Edited version of private ruling

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Ruling

Subject: Effectiveness of salary sacrifice arrangements

Question 1

Can an employment termination payment (ETP) paid under a deed of settlement be the subject of an effective salary sacrifice arrangement (SSA)?

Answer: No.

Question 2

Can the unused annual and long service leave accrued during the employment period and paid out on termination of the employee, be the subject of an effective SSA?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

Payments made to employee

The employee received an ETP under a deed of settlement which was an agreement to end his employment contract before the full term of the original employment contract.

The employee was of the opinion that he could salary sacrifice the full payment to an investment property loan account.

On termination the employee was also paid amounts for accrued rostered days off, unused annual leave, unused long service leave and a salary package reconciliation.

The employment contract allowed for SSAs to be entered into for superannuation and repayments to investment property loan accounts.

Accrual of Leave

Long Service Leave started accruing from the 2001 year. The long service leave has been accrued through a number of similar employers.

Unused annual leave has accrued since the August 2008.

The rostered day off entitlement has accrued since March 2009.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 6-10
Income Tax Assessment Act 1936 Section 23L
Fringe Benefits Taxation Assessment Act 1986 Subsection 136(1)

Reasons for decision

Summary

The payments on termination including the unused annual leave, unused long service leave and the ETP cannot be the subject of an effective SSA. The benefits have accrued before any arrangement was attempted to be entered into to salary sacrifice these amounts. There was no valid negotiation between the employer and employee to enter into a SSA. The ETP cannot be salary sacrificed as it falls outside the definition of a Fringe Benefit.

Detailed reasoning

(a) Payment on termination [fortnightly pay; salary package reconciliation; accrued RDO's; unused annual and long service leave]

The information provided shows that this termination payment was treated as though part of the gross amount was paid to the employee less deductions, less PAYG withholding and the remaining amount was salary sacrificed to investment property mortgage account at the direction of the employee.

The Commissioner's view on the taxation and superannuation implications of SSAs is discussed in Taxation Ruling TR 2001/10 Income tax: fringe benefits tax and superannuation guarantee: salary sacrifice arrangements. This ruling defines a SSA as being an arrangement whereby an employee negotiates with their employer to forego some part of their salary in return for some other benefit provided by the employer. If the salary sacrifice is effective, the employee will only be liable for income tax on the reduced salary.

There are two types of SSAs:

· 'Effective SSA' - an effective SSA involves the employee agreeing to receive part of his or her total amount of remuneration as benefits before the employee has earned the entitlement to receive that amount as salary or wages.

· 'Ineffective SSA' - an ineffective SSA involves the employee directing that an entitlement to receive salary or wages that has been earned is to be paid in a form other than as salary or wages.

TR 2001/10 considers benefits paid under effective SSAs are not 'salary or wages' within the meaning of that term in subsection 136(1) of the Fringe Benefits Taxation Assessment Act 1986 and employers, accordingly, have no Pay As You Go withholding liabilities in relation to the benefits.

Fortnightly pay

The salary component can only be salary sacrificed to the extent that the SSA was in place prior to the salary being earned. There was no arrangement in place for the remainder of the salary after allowance for the superannuation payment to be salary sacrificed. The salary component will be ordinary assessable income of the employee and subject to PAYG-W.

Salary package reconciliation

This is a calculation of what is purportedly a shortfall in the amount of benefits that were to be paid in the salary package during the financial year to date. Because it was calculated that there was a shortfall in benefits provided this amount is paid out as salary or wages. The amount cannot be then salary sacrificed to some other benefit, as there was no arrangement in place prior to it being paid. It is assessable as ordinary income to the employee and subject to PAYG-W.

Accrued RDO's

This is considered to be an ETP, as the payment is related to the termination of employment. As explained below an ETP cannot be salary sacrificed.

Unused annual and long service leave

In respect of salary sacrificing leave entitlements TR 2001/10 states the following:

SSAs that involve leave entitlements

89. Once an employee has completed the relevant qualifying period of employment and has an entitlement to take annual leave, long service or sick leave, the employee has an entitlement to be paid salary or wages. An entitlement to take leave is synonymous with an entitlement to be paid salary or wages because the employee has done everything necessary, apart from taking the leave, to be entitled to be paid.

90. It then follows that a SSA exchanging an entitlement to take leave that is accruing, or that has accrued, for past services performed in return for benefits is ineffective. Benefits paid under an ineffective SSA are payments of salary or wages and form part of the employee's assessable income under section 6-5 or 6-10 of the ITAA 1997.

