House of Representatives

Tax Laws Amendment (Simplified Superannuation) Bill 2006

Superannuation (Excess Concessional Contributions Tax) Bill 2006

Superannuation (Excess Concessional Contributions Tax) Act 2007

Superannuation (Excess Non-concessional Contributions Tax) Bill 2006

Superannuation (Excess Non-concessional Contributions Tax) Act 2007

Superannuation (Excess Untaxed Roll-over Amounts Tax) Bill 2006

Superannuation (Excess Untaxed Roll-over Amounts Tax) Act 2007

Superannuation (Departing Australia Superannuation Payments Tax) Bill 2006

Superannuation (Departing Australia Superannuation Payments Tax) Act 2007

Superannuation (Self Managed Superannuation Funds) Supervisory Levy Amendment Bill 2006

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 4 - Employment termination payments

Outline of chapter

4.1 Schedule 2 to this Bill establishes the taxation treatment of employment termination payments as a result of the Government's Simplified Superannuation reforms.

4.2 Currently, payments made in consequence of the termination of employment are a subset of the existing eligible termination payment (ETP) category of statutory income. ETPs will cease to exist from 1 July 2007, being replaced by employment termination payments and superannuation lump sums (dealt with elsewhere in this Bill). Employment termination payments will cover payments in consequence of termination where such a payment is not made from a superannuation entity.

4.3 Schedule 2 also contains a number of provisions to move associated payments from the Income Tax Assessment Act 1936 (ITAA 1936) into the Income Tax Assessment Act 1997 (ITAA 1997). These provisions retain the same effect as under existing law but have been rewritten to reflect the current drafting style and to deliver legislative simplification.

Context of amendments

4.4 Under current legislation, the concessional taxation treatment of ETPs is in line with the taxation arrangements that apply to superannuation benefits, including the application of the reasonable benefit limits (RBLs).

Summary of new law

4.5 The reforms made as part of Simplified Superannuation mean that it is no longer appropriate to continue to treat these payments as having a retirement payment characteristic.

4.6 The reforms will remove the current limits on the amount of taxation concessions attached to these payments. The concessionality of the tax treatment of employment termination payments is limited under existing legislation through the operation of RBLs and end benefits tax. The RBLs will be abolished from 1 July 2007 as part of the Government's Simplified Superannuation reforms.

4.7 Under Simplified Superannuation , employment termination payments received in a given year or relating to a single termination (where the payment is split over more than one year) only receive concessional tax treatment for amounts below the employment termination payments cap. The cap will be $140,000 in 2007-08 and will be indexed. As with the existing law, the Medicare levy is payable in addition to the maximum rate of tax which applies to an employment termination payment.

4.8 To access these tax concessions, employment termination payments must generally be made within 12 months of the employment termination.

4.9 As superannuation benefits paid to those over 60 will be tax free, employment termination payments will no longer be able to be rolled into superannuation. This would have allowed people to put in place arrangements to avoid the intent of the caps on concessional and post-tax contributions.

4.10 Transitional arrangements are available for certain termination payments made as a result of employment entitlements in place before 10 May 2006. Payments made under these arrangements will attract tax concessions designed to broadly mirror existing arrangements, including the ability to roll these amounts into superannuation. To access the transitional arrangements, payments will need to occur prior to 1 July 2012.

4.11 The amendments apply from 1 July 2007 and affect individuals who receive a payment, other than from a superannuation plan, as a result of their employment termination.

Comparison of key features of new law and current law

New law Current law
Employment termination payments must be made within 12 months of the termination of employment or office, unless the Commissioner of Taxation (Commissioner) considers that 12 months is too short in the circumstances.
Genuine redundancy payments and early retirement scheme payments are exempt from this requirement. Employment termination payments, with the exception of certain transitional arrangements, will no longer be able to be paid into superannuation.
Payment may be made at any time following the termination of employment or office. Employees can currently elect to have all or part of a payment made into superannuation.
For recipients who reach preservation age in the year a payment is received, the taxable component of an employment termination payment is taxed at 15 per cent for amounts below the employment termination payments cap ($140,000 from 2007-08, and indexed annually) and at the top marginal rate for amounts above the cap. The pre-July 1983 component will be tax free. For recipients aged 55 (the current preservation age) and over, the post-June 1983 component is taxed at 15 per cent for amounts below the threshold ($135,590 in 2006-07) and 30 per cent for amounts above the threshold up to the RBL. Amounts above the RBL are effectively taxed at the top marginal rate. Five per cent of the pre-July 1983 component is taxed at marginal rates.
For recipients below preservation age, the taxable component of an employment termination payment is taxed at 30 per cent for amounts below the employment termination payments cap and at the top marginal rate for amounts above the cap. The pre-July 1983 component is tax free. For recipients below age 55, the post-June 1983 component of an ETP is taxed at 30 per cent for amounts below the RBL. Amounts above the RBL are taxed at the top marginal rate. Five per cent of the pre-July 1983 component is taxed at marginal rates.
Death benefit termination payments are tax free up to the employment termination payments cap for dependants. The pre-July 1983 component is tax free.
Death benefit termination payments are taxed at a maximum of 30 per cent up to the employment termination payments cap if paid to a non-dependant. The pre-July 1983 component is tax free.
In both cases, any amount above the cap is taxed at the top marginal rate.
Death benefit termination payments are tax free up to the RBL for dependants.
Death benefit termination payments are taxed at a maximum of 30 per cent up to the RBL if paid to a non-dependant. Five per cent of the pre-July 1983 component is taxed at marginal rates.
* The Medicare levy is payable in addition to the maximum rate.

