Explanatory Memorandum(Circulated by the authority of the Deputy Prime Minister and Treasurer, the Hon Wayne Swan MP)
Better targeting of the employment termination payment tax offset
Outline of chapter
5.1 Schedule 5 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) so that access to the employment termination payment (ETP) tax offset and the amount of offset received takes into account an individual's taxable ETP as well as any other taxable income in the year they receive the ETP. From 1 July 2012, any taxable component of an ETP that takes a person's total taxable income in a year above $180,000 will be taxed at marginal rates.
Context of amendments
5.2 An employment termination payment is a payment, or property in lieu of a payment, given to an employee, or another person, as a consequence of the termination of that employee's job (section 82-130 of the ITAA 1997).
- It does not matter who pays the termination payment, as long as it is paid in consequence of the termination of a person's employment.
- A person's employment is terminated where it ceases, regardless of the reason for that person's job ending. This means termination includes retirement, resignation, dismissal or termination due to death.
- Examples of ETPs include gratuities, severance pay, payments in lieu of notice of termination, taxable components of genuine redundancy payments and, in limited contexts, compensation payments arising out of employment disputes.
5.3 A payment made upon termination of employment may be tax free (in whole or in part). For example, genuine redundancy and early retirement scheme payments have a tax free component calculated according to an employee's years of service. Death benefits paid to an employee's dependants are tax free up to the ETP cap amount ($175,000 in 2012-13, indexed). Other ETPs, such as gratuities, may include a tax free component if the payment relates to invalidity or work performed prior to July 1983 (section 82-140).
5.4 A tax offset applies to the taxable component of ETPs. This offset ensures that the maximum tax payable on a person's ETP is:
- 30 per cent (excluding the Medicare levy), if the ETP recipient is under preservation age (55 years of age in 2012-13); or
- 15 per cent (excluding the Medicare levy), if the ETP recipient is over preservation age (subsection 82-10(3)).
5.5 The ETP tax offset is available for taxable ETPs up to an ETP cap amount which is indexed by the rules set out at Subdivision 960-M in ITAA 1997 (section 82-160). The ETP cap amount is $175,000 in 2012-13.
5.6 The design of the ETP tax offset provides the most benefit to taxpayers on the top marginal tax rate. Taxpayers on low incomes get little or no benefit from the ETP tax offset.
5.7 Based on marginal tax rates in 2011-12:
- For taxpayers aged under 55, those taxpayers with taxable income of $80,000 or less (including their ETP) are not able to benefit from the offset.
- For taxpayers aged 55 and over, those taxpayers with taxable income of $37,000 or less (including their ETP) are not able to benefit from the offset.
5.8 High income earners are twice as likely as low-income earners to receive taxable ETPs and, on average, receive payments that are more than forty times as large.
5.9 To make the taxation of ETPs fairer, the Deputy Prime Minister and Treasurer announced in the 2012-13 Budget that the Government would scale back the tax offset applying to ETPs, such as gratuities, while keeping the existing offset for ETPs relating to hardship.
Summary of new law
5.10 This Schedule reforms eligibility for the ETP tax offset for termination payments, so that the amount of a payment that attracts the ETP tax offset is dependent on an individual's total taxable income (including the ETP) in a year they receive an ETP.
5.11 The part of a taxable component of an ETP that, when added last to an individual's other taxable income, is equal to or below a 'whole-of-income cap' of $180,000 will continue to be eligible for the ETP tax offset. Any amount of a taxable component of an ETP that takes a person's total taxable income over $180,000 will be taxed at marginal rates.
- The $180,000 whole-of-income cap will not be indexed.
- The existing ETP cap ($175,000 in 2012-13, indexed) will work in conjunction with the whole-of-income cap so that, regardless of other taxable income, ETPs can only access the offset for ETP amounts up to a maximum of the ETP cap amount.
