Eligible termination payments - a guide for employers on redundancy of an employee

In May 2006, the Treasurer announced major reforms to simplify the superannuation system. Part of this is a proposal to abolish reasonable benefit limits. If passed by Parliament, this will apply from 1 July 2007. RBL reporting requirements for 2006–07 remain unchanged. This guide will be revised if the simplification proposals are enacted.

For more information visit www.ato.gov.au/super

This publication can be downloaded in Portable Document Format (PDF): download Eligible termination payments—a guide for employers on redundancy of an employee.

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About this guide

This guide helps employers decide if they are paying a redundancy payment called an ‘approved early retirement scheme payment’ or a ‘bona fide redundancy payment’. If you are an employer it will help you calculate the tax-free amount of these payments and explain what amounts are eligible termination payments (ETPs). The guide also explains how to get approval to pay early retirement scheme payments.

A checklist is included at the back of this publication to help you through the payment process.

A glossary of commonly used terms in this guide is available by visiting our website at www.ato.gov.au and click on the ‘Definitions’ link at bottom of the home page screen.

Tax benefits for employees

Some payments you make as a result of an employee’s termination are taxed at special rates. These are:

• approved early retirement scheme payments, and
• bona fide redundancy payments.

An approved early retirement scheme is when an employer offers an incentive for certain groups of employees to retire early or resign. To get the special tax rates, the Tax Office must approve the scheme.

A bona fide redundancy payment is made to an employee who is dismissed because the job they were doing has been made redundant.

Approved early retirement scheme payments and bona fide redundancy payments are tax-free up to the tax-free limit. The tax-free limit is a flat dollar amount plus an amount for each year of the employee’s completed service, including annual and long service leave taken. The tax-free limit changes on 1 July each year.

The tax-free limit for the 2005–06 year is a flat dollar amount of $6,491 plus $3,246 for each completed year of service. The tax-free limit for the 2006–07 year is a flat dollar amount of $6,783 plus $3,392 for each completed year of service.

If the payment is more than the tax-free limit, the amount over the limit is an eligible termination payment (ETP). Special tax benefits also apply to the ETP part of the payment.

You can use our ETP calculator, available on the Tax Office website, to complete the calculations required when paying ETPs.

You cannot use the calculator to work out the tax-free amount of a bona fide redundancy payment. The amount over the tax-free limit is an ETP and the calculator can only be used for this part of the payment.

Which payments can be tax-free up to the limit?

Any payments you make which are employer ETPs and meet the conditions for payments under an approved early retirement scheme or redundancy are tax-free up to the limit for that year.

Examples of payments that can meet the conditions are:

• payment in lieu of notice
• severance payment of a number of weeks’ pay for every year of service, and
• a gratuity or golden handshake.

Payments that are not employer ETPs and are taxed differently include payments for unused:

• annual leave and leave loading, and
• long service leave.

You may also pay an employee a lump sum to compensate them for superannuation benefits they have lost because of redundancy. This payment does not meet the conditions for an approved early retirement scheme or bona fide redundancy tax-free payment. However, the payment is still an ETP and is taxed at a special rate.

If you need more information about employer ETPs, there is a checklist of these payments in Eligible termination payments – a practical guide for employers (NAT 2698).

What are the conditions for payments to be tax-free up to the limit?

Before a payment is tax-free up to the limit, your employer-type ETP needs to meet all of these conditions.

• The payment is more than the amount you would have paid to your employee, if your employee voluntarily resigned or retired in other circumstances. See the examples in this guide.
• The termination of employment is before your employee turns 65, and termination is not due to your employee
• reaching a particular age (for example, a maximum age set in an employment contract), or
• completing a particular period of service (for example, the full term of a fixed term contract).
• You do not have any agreement with another person to re-employ your employee.
• If you are related to your employee in some way, the payment is not more than it would have been if you and your employee were not related (known in tax law as dealing with each other at ‘arm’s length’).
• If the payment is an early retirement scheme payment, the Tax Office has approved your early retirement scheme.
• If the payment is a redundancy payment, the redundancy is genuine.

Last Modified: Wednesday, 7 March 2007