Detailed explanation of new law

Employment termination payments

4.12 These amendments apply to payments to individuals who retire or stop working provided that the payment is not made from a superannuation plan. These payments are referred to as 'employment termination payments'.

4.13 As with the existing ETP arrangements, the concept of employment has an expanded meaning in the employment termination payment regime such that it includes the holding of an office. [ Schedule 2, item 1, section 80 - 5 ]

4.14 The circumstances in which a payment can arise in consequence of the termination of employment (and can therefore be an employment termination payment) include dismissal, resignation, retirement and death. [ Schedule 2, item 1, section 80 - 10 ]

What is an employment termination payment?

4.15 An 'employment termination payment' is a lump sum payment made in consequence of the termination of an individual's employment. [ Schedule 2, item 1, subsection 82 - 130(1 )]

4.16 A life benefit termination payment is an employment termination payment made in consequence of a person's termination of employment, other than as a result of death. [ Schedule 2, item 1, subparagraph 82 - 130(1 )( a )( i ) and subsection 82 - 130(2 )]

4.17 A death benefit termination payment is an employment termination payment made to a person after another person's death. [ Schedule 2, item 1 subparagraph 82 - 130(1 )( a )( ii ) and subsection 82 - 130(3 )]

4.18 To qualify as an employment termination payment, the payment must be made within 12 months of the termination. However, provision is made for the Commissioner to allow a payment made after this period to be taxed under the concessional arrangements applying to employment termination payments. The Commissioner may prepare determinations covering a class of payments or recipients or in respect of an individual taxpayer. [ Schedule 2, item 1, paragraphs 82 - 130(1 )( b ) and 82 - 130(4 )( a ) and subsections 82 - 130(5 ) to ( 8 )]

4.19 The 12-month rule exists to prevent abuse of the tax concession offered for these payments by using a series of payments over a number of income years. The provisions dealing with the Commissioner's ability to issue a determination are provided to allow flexibility where delays in payment are reasonable and not constructed with the intent of delivering taxation advantages. The following examples illustrate the circumstances in which it is intended the Commissioner would, or would not, issue such a determination.

Example 4.1 Stephen is dismissed from his employment. No employment termination payment is made. Stephen commences legal action against the employer to secure payment of amounts he believes he was entitled to on termination and to seek damages for unfair dismissal.After a lengthy court process, lasting more than 12 months, Stephen is successful in his claim and a payment is made by his employer. Stephen writes to the Commissioner to seek relief from the 12-month rule. The Commissioner, having regard to the circumstances of the payment, determines that the delay in payment is reasonable given that it arose as a result of a legal dispute over entitlement.

Example 4.2 Rachel is employed in a company selling mining hardware. After a period of declining sales, the company suffers financial difficulties out of which it determines that it is unable to trade, and Rachel is dismissed. An administrator is appointed and determines that the company has no cash and must rely on the sale of its assets to meet its outstanding liabilities.After 18 months all assets of the company are sold and the administrator is ready to make payments to creditors. At this point Rachel receives a payment in respect of the termination of her employment. Rachel writes to the Commissioner to seek relief from the 12-month rule (in so far as the payment is not a genuine redundancy payment and hence exempt from the 12-month rule). The Commissioner, having regard to the circumstances of the person making the payment, determines that the delay in payment is reasonable given that the payment could not be made earlier as a result of the financial situation of the payer.

