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Ruling

Subject: Employment termination payment - PAYG obligations

Question 1

Is any part of the payment received by the Employee on termination of employment an employment termination payment in accordance with subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

Yes.

Question 2

Is any part of the payment received by the Employee considered to be the tax-free part of a genuine redundancy payment in accordance with section 83-170 of the ITAA 1997?

Advice/Answers

Yes.

This ruling applies for the following period

Year ending 30 June 2010

The scheme commenced on

4 September 2009

Relevant facts

The Employee was employed by an employer (the Employer).

The Employee is under 55 years of age.

The Employer made the Employee redundant in the 2009-10 income year.

The Employee subsequently lodged an application for unfair dismissal remedy with Fair Work Australia pursuant to section 394 of the Fair Work Act 2009 (Cth).

The matter was settled between the Employer and the Employee out of court and prior to any formal determinations.

A deed of settlement and release (the Deed) was signed in the 2009-10 income year.

The Deed states that without admission or concession, the Employer and the Employee agreed to settle all proceedings, issues, and claims between them, arising, directly, or indirectly, from the Employee's employment, the termination of the Employee's employment, or both.

The payment is made within 12 months after the termination of the Employee's employment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 995-1.

Income Tax Assessment Act 1997 Subsection 82-130(1).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(a).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Paragraph 82-130(1)(b).

Income Tax Assessment Act 1997 Subsection 82-130(4).

Income Tax Assessment Act 1997 Paragraph 82-130(5)(a).

Income Tax Assessment Act 1997 Section 83-175.

Income Tax Assessment Act 1997 Subsection 83-175(1).

Income Tax Assessment Act 1936 Section 27F.

Income Tax Assessment Act 1997 Paragraph 83-175(2)(a).

Income Tax Assessment Act 1997 Paragraph 83-175(2)(b).

Income Tax Assessment Act 1997 Paragraph 83-175(2)(c).

Income Tax Assessment Act 1997 Subsection 83-175(3).

Reasons for decision

Summary of decision

The payment received by the Employee is an employment termination payment as it is received in consequence of the termination of the Employee's employment, is received within 12 months after the termination of employment and, apart from the amount determined to be the tax-free part of a genuine redundancy payment, is not excluded from being an employment termination payment.

As the Employee has been dismissed because their position is redundant and the necessary conditions for the payment to be considered as a genuine redundancy payment have been met, the payment is a genuine redundancy payment. Accordingly, a portion of the payment will be a tax-free part of a genuine redundancy payment. The tax-free part genuine redundancy payment is excluded from being an employment termination payment.

The remaining amount of the payment after deducting the tax-free part of the genuine redundancy payment is an employment termination payment.

Detailed reasoning

Employment termination payment

From 1 July 2007, payments made in consequence of the termination of a taxpayer's employment are known as employment termination payments. Prior to 1 July 2007, these payments were known as eligible termination payments.

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states:

employment termination payment has the meaning given by section 82-130.

Subsection 82-130(1) of the ITAA 1997 states:

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 person's death, in consequence of the termination of the other person's 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.

Therefore, it can be seen that a number of conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of the conditions will result in the payment not being considered an employment termination payment.

Payment is made in consequence of the termination of employment

The first condition to be met is that the payment is received by the person in consequence of the termination of their employment.

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 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.

In paragraph 5 of TR 2003/13 the Commissioner also notes that the Courts have considered the meaning of the words 'in consequence of' in several cases.

Of note are the decisions made by the Full Bench of 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).

In Reseck, Justice Gibbs stated:

Within the ordinary meaning of the words a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination. It is not my opinion necessary that the termination of the services should be the dominant cause of the payment.

While Justice Jacobs, in the same case, stated:

It was submitted that the words in consequence of import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a following on.

In looking at the phrase 'in consequence of' the Full Federal Court in McIntosh considered the decision in Reseck. In doing so the Full Federal Court emphasised that a payment may be in consequence of the termination of employment even though the termination is not the dominant cause of the payment.