5.12 People who:
- receive genuine redundancy payments (or who would have but for existing age or retirement restrictions on genuine redundancy payments);
- lose their job due to invalidity (regardless of how close to retirement);
- receive compensation due to a genuine employment related dispute relating to personal injury, harassment, discrimination or unfair dismissal (where the payment is currently considered an ETP); or
- receive a non-superannuation death benefit ETP;
would continue to receive the current tax treatment (ETP tax offset up to the existing ETP cap, excluding other income, of $175,000 in 2012-13, indexed) and continue to have access to the full benefit of the ETP tax offset.
5.13 Any tax free component of a termination payment, such as invalidity or pre-July 1983 employment components, will continue to be tax free. This includes the tax free component of genuine redundancy and early retirement scheme payments, as well as tax free components of death benefit ETPs.
5.14 Foreign termination payments and the offset for unused annual leave and unused long service leave will also be unaffected by these amendments.
Comparison of key features of new and current law
|New law||Current law|
|People who receive a life benefit ETP not related to genuine redundancy, early retirement, invalidity or certain types of compensation, are eligible for the ETP tax offset for that part of the ETP that takes their total taxable income up to $180,000, from 1 July 2012.||People who receive an ETP are eligible for a tax offset for the first $175,000 (in 2012-13, indexed) of the taxable component of the ETP, after which marginal rates apply.|
|The existing ETP cap amount continues to apply to ETPs so that a maximum $175,000 (in 2012-13, indexed) of an ETP can receive the ETP tax offset (where the $180,000 whole-of-income cap has not already been breached).|
Detailed explanation of new law
5.15 These amendments provide that the ETP tax offset mentioned in subsection 82-10(3) of the ITAA 1997 takes account of a person's other taxable income in the year that they receive an ETP.
5.16 The amendments give effect to the 2012-13 Budget measure to provide a fairer tax treatment of ETPs, such as golden handshakes.
5.17 The ETP tax offset in subsection 82-10(3) applies to the amount worked out under subsection 82-10(4).
5.18 Subsection 82-10(4) is amended so that the ETP tax offset applies to so much of the taxable component of an ETP that does not exceed the smallest of the amounts worked out under the ETP cap or the new whole-of-income cap of $180,000. [Schedule 5, item 1, subsection 82-10(4)]
- The amendments only apply to life benefit termination payments. Death benefit termination payments will continue to receive their existing tax treatment.
- The ETP cap is reduced by ETPs received earlier in the year or by ETPs received in an earlier year relating to the same termination. This is a feature of the existing ETP cap.
5.19 The $180,000 whole-of-income cap will operate by subtracting a person's non-ETP taxable income from $180,000, leaving an amount equal to or less than $180,000 (but not less than zero) which will be eligible for the ETP tax offset. [Schedule 5, item 1, paragraph 82-10(4)(c)]
5.20 This is achieved by reducing the $180,000 whole-of-income cap by a person's taxable income for the income year in which the ETP is made (disregarding as a part of taxable income the ETP in question or any ETPs received later in the income year). [Schedule 5, item 1, paragraph 82-10(4)(c) and subsection 82-10(5)]
Example 5.10 Percival has taxable income from wages and investments of $100,000 in 2012-13. He retired from his job in December 2012 and received a termination package of $100,000, paid in two instalments of $50,000 (one in December 2012 and one in June 2013) which forms a taxable ETP in its entirety.Under the whole-of-income cap, $180,000 is reduced by Percival's taxable income for the income year, disregarding the total of the first termination payment received and subsequent termination payments. For Percival's first payment of $50,000, the entire amount would fall within the whole-of-income cap ($180,000 whole of income cap, less $100,000 wage and investment income, leaves $80,000 of termination payment that can fall within the whole-of-income cap).For the second payment of $50,000, only $30,000 will fall within the whole-of-income cap ($180,000 whole of income cap, less $100,000 wage and investment income, less $50,000 taxable termination payment received earlier in the income year, equals $30,000 remaining cap available). As only $30,000 of the second payment falls within this amount, only $30,000 of Percival's second termination payment will be eligible for the ETP tax offset.This means in total, Percival is eligible for the ETP tax offset on $80,000 ($50,000 of the first payment and $30,000 of the second payment) of his total termination package. Since his non-ETP taxable income for the year was $100,000, the $80,000 of ETP tax offset eligible termination payment represents the amount available to Percival that takes his income up to the $180,000 whole-of-income cap.