Example 4.3 Rithy is employed part-time by Erica. They have an agreement which provides for a payment to Rithy on the termination of his employment. Rithy is also employed part-time with Louise. They also have an agreement which provides for a payment on the termination of employment.On 1 July Rithy terminates his employment with both employers in order to take a holiday. At Rithy's request neither employer makes an immediate payment. On 1 July the following year Louise pays Rithy $140,000. Rithy then enters into an arrangement with Erica to defer the payment of the amount she owes him for another year in order to secure a better taxation outcome.As the deferral of the payment would mean that it occurs more than 12 months after the termination of employment Rithy seeks the Commissioner's agreement to determine that the 12-month rule does not apply. Given the circumstances of the request and of the payment the Commissioner declines to provide such a determination.

4.20 Genuine redundancy payments and early retirement scheme payments (including amounts in excess of the tax free component) are exempted from the operation of the 12-month rule. [ Schedule 2, item 1, paragraph 82 - 130(4 )( b )]

4.21 Provision is made to ensure that the existing ability to receive an ETP as a transfer of property is retained under the employment termination payments regime. This will also apply to genuine redundancy payments, early retirement scheme payments and foreign termination payments. The value of such a payment is to be assessed as the market value of the property less any consideration given for the transfer of the property. [ Schedule 2, item 1, section 80 - 15 ]

Payments that are not employment termination payments

4.22 Consistent with current legislation, certain payments are prevented from qualifying as employment termination payments. The following payments are expressly stated to not be employment termination payments:

·
superannuation benefits;
·
payments from a pension or an annuity (to exclude from these provisions an income stream which may be paid by an employer);
·
unused annual leave payments;
·
unused long service leave payments;
·
the part of a genuine redundancy payment or an early retirement scheme payment that is tax free;
·
foreign termination payments;
·
advances or loans on arm's length terms;
·
a payment that is deemed to be a dividend under paragraph 109(1)(d) of the ITAA 1936;
·
reasonable capital payments for personal injury;
·
reasonable capital payments for restraint of trade; and
·
payments resulting from the commutation of a superannuation income stream that are wholly applied in paying any superannuation contributions surcharge.

[ Schedule 2, item 1, paragraph 82 - 130(1 )( c ) and section 82 - 135 ]

Payments for the individual's benefit or at the individual's direction or request

4.23 Payments to which Divisions 82 and 83 apply are taxed as though they were paid directly to the individual, even if the individual directs their employer to make the payment to another person. However, this does not mean that where a death benefit termination payment is made, that the deceased is assessed as if they had received the payment. [ Schedule 2, item 1, section 80 - 20 ]

Tax treatment of life benefit termination payments

4.24 The concessionality of the tax treatment of employment termination payments is limited under existing legislation through the operation of RBLs and end benefits tax. The RBLs will be abolished from 1 July 2007 as part of the Government's Simplified Superannuation reforms. As a result, new taxation arrangements are required to ensure that certain payments on the termination of employment continue to receive more concessional taxation treatment than other forms of income while preventing abuse of the system.

4.25 Under the new arrangements, an individual who receives an employment termination payment after they reach their preservation age, or in the year in which they will reach their preservation age, will pay less tax on that payment than if it was received by an individual who is below their preservation age for the whole income year in which the payment is received.

4.26 The tax free component is the portion of an employment termination payment that relates to invalidity or to pre-July 1983 employment. This portion of the payment will not be subject to tax and it will not be exempt income (ie, it is tax free). [ Schedule 2, item 1, subsection 82 - 10(1 ) and section 82 - 140 ]

4.27 An employment termination payment contains an 'invalidity segment' if:

·
the payment was made to a person because they can no longer work because of physical or mental ill-health;
·
the person stopped working before they reached their 'last retirement day'; and
·
two legally qualified medical practitioners have certified that it is unlikely the person can ever work again in a role for which they are qualified by virtue of training, experience or education.

[ Schedule 2, item 1, subsection 82 - 150(1 )]

4.28 The invalidity segment is calculated as the portion of the payment that represents the period between termination and the person's 'last retirement day'. [ Schedule 2, item 1, subsection 82 - 150(2 )]

4.29 The pre-July 1983 segment is calculated as the portion of the payment that represents the individual's service period prior to 1 July 1983. The methodology for calculating this is currently set out in the ITAA 1936. The formula to be inserted into the ITAA 1997 effectively mirrors the existing calculation by apportioning the benefit based on the number of days of service prior to 1 July 1983 divided by the total number of days in the service period. [ Schedule 2, item 1, section 82 - 155 ]

4.30 The taxable component is the part of an employment termination payment that is not the tax free component (ie, the remainder of the payment after the tax free component is calculated). [ Schedule 2, item 1, section 82 - 145 ]

