Private ruling: Employment termination payment
Published: October 2013
Ruling period: 1 July 2012 to 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: 1. Are the monthly payments received by your client on termination of employment assessable as employment termination payments under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)? 2. If the monthly payments are employment termination payments are any part of these payments to be excluded as the tax-free part of a genuine redundancy payment under section 83-170 of the ITAA 1997? 3. Will your client be entitled to a tax offset under section 83-15 of the ITAA 1997 in respect of the payment for unused annual leave on termination of employment? Advice/Answers: 1. Yes. 2. Yes 3. Yes.


Relevant legislative provisions: Income Tax Assessment Act 1936 Section 27F. | Income Tax Assessment Act 1997 Subsection 82-10(1). | Income Tax Assessment Act 1997 Subsection 82-10(2). | Income Tax Assessment Act 1997 Subsection 82-10(3). | Income Tax Assessment Act 1997 Subsection 82-10(4). | Income Tax Assessment Act 1997 Section 82-130. | Income Tax Assessment Act 1997 Subsection 82-130(1). | Income Tax Assessment Act 1997 Paragraph 82-130(1)(a). | Income Tax Assessment Act 1997 Paragraph 82-130(1)(b). | Income Tax Assessment Act 1997 Paragraph 82-130(1)(c). | Income Tax Assessment Act 1997 Subsection 82-130(2). | Income Tax Assessment Act 1997 Section 82-135. | Income Tax Assessment Act 1997 Paragraph 82-135(e). | Income Tax Assessment Act 1997 Section 82-140 | Income Tax Assessment Act 1997 Section 82-145. | Income Tax Assessment Act 1997 Section 82-150. | Income Tax Assessment Act 1997 Section 82-155. | Income Tax Assessment Act 1997 Section 82-160. | Income Tax Assessment Act 1997 Section 83-15. | Income Tax Assessment Act 1997 Section 83-170. | Income Tax Assessment Act 1997 Subsection 83-170(1) | Income Tax Assessment Act 1997 Subsection 83-170(2) | Income Tax Assessment Act 1997 Subsection 83-170(3). | Income Tax Assessment Act 1997 Section 83-175. | Income Tax Assessment Act 1997 Subsection 83-175(1). | Income Tax Assessment Act 1997 Subsection 83-175(2). | Income Tax Assessment Act 1997 Subsection 83-175(3). | Income Tax Assessment Act 1997 Subsection 83-175(4).

Reasons for decision: Detailed Reasoning - Is the payment an employment termination payment?: A payment made to an employee is an employment termination payment if the payment satisfies all the requirements in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997), and is not specifically excluded under section 82-135 of the ITAA 1997. Subsection 82-130(1) of the ITAA 1997 states: 82-130(1) A payment is an employment termination payment if: (a) it is received by you: (i) in consequence of the termination of your employment; or (ii) after another persons death, in consequence of the termination of the other persons employment; and (b) it is received no later than 12 months after the termination (but see subsection (4)); and (c) it is not a payment mentioned in section 82-135. | Detailed Reasoning - Payment is made in consequence of the termination of employment: The first condition to be met is that there must be an employment termination payment that is made in consequence of the termination of employment of the taxpayer. The phrase in consequence of is not defined in the ITAA 1997. However, the words have been interpreted by the courts in several cases. The Commissioner has also issued Taxation Ruling TR 2003/13 titled Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of' ( TR 2003/13) which discusses the meaning of the phrase. 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. Some court cases are discussed below. Of note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 ( Reseck ) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 ( McIntosh ). 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. Therefore if the payment follows as an effect or a result from the termination of employment, the payment will be made 'in consequence of' the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135 of the ITAA 1997. Your client was employed by a company and commenced employment more than 5 years ago. Later your client held a senior position with a company after a merger of two companies. Your client's employment was in accordance with the terms and conditions set out in a written employment agreement signed after the merger. Your client's employment has been continuous through the merger of both companies. In the relevant income year your client received a payment in lieu of notice. The employment agreement states that on termination by the employer your client would receive a particular amount subject to adjustment from time to time as approved and in accordance with the employer policy. Your client received a payment paid in monthly instalments due to cash flow issues. The pay slips provided show the monthly payments classified as employment termination payments (ETP) by the employer. The quantum of the payment reflects the amount that would be a payment in lieu of notice in accordance with the employment agreement. Therefore it is evident that the payment was made in consequence of your client's termination of employment. The payment would not be made if there was no termination of employment. The termination of employment and the payment are intertwined and connected. Therefore the requirement of subparagraph 82-130(1)(a) of the ITAA 1997 has been met. | Detailed Reasoning - The 12 month rule set out in paragraph 82-130(1)(b) of the ITAA 1997:: To qualify as an employment termination payment, the payment must be received 'no later than 12 months after' the termination of the taxpayer's employment (paragraph 82-130(1)(b) of the ITAA 1997). In this case the payment was made in the relevant income year which is within 12 months of the termination. Therefore this condition is satisfied and the requirement of subparagraph 82-130(1)(b) of the ITAA 1997 has been met. | Detailed Reasoning - Payments excluded