5.21 The existing ETP cap ($175,000 in 2012-13, indexed) will still apply in conjunction with the $180,000 whole-of-income cap. This means that a taxable component of an ETP cannot receive an ETP tax offset for that part of the payment that exceeds the 'ETP cap amount' in section 82-160. [Schedule 5, item 1, subsection 82-10(8)]
Example 5.11 Shen retires on 1 July 2012 and receives a termination payment of $200,000. Because of some negatively geared investments, Shen has a tax loss of $20,000 in 2012-13 and a taxable income of nil (disregarding his ETP). Under the whole-of-income cap provision in paragraph 82-10(4)(c), Shen reduces $180,000 by his non-ETP taxable income for the year - tax losses are disregarded. Therefore, $180,000 of taxable ETP could fall within the whole-of-income cap. However, as the amount eligible for the ETP offset is the smallest of the amounts worked out under the whole-of-income cap and the ETP cap, Shen is only eligible for the ETP offset on $175,000 of his ETP (as worked out under paragraphs (a) and (b) of subsection 82-10(4)).
5.22 People who:
- receive a genuine redundancy payment or early retirement scheme payment (or who receive payments that would have been genuine redundancy or early retirement scheme payments but for existing age or retirement restrictions);
- lose their job due to invalidity (regardless of how close to retirement); or
- receive an ETP which is paid principally to compensate a person for a genuine dispute arising out of personal injury, unfair dismissal, harassment or discrimination;
are explicitly excluded from the whole-of-income cap arrangements and are unaffected by the measure. These payments are excluded payments and are listed in subsection 82-10(6). [Schedule 5, item 4, subsection 82-10(6)]
Example 5.12 Hania is a 66 year old executive who has been working for her employer for five years. In 2012-13, the company she works for is taken over by a larger company and Hania's position is no longer needed. No other appropriate position is offered to Hania, so she accepts a redundancy and is immediately paid $190,000, of which $50,000 could reasonably be expected to be received as a result of Hania voluntarily terminating her employment. Hania's other taxable income for the year 2012-13 is $200,000.Although Hania's payment is not a 'genuine redundancy payment' under section 83-175 of the ITAA 1997 because she is aged over 65 (and therefore does not contain a tax free component), her position is still genuinely redundant because her employer no longer requires her position. Because Hania is made genuinely redundant, the genuine portion of her redundancy payment is carved out from the whole-of-income cap (it is an 'excluded payment'). The existing $175,000 ETP cap amount continues to apply to this portion of Hania's payment. As all of the $140,000 of Hania's genuine redundancy portion of her ETP falls within the ETP cap amount, this whole amount is eligible for the ETP tax offset. The whole-of-income cap would operate to deny the ETP tax offset to any of the $50,000 portion of Hania's payment (which she could have received upon voluntarily terminating her employment). This is because Hania's other taxable income of $200,000 already exceeds the whole-of-income threshold. Example 5.13 Maureen suffered an injury outside her workplace and is medically certified as being unable to be gainfully employed in the capacity for which she is trained and has experience. As a result, Maureen's employer terminates Maureen's employment and pays Maureen $100,000. Maureen is 60 when she receives her payment. Maureen's other income for the year is $180,000. Part of Maureen's payment is tax free as an 'invalidity segment'. The invalidity segment of Maureen's payment is calculated based on the number of days she has until retirement and her total days working for her employer. Using the formula in subsection 82-150(2), $30,000 of Maureen's payment is an invalidity segment. The remainder of Maureen's payment is a taxable ETP. However, subsection 82-10(6) ensures that ETPs that include an invalidity segment are not subject to the new whole-of-income cap. This means that the taxable component of Maureen's payment will receive the ETP tax offset regardless of her income. As Maureen is 60 years old (over preservation age), the maximum tax payable on the taxable component of her payment, which is $70,000, is 15 per cent (excluding the Medicare levy).