Treatment of the taxable component

4.31 The taxable component of an employment termination payment is included in an individual's assessable income for tax purposes. [ Schedule 2, item 1, subsection 82 - 10(2 )]

4.32 Individuals who have reached their preservation age (or will do so in the income year in which they receive the payment) will pay no more than 15 per cent tax on the taxable component of the employment termination payment that is within the employment termination payments cap. [ Schedule 2, item 1, paragraph 82 - 10(3 )( a ) and subsection 82 - 10(4 )]

4.33 Individuals who are below their preservation age throughout an income year will pay no more than 30 per cent tax on the taxable component of the employment termination payment that is within the employment termination payments cap. [ Schedule 2, item 1, paragraph 82 - 10(3 )( b ) and subsection 82 - 10(4 )]

4.34 The employment termination payments cap for the 2007-08 financial year is $140,000. The amount of the cap will be indexed annually. Details of the indexation arrangements can be found in Chapter 7 of this explanatory memorandum. [ Schedule 2, item 1, section 82 - 160 ]

4.35 If the employment termination payment is greater than the employment termination payments cap, the amount above the cap will be taxed at the top marginal rate in accordance with the Income Tax Rates Act 1986 .

Example 4.4 In November 2007, Ryan retires from his position as an executive at Mighty Power at age 65 after working there for 20 years. He receives a payment of $400,000 as a retirement bonus. As the payment relates only to post-June 1983 employment and there is no invalidity segment, there is no tax free component. Ryan pays tax at no more than 15 per cent on the first $140,000 of the payment and at the top marginal rate on the remaining $260,000.

4.36 The employment termination payments cap is reduced by the amount of any earlier life benefit termination payment received in the same financial year. This means that if the cap is exceeded by an earlier employment termination payment, any further payments received in the same year will be taxed at the top marginal rate. [ Schedule 2, item 1, paragraph 82 - 10(4 )( a )]

Example 4.5 Continuing Example 4.4, following his retirement, Ryan is approached to undertake a consulting role due to his industry experience. The consultancy is undertaken over a six month period and as part of his contract he receives a $100,000 payment when the work is complete. The payment falls within the same income year as his retirement from Mighty Power. As the employment termination payments cap was exceeded by the payment from Mighty Power, Ryan will pay tax at the top marginal rate on the full amount of the second employment termination payment.

4.37 The employment termination payments cap is also reduced by any earlier payments (whether in the same income year, or previous income years) received in relation to the same termination. This will mean that no more than the employment termination payments cap amount ($140,000 in 2007-08) can be received at concessional taxation rates in respect of any one termination. This ensures that individuals can not seek to pay less tax by having their employment termination payment paid to them in instalments over two or more years. [ Schedule 2, item 1 , paragraph 82 - 10(4 )( b )]

Example 4.6 Ryan, having terminated his employment with Mighty Power and being entitled to receive an employment termination payment of $400,000, arranges for his employer to make a payment of $200,000 in the income year in which his employment was terminated. He has no other employment termination payments in that year. The first $140,000 is taxed at no more than 15 per cent (as Ryan is 65). The remaining $60,000 is taxed at the top marginal rate.The remainder of Ryan's entitlement is paid to him in the following income year. The available taxation concession for Ryan in the second income year is reduced by the $140,000 he received at concessional tax rates in the earlier income year. Assuming no increase in the value of the employment termination payments cap, the entirety of the $200,000 received in the subsequent income year would be taxed at the top marginal rate.

Termination payments made more than 12 months after termination

4.38 A payment that would have been an employment termination payment, had it been made within 12 months of the employment termination, is assessable income and subject to tax at an individual's marginal tax rate if it is paid after the 12-month period and is not exempted from the 12-month rule by a determination by the Commissioner. [ Schedule 2, item 1, section 83 - 295 ]

Death benefit termination payments

4.39 The amendments apply to death benefit termination payments from 1 July 2007. Changes to the tax treatment of these payments reflect the abolition of benefits tax and RBLs, which operate to limit the concessional tax treatment of death benefit payments under existing legislation.

4.40 The tax treatment of death benefit termination payments depends on whether the recipient was a death benefits dependant of the deceased.

