the appellant for his services immediately following upon shareholder approval of the terms of the Share Issue Deed. | 37. It follows that the appellant derived the $11,600,000 as ordinary income within the meaning of s 6-5(4) of the 1997 Act as soon as Primelife paid it to the Trustee as his nominee. | 38. In our view, the primary judge did not err when he held that the whole of the $11,600,000 payment was assessable income of the appellant in the year of income. | 39. It is for these reasons that the other or consequential issue referred to in [5] above, did not arise. | Your assessable income includes the value to you of all allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you (subsection 15-2(1) ITAA 1997). | This is so whether the things were provided in money or in any other form (subsection 15-2(2) ITAA 1997). | However, the value of an employment termination payment is not included in your assessable income under this section (paragraph 15-2(3)(a) ITAA1997). | Application to your circumstances | When you entered into the agreement with the Employer, you received to right to receive a payment calculated as X% of the goodwill portion of any sale of the business whilst you remained employed by the Employer (sub-clause 5(3) of the agreement). In this instance, your Employer created the contractual right in you to receive an amount if certain conditions were met. You did not create the contractual right and therefore CGT event D1 does not occur to you. | When you entered into the deed, you have released the Employer from its obligation under the agreement (clause 3 of the deed) and a CGT event C2 will occur at this point. However, as per the decision in the Sent case, the original character of the payment was income to you under the agreement and this character will be maintained when payment is made under the deed. | The Commissioner considers that as the nature of the receipt was income originally and that character will be maintained when it is paid to you. Therefore any capital gain you make when your right to receive payment under the deed is satisfied (section 104-25 ITAA 1997) will be reduced by the amount otherwise included in your assessable income (section 118-20 ITAA 1997). | Question 2 | A discount capital gain is a capital gain that meets the requirements (section 115-5 ITAA 1997). A capital gain arising from a CGT event D1 is not a discount capital gain (section 115-25(3) ITAA 1997). | Application to your circumstances | You did not have a capital gain arising from a CGT event upon entering the agreement. Whilst a CGT event C2 will occur when payment is made to you under the deed, the capital proceeds from such event will be reduced by the amount otherwise included in your assessable income and you will not make a capital gain. The Commissioner considers that you will not make a discount capital gain. | Question 3 | Summary | The transition bonus payments are not in consequence of the termination of employment it also does not satisfy subparagraph 82-130(1)(a)(i) of the ITAA 1997, one of the main criteria that must be satisfied for it to be treated as an employment termination payment. | Accordingly, the transition bonus payments are assessable as ordinary income. | Detailed reasoning | Meaning of received ‘in consequence of’ the termination | 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. | As further stated by the Commissioner in paragraph 6 of TR 2003/13, there must be: | … a causal connection between the termination and the payment, although the termination need not be the dominant cause of the payment. The question of whether a payment is made in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case. | The phrase in consequence of termination of employment has been interpreted by the courts in several cases. | Of note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation (1975) 133 CLR 45 ( Reseck ) and the Full Federal Court in McIntosh v. Federal Commissioner of Taxation (1979) 25 ALR 557; ( McIntosh ). | In Reseck Justice Gibbs stated: | Within the ordinary meaning of the words, a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination... It is not in my opinion necessary that the termination of the services should be the dominant cause of the payment.... | While Justice Jacobs stated: | It was submitted that the words ‘in consequence of’ import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a ‘following on’. | In looking at the phrase ‘in consequence of’ the Full Federal Court in McIntosh considered the decision in Reseck . Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment. | Suffice it to say that both Courts’ views were that for a payment to be made in consequence of the termination of employment it had to follow on as a result or effect of the termination of employment. Additionally, while it is not necessary to show that termination of employment is the sole or dominant cause, a temporal sequence alone would not be sufficient. | The question of whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case. | Application to your circumstances | Under the deed you are to be paid an amount to honour the agreement. | The proposed payment was not made in consequence of the termination of employment. Rather, the amounts are to be made as a contractual obligation made under the agreement. | Accordingly, there is no causal connection between the termination and the transition bonus. The amounts were not conditional on the termination of your employment. It cannot be said that the amounts followed on as an effect or a result of the termination of employment. Therefore the transition bonus payments are not considered to be made in consequence of the termination of employment. | Ultimately, a distinction has been made between the amounts being paid as a consequence of the sale of the employers business. | In this case, as the transition bonus payments are not made in consequence of the termination of employment, the purposed payment cannot be treated as a genuine redundancy payment.