In particular, Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment.

Thus, 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.

The phrase 'in consequence of' and the decisions in Reseck and McIntosh were considered more recently by the Federal Court in Le Grand v Federal Commissioner of Taxation [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39 (Le Grand).

In Le Grand, a settlement payment in relation to legal proceedings involving a wrongful dismissal claim, together with a claim for misleading and deceptive conduct, was held to be an eligible termination payment. Justice Goldberg, the presiding judge, considered that the settlement of the misleading and deceptive conduct component of the claim did not break the casual relationship that existed between the settlement payment and the termination of the taxpayer's employment.

In making his decision, Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicants employment and the payment to warrant the finding that the payment was made in consequence of the termination of the applicants employment. I am satisfied that the payment was an effect or result of that termination in the sense that there was a sequence of events following the termination of the employment which had a relationship and connection which ultimately led to the payment.

Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was articulated by Justice Gibbs in Reseck.

The approach taken in Le Grand was also adopted in Dibb v Commissioner of Taxation (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126, where the Full Federal Court held that a payment received under a deed of release following the settlement of legal proceedings against the taxpayer's former employer was an eligible termination payment. The Court considered that there was a clear chain of causation between the payment and the termination. That is, the subject matter of the litigation was clearly interwoven and intertwined with the termination.

Thus, for the payment to have been made in consequence of the termination of employment, the payment must follow as an effect or result of the termination of employment. As noted in paragraph 6 of TR 2003/13, there must be 'a causal connection between the termination and the payment even though the termination need not be the [sole or] dominant cause of the payment'.

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.

From the facts provided the Employee's employment with the Employer was terminated on in the 2009-10 income year. As a result, the Employee lodged an application for unfair dismissal remedy with Fair Work Australia pursuant to section 394 of the Fair Work Act 2009 (Cth).

The matter was settled between the Employer and the Employee out of court and prior to any formal determinations. A deed of settlement and release (the Deed) was signed in the 2009-10 income year and a gross settlement amount (the payment) was made to the Employee.

The payment is considered to be made in consequence of the Employee's termination of employment. The payment would not have been made had there been no termination of employment. The termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the issue of paying a lump sum would not have arisen.

As the lump sum payment is considered to be received by the Employee in consequence of the termination of employment, the requirement of subparagraph 82-130(1)(a) of the ITAA 1997 will be met.

The payment is received no later than 12 months after termination of employment

To qualify as an employment termination payment, the payment must be received no later than 12 months after the termination of the taxpayers employment (paragraph 82-130(1)(b) of the ITAA 1997). This is referred to as the 12 month rule.

The payment is made within 12 months after the termination of the Employee's employment. Therefore, this condition will be satisfied.

Not a payment mentioned in section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 lists payments that are excluded from being an employment termination payment. These include (among others):

- superannuation benefits;

- unused annual leave or long service leave payments;

- foreign termination payments covered under Subdivision 83-D of the ITAA 1997; and

- the tax free part of a genuine redundancy payment or an early retirement scheme payment.

Relevant to this particular case is whether the payment represents the tax free part of a genuine redundancy payment.

Genuine redundancy payment

A payment made to an employee, after 30 June 2007, is a genuine redundancy payment 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 previously referred to as bona fide redundancy payments.

Section 83-175 of the ITAA 1997 states:

(1) A genuine redundancy payment is so much of a payment received by an employee who is dismissed from employment because the employees position is genuinely redundant as 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 dismissal.

(2) A genuine redundancy payment must satisfy the following conditions:

(a) the employee is dismissed before the earlier of the following:

(i) the day he or she turned 65;

(ii) if the employees 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 the age or complete the period of service (as the case may be);

(b) if the dismissal was not at arms length the payment does not exceed the amount that could reasonably be expected to be made if the dismissal were at arms length;

(c) 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 dismissal.