Death benefit termination payments to dependants

4.41 Any tax free component of an employment termination payment received by a death benefits dependant is not subject to tax. [ Schedule 2, item 1, subsection 82 - 65(1 )]

4.42 The part of the taxable component of a death benefit termination payment that is within the employment termination payments cap is not subject to tax and is not exempt income (ie, it is tax free) when paid to a death benefits dependant. [ Schedule 2, item 1, paragraph 82 - 65(2 )( a ) and subsection 82 - 65(3 )]

4.43 The part of the taxable component of a death benefit termination payment that exceeds the employment termination payments cap will be taxed at the top marginal rate. [ Schedule 2, item 1, paragraph 82 - 65(2 )( b ) and subsection 82 - 65(3 )]

4.44 As with life benefit termination payments, the employment termination payments cap is reduced by any death benefit termination payments received in the same or previous financial years in consequence of the same termination of employment. [ Schedule 2, item 1, subsection 82 - 65(4 )]

Example 4.7 Angela is a full-time student who lives at home. Her mother, who has supported her throughout her studies, dies. Her mother's employer pays Angela a death benefit termination payment of $150,000. As Angela was a death benefits dependant, she will pay no tax on the first $140,000 of the payment. She will pay tax at the top marginal rate on the remaining $10,000.

Death benefit termination payments for non-dependants

4.45 Death benefit termination payments made to those who are not death benefits dependants (non-dependants) will be taxed less concessionally than payments made to death benefits dependants. The additional concession available to death benefits dependants reflects the reliance these people had on the income of the deceased.

4.46 Any tax free component of an employment termination payment received by the non-dependant is not subject to tax. [ Schedule 2, item 1, subsection 82 - 70(1 )]

4.47 The remaining portion of a death benefit termination payment - the taxable component - is taxed at a maximum rate of 30 per cent for amounts below the employment termination payments cap. Any part of the payment that exceeds the employment termination payments cap is taxed at the top marginal rate. [ Schedule 2, item 1, subsections 82 - 70(2 ) to ( 4 )]

Example 4.8 Mark is employed full-time as a carpenter. Following the death of his grandfather, he receives a death benefit termination payment of $200,000 from his grandfather's employer. The pre-July 1983 component of this payment is $75,000. This amount is the tax free component and is not subject to tax. The remaining $125,000 is the taxable component, and as Mark was not a death benefits dependant of his grandfather, Mark will pay tax at no more than 30 per cent on this amount.

4.48 As with life benefit termination payments, the employment termination payments cap is reduced by any death benefit termination payments received in the same or previous financial years in consequence of the same termination of employment. [ Schedule 2, item 1, subsection 82 - 70(5 )]

Death benefits paid to the trustee of a deceased estate

4.49 Death benefit termination payments to trustees of deceased estates are subject to slightly different treatment than payments made directly to beneficiaries. [ Schedule 2, item 1, subsections 82 - 65(5 ), 70(6 ) and 75(1 )]

4.50 The portions of a death benefit termination payment relating to beneficiaries will be taxed in the hands of the trustee in the same way it would have been taxed if paid directly to a beneficiary.

4.51 The proportion of a payment that has or will benefit death benefits dependants of the deceased will be subject to tax as if the trustee of the deceased estate was a death benefits dependant who received the payment. [ Schedule 2, item 1, subsection 82 - 75(2 )]

4.52 The proportion of a payment that has or will benefit non-dependants of the deceased will be subject to tax as if the trustee of the deceased estate was a non-dependant who received the payment. [ Schedule 2, item 1, subsection 82 - 75(3 )]

Example 4.9 Yasmin is the trustee of her friend Michael's estate. Michael's will evenly divided his estate between his daughter and nephew. Michael's nephew is not a death benefits dependant, but his daughter is a death benefits dependant. As trustee, Yasmin receives a death benefit termination payment from Michael's employer of $150,000 (of which there is no tax free component). Half of the payment will be treated as though it had been paid directly to Michael's daughter and will not be subject to tax. The remaining $75,000 will be treated as though it had been paid directly to Michael's nephew and will be subject to tax at 30 per cent as it is below the employment termination payments cap.

Example 4.10 Matthew is the trustee of his friend Justin's estate. Justin's will evenly divided his estate between his son, Ricky, who is a death benefits dependant, and his three friends, Glenn, Shane and Adam. As trustee, Matthew receives a death benefit termination payment from Justin's employer of $400,000 (of which there is no tax free component). One quarter of the payment ($100,000) will be treated as though it had been paid directly to Justin's son Ricky. As this amount is less than $140,000 it will not be subject to tax. The remaining $300,000 will be treated as if it were paid to Matthew as a non-dependant of Justin. The first $140,000 of this amount will be taxed at 30 per cent. The remaining $160,000 will be taxed at the top marginal tax rate.

Other payments on termination

4.53 Division 83 of the ITAA 1997 contains the provisions related to unused annual leave, unused long service leave, genuine redundancy payments, early retirement scheme payments and foreign termination payments. The provisions relating to these payments are intended to retain their existing application but may have been redrafted to reflect current drafting approaches.