5.23 Payments that are made principally to compensate a person for a genuine dispute arising out of personal injury, unfair dismissal, harassment, discrimination or any other matter prescribed by the regulations will be excluded from the operation of the whole-of-income cap. [Schedule 5, item 1, paragraph 82-10(6)(d)]
- A payment does not need to be made as a consequence of proceedings before a court in order to be compensation.
5.24 Where a person receives multiple termination payments at different points in time, where some of the termination payments are excluded payments (for example genuine redundancy payments) and some are not-excluded payments (for example gratuities), the ETP cap amount will be applied separately to the excluded payments and not-excluded payments. [Schedule 5, item 1, paragraphs 82-10(4)(a) and 82-10(4)(b)]
- This ensures that a person who receives a non-excluded payment earlier in the year and who is affected by the whole-of-income cap does not exhaust their ETP cap on the non-excluded payment (which may not be eligible for an ETP tax offset) at the expense of an excluded payment they may receive later in the year (which will be eligible for an ETP tax offset).
5.25 Excluded payments will benefit from the ETP tax offset in the first instance, as the ETP cap amount will be reduced only by prior excluded payments received. [Schedule 5, item 1, subparagraphs 82-10(4)(a)(i) and 82-10(4)(b)(i)]
5.26 Not-excluded payments will benefit from the ETP tax offset in the second instance, as the ETP cap amount will be reduced by any prior life benefit termination payments received, whether or not they are excluded or not-excluded payments. [Schedule 5, item 1, subparagraphs 82-10(4)(a)(ii) and 82-10(4)(b)(ii)]
5.27 The total amount of termination payment, whether excluded or not, that can receive the ETP offset is limited to the amount of all termination payments that fall under either the ETP cap amount or the whole-of-income cap, and which in aggregate do not exceed the ETP cap amount. [Schedule 5, item 1, subsection 82-10(8)]
Example 5.14 Barry is made genuinely redundant in May 2013 and immediately receives a termination gratuity of $50,000, which is a set amount that Barry is due to receive under his contract when he leaves his job for any reason (including resigning voluntarily).In July 2013, Barry receives a further amount of $150,000 which represents the genuine redundancy portion of Barry's total termination package.Barry's income for the 2012-13 income year is $140,000. In considering Barry's first termination payment, $40,000 falls beneath the whole-of-income cap ($180,000 whole-of-income cap minus $140,000 taxable income leaves $40,000). Therefore, only $40,000 of the $50,000 payment receives the ETP tax offset.In considering the second payment, which is entirely an 'excluded payment', the whole $150,000 amount will fall beneath the ETP cap amount tests in subparagraphs 82-10(4)(a)(i) and 82-10(4)(b)(i), as Barry has not received any other excluded amounts as part of termination payments received either earlier in the same income year, or in earlier income years in relation to the same termination.However, under subsection 82-10(8) Barry is not entitled to have the ETP tax offset apply to total termination payment amounts exceeding the ETP cap amount. Barry has already received the ETP tax offset on $40,000 of the first termination payment and if the ETP cap amount for 2013-14 is $185,000, only a further $145,000 can receive the ETP tax offset. Of the second payment $5,000 will be taxed at marginal rates as this amount exceeds the ETP cap amount.In this way Barry can still access the full benefit of the ETP tax offset on termination payments received up to the ETP cap amount (as he would in the absence of this measure).