from being employment termination payments: Paragraph 82-130(1)(c) of the ITAA 1997 requires that an employment termination payment is not a payment under section 82-135 of the ITAA 1997. Section 82-135 of the ITAA 1997 includes payments such as pensions, foreign termination payments, unused annual leave and unused long service leave and the tax-free part of genuine redundancy payments or early retirement scheme payments. We will now consider if any part of the payment is a tax free part of a genuine redundancy payment. | Detailed Reasoning - Genuine redundancy payment: A payment made to an employee is a genuine redundancy payment (GRP) if it satisfies all criteria set out in section 83-175 of the ITAA 1997. Section 83-175 of the ITAA 1997 replaces former section 27F of the Income Tax Assessment Act 1936 (ITAA 1936) where such payments were referred to as bona fide redundancy payments. The first criteria to be satisfied (subsection 83-175(1) of the ITAA 1997) is: Ÿ that the payment is received by an employee who is dismissed from employment because the employee's position is genuinely redundant; and Ÿ that the payment exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of the dismissal. Subsection 83-175(2) of the ITAA 1997 requires that all of the following conditions must be met: Ÿ The employee is dismissed before the earlier of: Ÿ the day he or she turned 65; or Ÿ if the employee's employment would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach that age or complete the period of service (as applicable). Ÿ If the dismissal was not at arms length the payment must not exceed the amount that could reasonably be expected to be made if the dismissal was at arms length. Ÿ At the time of the 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. Subsection 83-175(3) of the ITAA 1997 imposes a further condition that the 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. Each condition is discussed below. | Detailed Reasoning - Dismissal because of genuine redundancy: The first condition requires the taxpayer to be dismissed from employment because the taxpayer's position is genuinely redundant. The Commissioner's view as stated in Taxation Ruling TR 2009/2 - Income tax: genuine redundancy payments (TR 2009/2) is that 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. The decision to make an employee's position redundant is fundamentally one made by the employer. Dismissal requires that a termination of employment is made at the initiative of the employer without the consent of the employee. Further, a dismissal is not caused by redundancy where personal acts or default are the cause for termination for example unsatisfactory performance or behaviour. Therefore the questions to be answered are whether the position your client occupied was abolished and whether they were dismissed from employment. The Commissioner's view is that a genuine redundancy payment (GRP) can only arise where there is no suitable job available for the employee with the employer and therefore the employee must be dismissed. You have advised that the position your client occupied as Managing director was removed from the company's structure and the duties reassigned to other directors and their employment terminated. Paragraph 26 of IT 2009/2 states the following: 26. In some circumstances, an employer may reallocate the duties and functions attached to a particular position to another position within the employer's organisational structure. In such cases, the former position is redundant. However, if the employee who had been working in that position is still employed by the employer following the reallocation of duties and functions, there will not be a dismissal. Based on the above, as your client's duties have been reassigned and your client is no longer employed, the termination of employment is considered a dismissal. Consequently, it is considered that your client's position has been abolished. The employment contract states that if your client was terminated from employment by the employer, your client would be paid a payment in lieu of notice of total of a particular amount subject to adjustment from time to time in accordance with the company policy if the employment is terminated by the employer. This is what your client did receive. Consequently, the decision to terminate your client's employment is that of the employer and not your client's own. Therefore your client has been dismissed from employment as your client's position has been made genuinely redundant. In light of these factors it is considered that your client's termination of employment is due to genuine redundancy. As your client's position was abolished and there was a dismissal, part of the first condition under section 83-175 of the ITAA 1997 has been met. The condition also requires that for a payment to be a GRP, it should exceed the amount that would be received by the employee on voluntary termination of employment. | Detailed Reasoning - In excess of the amount that would be received on voluntary termination of employment: The employment agreement states regarding termination that the employee is required to give 3 months' notice if they terminate the agreement. The employment agreement states that if the employer terminates the employment your client will receive a payment in lieu of notice by of 12 month's pay. This is what your client has received. You have advised that your client would only receive their statutory leave entitlements if your client had resigned voluntarily. Clearly the payment in lieu of notice would not have been paid if your client had resigned voluntarily. Consequently, the amount paid is in excess of what your client could have received on voluntary termination of employment and the first condition is satisfied. | Detailed Reasoning - Termination occurred before age 65 or expiration of fixed term: The second condition is that the termination time was a date before the taxpayer attained age 65 or such earlier date on which his or her