Unused annual leave payments

4.54 A person's assessable income will continue to include payments in consequence of unused annual leave, recreational leave, annual holidays and any other similar leave. [ Schedule 2, item 1, subsections 83 - 10(1 ) and ( 2 )]

4.55 An unused annual leave payment is a payment or bonus in relation to unused annual leave (including for leave that is yet to accrue) in consequence of an employment termination. [ Schedule 2, item 1 , subsection 83 - 10(3 )]

4.56 To the extent that an unused annual leave payment is made in connection with a genuine redundancy payment, early retirement scheme payment, the individual's invalidity or relates to employment before 18 August 1993 the rate of tax will be no more than 30 per cent (plus the Medicare levy). These eligibility criteria are the same as under existing legislation. Any other unused annual leave payments are taxed at marginal rates. [ Schedule 2, item 1, section 83 - 15 ]

Unused long service leave payments

4.57 A person's assessable income will continue to include payments in consequence of unused long service leave that are paid in consequence of an employment termination. The definition of 'unused long service leave' and the criteria for entitlement to a tax offset (including the methodology for calculating the components attributable to different periods and to part-time and full-time work) are the same as under existing legislation. [ Schedule 2, item 1, sections 83 - 70 to 83 - 115 ]

Genuine redundancy payments and early retirement scheme payments

4.58 The new terminology of 'genuine redundancy payment' and 'early retirement scheme payment' replace the existing ITAA 1936 terminology dealing with payments in consequence of bona fide redundancy and approved early retirement schemes respectively. [ Schedule 2, item 1, subsection 83 - 170(1 ) and sections 83 - 175 and 83 - 180 ]

Tax treatment

4.59 Genuine redundancy payments and early retirement scheme payments continue to receive the same concessional tax treatment provided for in the ITAA 1936.

4.60 The tax free part of the payment is excluded from assessable income and is not exempt income. [ Schedule 2, item 1, subsection 83 - 170(2 )]

4.61 The tax free part of a payment is determined by reference to a base amount plus an amount per year of service. This replicates the existing concession offered to such payments. [ Schedule 2, item 1, subsection 83 - 170(3 )]

4.62 If a payment on redundancy or early retirement exceeds the available tax free amount then the remaining part of the payment will qualify as an employment termination payment and be taxed accordingly. [ Schedule 2, item 1, subsections 83 - 175(4 ) and 180(6 ) and section 82 - 130 ]

Foreign termination payments

4.63 Termination payments related exclusively to overseas employment or service are treated differently to employment termination payments resulting from domestic employment.

4.64 The treatment of these payments reflects the existing treatment of exempt non-resident foreign termination payments and exempt resident termination payments as contained in the ITAA 1936. Payments that meet the conditions in sections 83-235 and 83-240 are not subject to tax in the hands of the recipient (ie, they are not assessable). They are, however, not exempt income. [ Schedule 2, item 1, Subdivision 83 - D ]

Application provisions

4.65 These amendments apply from 1 July 2007.

Transitional provisions

Pre-10 May 2006 entitlement to a termination payment

4.66 The transitional provisions operate to reduce the risk that employees with an entitlement to a payment on termination as at 9 May 2006 will terminate employment prior to that date in order to access the existing ETP provisions, including the ability to have an unlimited amount of such a payment made to a superannuation fund.

4.67 The transitional arrangements apply where a person is entitled, as at 9 May 2006, to a payment on termination of employment under a written contract, Australian or foreign law, legal instrument or workplace agreement made under the Workplace Relations Act 1996 , provided that the payment is made before 1 July 2012. Such a payment is referred to as a 'transitional termination payment'. Payments to which these transitional arrangements apply are not taxed under the normal employment termination payment provisions in the ITAA 1997. [ Schedule 2, item 2, subsections 82 - 10(1 ), ( 2 ), ( 5 ) and ( 6 )]

4.68 In order to ensure that the transitional provisions are not open to abuse, they are only available in situations where the payment was able to be determined as at 9 May 2006. This will encompass arrangements where the contract refers to the amount of the payment by way of a formula which can be objectively determined, or to payments made in kind (eg, shares). [ Schedule 2, item 2, subsections 82 - 10(3 ) and ( 4 )]