5.28 If a person's single termination payment includes both an excluded payment part and a not-excluded payment part (where the two parts of the payment are received at the same time), then the amount of the payment that will be eligible for the ETP tax offset as calculated in subsection 82-10(4) is the amount worked out as if the part of the payment that is an excluded payment was received first. [Schedule 5, item 1, subsection 82-10(7)]
- For example, a person who receives a compensation ETP is only excluded from the whole-of-income cap to the extent that that payment is in excess of what the person would have been eligible for had they voluntarily terminated their employment, such as through retirement or resignation. The component of the payment they would have been eligible for upon voluntary termination of their employment is not an 'excluded payment', while the amount in excess of this is an 'excluded payment'. [Schedule 5, item 1, subparagraph 82-10(6)(d)(iii)]
Example 5.15 Under Dennis's employment contract, he is entitled to a gratuity of $160,000 upon termination. However, upon termination, Dennis receives nothing from his employer. Dennis also believes that his employer unfairly terminated his employment. Dennis launches a court action against his employer claiming unfair dismissal. The court finds in favour of Dennis and orders he be paid an amount of $200,000 in compensation, of which $160,000 is for his unpaid entitlement under his employment contract and $40,000 is compensation for unfair dismissal. Dennis's other taxable income is $150,000.Of the $200,000 Dennis received, $160,000 could reasonably be expected to be received by Dennis if he had terminated his employment voluntarily and $40,000 represents compensation for unfair dismissal. The compensation Dennis received was paid in consequence of the termination of his employment, and so the full $200,000 is an ETP. The $160,000 that Dennis was entitled to under his contract is a taxable ETP that is not expressly excluded from the whole-of-income cap (it is not an 'excluded payment'). The $160,000 payment is therefore subject to both the ETP cap amount and the whole-of-income cap.The $40,000 compensation amount is a taxable ETP that is expressly excluded from the whole-of-income cap (it is an 'excluded payment'). The $40,000 will therefore not be counted towards the whole-of-income cap, but it will count towards the ETP cap amount.In applying amounts towards the ETP cap amount, those amounts carved out from the whole-of-income cap are applied first. As such, the $40,000 in compensation falls within the ETP cap amount and is eligible for the ETP tax offset.When considering the not-excluded portion of Dennis' compensation payment, because Dennis has other taxable income of $150,000 only $30,000 of the $160,000 that Dennis receives is eligible for the ETP offset. The remaining $130,000 is taxed at marginal rates. Example 5.16 Zema receives a single termination payment of $200,000 in 2012-13. This includes two components - a $50,000 gratuity and $150,000 as compensation for unfair dismissal. Zema has no other taxable income. Under her employment contract, if Zema had resigned voluntarily, she would not have been eligible for any payment. Zema's payment is made up of a part that is subject to the whole-of-income cap (being the gratuity) and a part that is excluded from the whole-of-income cap (being the compensation). Even though the two components were part of the one payment, the amount under subsection 82-10(4) is worked out as though Zema received the compensation payment first. Zema is eligible for the ETP tax offset on the whole $150,000 of her compensation payment as this is within the ETP cap (and is exempted from the whole-of-income cap provision).In considering the gratuity, subsection 82-10(7)(a) requires that you treat this payment as the second of two payments received. Therefore, in applying the whole-of-income cap $180,000 would be reduced by the $150,000 compensation payment (which would be treated as a prior payment and which is taxed at a concessional rate through the application of the ETP offset). This leaves $30,000 of ETP that can fall within the whole-of-income cap.However, subsection 82-10(4) ensures that the amount of Zema's gratuity that is eligible for the ETP offset is the smallest of the amount worked out under the whole of income cap or the ETP cap. Under the ETP cap test in subparagraph 82-10(4)(a)(ii), Zema only has $25,000 remaining ($175,000 ETP cap less $150,000 compensation payment), so the amount worked out under subsection 82-10(4) for Zema's gratuity is $25,000.In total Zema is eligible for the ETP tax offset on $175,000 of her $200,000 termination payment ($150,000 of her $150,000 compensation payment and $25,000 of her $50,000 gratuity).
Application and transitional provisions
5.29 These amendments apply to employment termination payments received on or after 1 July 2012. [Schedule 5, item 2]