employment would have necessarily terminated under the terms of employment because of the employee attaining a certain age or completing a certain period of service. In accordance with the employment agreement there is no particular date when your client's employment would terminate. Your client's employment terminated when they were below the retirement age of 65 years. Therefore this condition is satisfied. | Detailed Reasoning - Dealing at arm's length: The third condition is that if the employer and the employee were not dealing with each other at arm's length in relation to the termination of employment, the amount of the eligible termination payment must not be greater than the amount that could reasonably be expected to have been paid if the parties had been at arm's length. You have advised that your client and the employer dealt with each other at arm's length. Therefore this condition is satisfied. | Detailed Reasoning - No agreement to employ after date of termination: The final condition is that at the termination time, there was no agreement in force between your client and the employer or the employer and another person, to employ your client after the date of termination. You have advised that there was an agreement between your client and the employer or the employer and another person to employ your client after termination of employment. Therefore this condition is satisfied. Therefore all requirements of subsection 83-175(2) of the ITAA 1997 have been satisfied. | Detailed Reasoning - Further requirements: In addition to the requirements discussed above, subsection 83-175(3) of the ITAA 1997 requires that no part of the payment which represents a payment in lieu of superannuation benefits will be included as part of a GRP. As no part of the payment is in lieu of superannuation benefits, this condition is satisfied. The last requirement is that the payment must not be a payment covered by section 82-135 of the ITAA 1997 apart from paragraph 82-135(e) i.e. a GRP. As noted earlier, none of the paragraphs of section 82-135 (apart from paragraph 82-135(e)) apply. Therefore, this requirement has been satisfied. All conditions must be satisfied before the payment is considered a GRP. In this case as all the conditions have been met, the payment is a GRP under section 83-175 of the ITAA 1997. | Detailed Reasoning - Tax-free part of a genuine redundancy payment: Section 83-170 of the ITAA 1997 applies to determine the tax-free treatment of a GRP. Section 83-170 places a limit on the amount of a GRP that is eligible for concessional tax treatment. So much of the GRP 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 (subsection 83-170(3) of the ITAA 1997) is: Base amount + [ Service amount × Years of service] For the 2012-13 income year: Base amount means $8,806; Service amount means $4,404; and Years of service means the number of whole years in the period, or sum of periods, of employment to which the payment relates For your client, the tax-free amount is calculated as follows: $8,806+[$4,404 × number of years of service] The amount calculated is the tax-free amount of a GRP and is not required to be included in your client's income tax return for the relevant income year. After deducting the tax-free component of a GRP, the remaining amount is considered to be a life benefit employment termination payment. The tax-free and taxable components of an employment termination payment will now be considered. | Detailed Reasoning - Tax Treatment of the employment termination payment: An employment termination payment is comprised of the following components: Ÿ Tax free component - this includes the pre-July 83 segment (if any) and/or the invalidity segment (if any); and Ÿ Taxable component - the amount remaining after deducting the tax free component from the total payment. The tax free component calculated above is not assessable income and is not exempt income. The taxable component is included, in full, as assessable income and is subject to tax depending on the person's age when the payment is received. As your client is over preservation age, the taxable component is taxed at 15% plus Medicare levy for amounts below the employment termination payments cap of $175,000 for the relevant income year. | Detailed Reasoning - Taxation of unused annual leave: Section 83-15 of the ITAA 1997 states the following: | Detailed Reasoning - Section 83-15 Entitlement to tax offset: 83-15 You are entitled to a tax offset to ensure that the rate of tax on an unused annual leave payment does not exceed 30%, to the extent that: (a) the payment was made in connection with a payment that includes, or consists of, any of the following: (i) a genuine redundancy payment; (ii) an early retirement scheme payment; (iii) the invalidity segment of an employment termination payment or superannuation benefit; or (b) the payment was made in respect of employment before 18 August 1993. Consequently, as your client's termination of employment is a genuine redundancy, they are entitled to a tax offset so that his unused annual leave will be taxed at no more than 30% plus Medicare levy.

Your client is over 55 Years of age. | A few years later the company merged with another company to form a third company (the employer) | Your client's employment was continuous through the merger and all employee benefits were transferred to the employer. | Your client signed an employment agreement with the employer. | Some years later your client's duties were allocated to other senior employees and your client was not offered an alternative position; and their employment with the employer was terminated. | On termination of employment your client received the following payments: | Monthly payments in lieu of notice; and | A payment for unused annual leave. | Your client's employment agreement states the employee may terminate the agreement with 3 months notice in writing and the employer can terminate it with 12 months notice and advises what amounts will be paid.