Example 4.11 Duncan is to have his employment terminated shortly after 1 July 2007. If Duncan were entitled, as at 9 May 2006, to an amount of $10,000 or an amount of 10,000 shares in the company, this would meet the transitional provision requirement of being a specified amount or providing for a way to work out the amount. If Duncan were able to choose between the shares or the cash, or was entitled to whichever had the greater value at termination, this would also meet the requirements. If Duncan were entitled to 10,000 shares only if they were at the time worth more than $5 each, this would also satisfy the test.If the payer has discretion as to whether the payment is made (but not the value of the payment) then such payments are also likely to satisfy the transitional provisions. For instance, if Duncan was entitled to 10,000 shares of the company if, in the opinion of the Board, he has raised the value of the company, or if he was entitled to $10,000 or 10,000 shares at the Board's discretion, these payments would qualify for the transitional arrangements. This is because the amount of the payment is still specified or able to be determined, despite the fact that the Board holds the sole decision-making power about the payment.If Duncan was entitled to an amount of money, or number of shares, at the complete discretion of the Board, this would not meet the requirements of the transitional provisions. Similarly, if the Board was to determine the value of the payment as an amount equal to 10 per cent of the amount by which the Board considers that Duncan has raised the value of the company, this would also fail to meet the requirements.

Taxation treatment if the recipient is below preservation age

4.69 The tax free component of a transitional termination payment made to a person below preservation age is not subject to tax. [ Schedule 2, item 2, subsection 82 - 10C(2 )]

4.70 Any remaining part of the payment - the taxable component - is included in assessable income. [ Schedule 2, item 2, subsection 82 - 10C(3 )]

4.71 The amount of the taxable component that does not exceed the upper cap amount of $1 million will be taxed at no more than 30 per cent. [ Schedule 2, item 2, subsections 82 - 10C(3 ) to ( 5 )]

4.72 The upper cap amount of $1 million is the upper limit on the amount of concessions that may be received during the transitional period. Therefore, the taxable components of all previous transitional termination payments, including directed termination payments, reduce the upper cap amount. [ Schedule 2, item 2, section 82 - 10D ]

4.73 Any amount which exceeds the upper cap amount worked out under section 82-10D is taxed at the top marginal rate.

Taxation treatment if the recipient has reached preservation age

4.74 If the recipient of a transitional termination payment will reach preservation age by the end of the income year in which the payment is received, the tax free component of the payment is not subject to tax. [ Schedule 2, item 2, subsections 82 - 10A(1 ) and ( 2 )]

4.75 The taxable component of a transitional termination payment is included in assessable income. [ Schedule 2, item 2, subsection 82 - 10A(3 )]

4.76 The amount of any transitional termination payment that does not exceed the 'lower cap amount' will be taxed at no more than 15 per cent. [ Schedule 2, item 2, subsections 82 - 10A(4 ) and ( 6 ) and section 82 - 10B ]

4.77 The amount of a transitional payment that exceeds the lower cap amount but does not exceed the upper cap amount will be taxed at no more than 30 per cent Any amount in excess of the upper cap will be taxed at the top marginal rate in accordance with the Income Tax Rates Act 1986 . [ Schedule 2, item 2, subsections 82 - 10A(5 ) and ( 7 )]

Example 4.12 Lian retires on 1 January 2008 at the age of 55. As at 9 May 2006 Lian was entitled to receive a payment on termination of $1.5 million. Lian will pay tax on the payment at a rate of no more than 15 per cent on the first $140,000, at a rate of no more than 30 per cent on the next $860,000 and at the top marginal tax rate on the remaining $500,000.

4.78 The lower and upper caps apply to each individual for the duration of the transitional period. Accordingly, the caps are reduced by the taxable components of any earlier transitional termination payments they may have received, including directed termination payments. [ Schedule 2, item 2, sections 82 - 10B and 82 - 10D ]

4.79 The lower cap amount is reduced by all amounts that have previously used the concession available to amounts below the lower cap amount. In addition, the lower cap amount is also reduced if the total of the taxable components of all directed termination payments in the income year in which the recipient reached preservation age or later and the taxable components of all payments received before preservation age exceed the difference between the upper cap amount and the lower cap amount. This prevents an individual, for example, receiving $900,000 worth of concessions before they reach preservation age, and an extra $140,000 of concessions after they reach preservation age, exceeding the concessional limit of $1 million (see Example 4.13). The lower cap amount cross-references the value of the employment termination payments cap and as such will be subject to indexation as that cap is indexed. [ Schedule 2, item 2, section 82 - 10B ]

4.80 The upper cap amount is reduced by the taxable components of all previous transitional payments, including directed termination payments. [ Schedule 2, item 2, section 82 - 10D ]