(3) However, a genuine redundancy 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 the payment was received or at a later time.

Payments not covered

(4) A payment is not a genuine redundancy payment if it is a payment mentioned in section 82-135 (apart from paragraph 82-135(e)).

Under subsection 83-175(1) of the ITAA 1997, a genuine redundancy payment is a payment resulting from:

(i) a dismissal; and

(ii) a redundancy.

The terms dismissal and redundancy are not defined in the ITAA 1997. Therefore, it is necessary to consider the common law or ordinary meaning of the terms and the meaning the judicial authorities have ascribed to each word.

The Explanatory Memorandum to the Income Tax Assessment Amendment Act (No.3) 1984, which inserted former section 27F into the ITAA 1936, states at page 91:

The terms dismissal and redundancy are not defined in the legislation and, therefore, should be given their ordinary meanings. Dismissal carries with it the concept of the involuntary (on the taxpayer's part) termination of employment. Redundancy carries the concept that the requirements of the employer for employees to carry out work of a particular kind, or for employees to carry out work of a particular kind in the place where they were so employed, have ceased or diminished or are expected to cease or diminish. Redundancy, however, would not extend to the dismissal of an employee for personal or disciplinary reasons or for reasons that the employee was inefficient.

The Commissioner has issued Taxation Ruling TR 2009/2, titled Income Tax: genuine redundancy payments. The Taxation Ruling provides useful guidance on the factors to be considered in the interpretation of section 83-175 of the ITAA 1997.

Paragraph 11 of TR 2009/2 states:

11. There are four necessary components within this requirement:

The payment being tested must be received in consequence of an employee's termination.

That termination must involve the employee being dismissed from employment.

That dismissal must be caused by the redundancy of the employee's position.

The redundancy payment must be made genuinely because of a redundancy.

The payment is in consequence of the termination of employment

The issue of whether the payment was paid in consequence of the termination of the Employee's employment was discussed above. It was determined that the payment is made in consequence of the Employee's termination of employment. Therefore, this requirement is met.

Dismissal from employment and dismissal caused by redundancy

Dismissal requires a termination of employment at the initiative of the employer without the consent of the employee.

Section 83-175 of the ITAA 1997 requires that the dismissal be caused by redundancy of the employees position, and not for some other reason. Redundancy must be the reason for termination of employment by way of dismissal.

At paragraphs 25 to 27 of TR 2009/2, the Commissioner makes the following comments regarding dismissal and redundancy:

25. An employee's position is redundant when an employer determines that it is superfluous to the employer's needs and the employer does not want the position to be occupied by anyone. Accordingly, it is fundamentally the employer's decision that a position is redundant. On occasion the decision may be unavoidable due to the circumstances surrounding the employer's operations.

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.

27. On the other hand, if an employer decides after downsizing or some other structural reorganisation to terminate an employee, the former position of the employee is redundant as long as the downsizing or reorganisation is the prevailing or most influential cause of the termination.

As noted in the facts the Employer made the Employee redundant in the 2009-10 income year. It is considered that the Employee is dismissed due to their position being made redundant by the Employer.

The redundancy payment must be made genuinely because of a redundancy

In regards to the redundancy payment being made genuinely because of a redundancy paragraph 277 of TR 2009/2 states:

277. Whether a redundancy payment is genuine is to be determined on an objective basis. It is not sufficient that an employer and employee have an understanding that a payment is a redundancy payment or that the employer calls the payment a redundancy payment to give the employee a better taxation outcome. The nature of the termination of an employee does not depend on what was communicated to that employee in relation to the termination

The need for the employee's position to be genuinely redundant establishes that contrived cases of redundancy will not meet the conditions in section 83-175 of the ITAA 1997.

In the present case there is nothing to indicate that the redundancy is not genuine. Therefore, this requirement of a genuine redundancy payment has been satisfied.