91. We recognise that a SSA exchanging any expected entitlement to leave that will accrue for future services rendered in return for benefits will be effective. While benefits provided under an effective SSA may be derived as ordinary or statutory income by the employee (see paragraph 28 above), the income is exempt because of the operation of section 23L of the ITAA 1936.

92. Whether the conditions necessary for the taking of leave have been met is a question of fact. Statute, award conditions, individual contracts, enterprise workplace agreements or similar agreements may be relevant to determining whether the conditions have been met. Where there is a lengthy qualifying period which must be completed before any entitlement to leave accrues (as is generally the situation for long service leave entitlements), until that qualifying period has been completed, the conditions have not been met. Most employees must complete a minimum period of service before any entitlement to long service leave accrues. If the employee terminates employment prior to completing the required minimum period of service, the employee has no enforceable right to payment in lieu of long service leave. Some employees' employment conditions give a pro rata entitlement to be paid salary or wages once a lesser period of service has been completed, if employment terminates after that lesser period but before the full qualifying period. An employee who has not completed sufficient service to be entitled to take long service leave or receive a pro rata entitlement of salary or wages on termination of employment can enter into an effective SSA. Once the conditions for taking long service leave have been met, the employee can only enter into an effective SSA in respect of future entitlements to take long service leave.'

To have a valid SSA, the arrangement must be prospective. That is, the employee must elect to enter into the SSA prior to the point in time at which any relevant employment services are performed, or prior to the commencement of services.

Entitlement to annual leave and long service leave is based on employment services already provided thus attempting to sacrifice annual leave and long service leave does not satisfy the essential qualification of prospectivity of an effective SSA.

If a SSA was entered into to apply to leave that will accrue in the future, it will constitute an effective SSA (that is, if the SSA arrangement entered into prior to the unused annual leave and long service leave clearly specify that future leave entitlements that will accrue will be salary sacrificed).

The Commissioner of Taxation does not give approval for SSAs and cannot comment on how employers and employees make their employment contracts or when they should be amended. However, if both the employer and employee wish to enter into a SSA, for the agreement to be effective, it needs to be negotiated prior to performing the employment services.

The only evidence that has been provided is a copy of the employment agreement. There is no separate SSA provided in writing. There is nothing in the employment agreement to indicate that there is a SSA to sacrifice annual and long service leave entitlements. There is no other evidence to indicate that any valid SSA was entered into between the employer and the employee prior to the entitlement to these leave payments. The only evidence available is that the employee instructed the Payroll Officer that, he had the ability to legitimately salary sacrifice investment loan repayments. He directed that the amount be salary sacrificed and the payment be made to his mortgage account and there was no requirement to deduct tax from the gross amount.

This is not an effective salary sacrifice as no arrangement was entered into with regards to leave entitlements prior to the employee becoming entitled to these payments. There has been no negotiation between the employee and employer to forgo part of his salary in return for some other benefit provided by the employer. It is merely a redirection of where the employee wanted the payment to be made.

The amounts will be assessable income to the employee as payments of unused annual and long service leave and the employer would have an obligation to make the correct PAYG-W deductions. An amended payment summary should be issued to reflect these amounts.

(b) Employment termination payment

An ETP is a lump sum payment made by an employer to an employee as a result of termination of employment of the employee. It is clear from the 'Settlement Deed' that the settlement sum amount was intended to be an ETP. The payment was to be made to the employee's bank account after the necessary pay as you go withholding tax was taken out.

You have stated that the employee instructed the pay roll officer to salary sacrifice the full amount into the investment property loan account and not to deduct any tax. These instructions were followed.

This has not been dealt with in accordance with the settlement deed instructions where PAYG-W should have applied. There was no allowance for negotiations between the employer and employee in terms of a SSA.

For the reasons outlined below employment termination payments cannot be the subject of 'salary sacrifice'.

In paragraph 19 of TR 2001/10, a SSA means:

An employee agrees to forgo part of his or her total remuneration that he or she would otherwise expect to receive as salary or wages, in return for the employer or someone associated with the employer providing benefits of a similar value.

TR 2001/10 also states at paragraph 2:

'…we regard SSAs as remuneration arrangements involving PAYG withholding amount payers and payees covered by sections 12-35 (salary, wages, commission, bonuses or allowances paid to an individual as an employee), 12-40 (remuneration of company directors) or 12-45 (salary, wages, etc. paid to certain office holders) of Schedule 1 to the Taxation Administration Act 1953…'

This paragraph makes no specific reference to section 12-85 of the Taxation Administration Act 1953 dealing with superannuation lump sums and ETPs. For this reason an ETP cannot be the subject of a SSA. The purported SSA is not an effective salary sacrifice.

The amounts will be assessable income to the employee as an ETP and the employer would have an obligation to make the correct PAYG-W deductions.