4.81 Any amount above the upper cap amount is taxed at the top marginal rate.

Example 4.13 Lian is the managing director of the Bouncing Baby child-care agency. Under the terms of her contract as at 9 May 2006, she is entitled to a termination payment of $900,000. She is also employed by Max's Employment Agency, and under her contract as at 9 May 2006 she is entitled to a payment of $500,000 on termination.On 1 July 2008, on her 54th birthday, Lian retires from her role with Bouncing Baby, and receives her transitional termination payment of $900,000. On 1 July 2009 on her 55th birthday, she retires from Max's Employment Agency and receives a payment of $500,000.None of the payments have a tax free component. First payment For the 2008-09 income year, Lian's entire payment of $900,000 will be taxed at no more than 30 per cent, because she is under her preservation age for the entire year and the payment does not exceed the upper cap amount of $1 million (subsections 82-10C(1) and (3) to (5)). Second payment The taxation of Lian's payment in the 2009-10 financial year is affected by the payment she received in the previous year, which will have to be taken into account when determining the tax rate on her second payment.As this second payment is made in the year in which Lian turned 55, she may be entitled to have an amount taxed at no more than 15 per cent. This amount is called the 'low rate part' and is that part of the payment which does not exceed the lower cap amount (subsection 82-10A(4)).The formula in subsection 82-10B(2) reduces the lower cap amount by an amount called the 'cap excess' and all previous transitional payments which have been taxed at 15 per cent.The 'cap excess' is the amount by which the sum of all previous transitional termination payments received prior to preservation age (plus any directed termination payments made after preservation age but prior to the payment in question) exceeds the 'cap difference' (subsection 82-10B(3)).The 'cap difference' is determined by subtracting the employment termination payments cap from $1 million (subsection 82-10B(3), step 3 of the method statement).Assuming no indexation, this gives the following result:

$1,000,000 - $140,000 = $860,000

In this example, the only earlier payment was the $900,000 Lian received on 1 July 2008. The cap excess is the amount by which this payment exceeds the cap difference. This is worked out under subsection 82-10B(3), step 3 of the method statement which gives the following result:

$900,000 - $860,000 = $40,000

This reduces the lower cap amount to $100,000. Lian's low rate part is therefore $100,000 which is taxed at a maximum rate of 15 per cent (subsections 82-10A(4) and (6)).The 'middle rate' part is so much of Lian's second payment that exceeds her low rate part, but does not exceed the amount worked out as:Upper cap amount - lower cap amountAs Lian's upper cap amount has been reduced by the $900,000 she previously received, the following calculation applies:

$100,000 (the reduced upper cap amount) - $100,000 (the lower cap amount reduced by the cap excess) = $0 (subsections 82-10A(5) and (7)).

Therefore none of the remaining $400,000 of Lian's second payment is entitled to concessional taxation treatment. $400,000 of Lian's second payment will be taxed at the top marginal tax rate.

Pre-payment statements

4.82 Employers who propose to pay a transitional termination payment are required to provide an individual with a 'pre-payment statement'. The statement must outline the components of the proposed payment and must ask the individual to make a choice between receiving the payment themselves, or a 'directed termination payment'. [ Schedule 2, item 2, section 82 - 10E ]

Transitional termination payment choice

4.83 An individual who wants to make a choice must advise their employer of their payment choice (ie, a direct payment to the individual or a directed termination payment) in the approved form and within 30 days of receipt of a pre-payment statement. In the absence of a decision, the payment must be made directly to the individual. [ Schedule 2, item 2, section 82 - 10F ]

4.84 A directed termination payment is a payment that an individual directs the payer to make to a complying superannuation plan or to purchase a superannuation annuity. [ Schedule 2, item 2, subsection 82 - 10F(1 ) and paragraphs 82 - 10F(2 )( a ) and ( b )]

4.85 If the recipient chooses to have the payer make a directed termination payment, the payer must comply with the direction and must give the recipient of the payment the details of the components of the payment. [ Schedule 2, item 2, paragraphs 82 - 10F(4 )( a ) and ( b )]

Taxation of directed termination payments

4.86 A directed termination payment is not subject to income tax and is not exempt income for the individual. The payment may be included in the assessable income of the superannuation provider. [ Schedule 2, item 2, section 82 - 10G ]

Pre-10 May 2006 entitlements: payments made after 1 July 2012

4.87 The employment termination payments cap applying to payments made after 1 July 2012 will be reduced by the amount of any transitional termination payments relating to the same employment termination, whether the transitional payment was made directly to the individual or rolled over into superannuation. [ Schedule 2, item 2, section 82 - 10H ]

Failure to make a transitional payment as directed

4.88 Amendments are being made to the Taxation Administration Act 1953 to apply penalties to transitional termination payment payers who receive a choice under subsection 82-10F(5) and do not make the payment as directed. [ Schedule 2, items 3 and 4, paragraphs 8C(1 )( h ) and ( i )]


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