Further conditions for a genuine redundancy payment

Before a payment that meets the basic redundancy requirement in subsection 83-175(1) of the ITAA 1997 qualifies as a genuine redundancy payment, all other conditions in section 83-175 must be met. These conditions include:

The payment must be made before the person turns 65 or an earlier mandatory age of retirement (paragraph 83-175(2)(a));

The payment must be made before the end of a fixed period of employment (subparagraph 83-175(2)(a)(ii));

The payment must not exceed an arm's length amount in the event that the employer and employee are not dealing at arm's length (paragraph 83-175(2)(b));

There must be no stipulated arrangement to employ the person after the termination (paragraph 83-175(2)(c)); and

The payment must not be in lieu of superannuation benefits (subsection 83-175(3)).

Each of these conditions will be addressed in turn.

The first condition under paragraph 83-175(2)(a) of the ITAA 1997 is that the termination time was a date before the employee 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.

The Employee is under 55 years of age when their employment was terminated. There was no date prior to the Employee turning 65 years of age on which his employment would have ceased. Therefore, this condition has been satisfied.

The second condition under paragraph 83-175(2)(b) of the ITAA 1997 is that if the employer and the employee were not dealing with each other at arms length in relation to the dismissal, the amount of the payment must not be greater than the amount that could reasonably be expected to have been paid if the parties had been at arms length.

In this case the Employer and the Employee dealt with each other at arms length. Therefore, this condition does not apply.

The third condition under paragraph 83-175(2)(c) of the ITAA 1997 is that at the time of dismissal, there is no arrangement in force between the employee and the employer or between the employer and another person, to employ the employee after the dismissal.

As there was no arrangement between the Employer and the Employee, or between the Employer and another person to employ the Employee after the time of the dismissal, this condition is satisfied.

A further requirement, as set out in subsection 83-175(3) of the ITAA 1997 is that no part of the payment which represents a payment in lieu of superannuation benefits will be included as part of a genuine redundancy payment.

As no part of the payment is in lieu of superannuation benefits, this condition is satisfied.

As all of the above requirements set out in subsection 83-175 of the ITAA 1997 are satisfied, the payment is a genuine redundancy payment.

Tax-free treatment of this genuine redundancy payment

Subsection 83-170(2) of the ITAA 1997 provides that so much of the genuine redundancy payment that does not exceed the amount worked out using the formula prescribed in subsection 83-170(3) is not assessable income and is not exempt income. The formula for working out the tax-free amount is:

Base amount + (Service amount Years of service)

For the 2009-10 income year:

Base amount means $Y;

Service amount means $X; and

Years of service means the number of whole years in the period, or sum of periods, of employment to which the payment relates.

This tax-free amount is not assessable income and is not exempt income under subsection 83-170(2) of the ITAA 1997.

Any amount in excess of the tax-free amount is taxed as an employment termination payment.

Tax Treatment of the employment termination payment

An employment termination payment made after 1 July 2007 will be comprised of the following components:

Tax free component this includes the pre-July 83 segment (if any) and/or the invalidity segment (if any); and

Taxable component the amount remaining after deducting the tax free component from the total payment.

The tax free component is not assessable income and is not exempt income.

The taxable component is included, in full, as assessable income.

The taxable component is subject to tax, depending on the persons age when the payment is received.

For recipients below preservation age, the taxable component of an employment termination payment is taxed at 30% for amounts below the employment termination payments cap of $150,000 for the 2009-10 income year, and at the top marginal rate for amounts above the cap.

Preservation age is the age at which retirees can access their superannuation benefits. This will be 55 for persons born before 1 July 1960 and between 55 and 60 for persons born after 30 June 1960.

Therefore, provided that the Employee does not receive any additional taxable components of employment termination payments which will count towards and exceed the employment termination payments cap amount of $150,000, a tax offset will apply to ensure that the rate of tax on the taxable component of the employment termination payment will not exceed 30%, in accordance with subsection 82-10(3) of the ITAA 1997.

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