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Ruling

Subject: Transitional termination payment

Is an amount in excess of the tax free amount of a genuine redundancy payment a transitional termination payment as defined in section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A)?

Yes.

This ruling applies for the following period

For the year ended 30 June 2009 and until 30 June 2012

The scheme commenced on

1 July 2008

Relevant facts

Prior to the second quarter of the 2004-05 income year, a number of employees who commenced employment with a company (Company A) were originally employed under a standard form employment contract (the Contract).

A restructure of the group and the listing of the parent company on the Australian Stock Exchange occurred in the second quarter of the 2004-05 income year (the Changeover date).

The existing employees of Company A were offered, in the Changeover Offer Letter, and accepted, employment with another company (Company B) from the Changeover Date 'on the same terms and conditions', as with the employment with Company A to be recognised in the calculation of service related benefits.

The Changeover Offer Letter, dated in the second quarter of the 2004-05 income year advised that from the Changeover Date their employment with Company A as nominee for Company A's Partnership will cease and were offered employment with Company B on the same terms and conditions currently applicable to them, to commence on the changeover date. Their period of service with Company A and any other companied within the company group by which they were previously employed, would be included in the computation of all their service related benefits with Company B, including their annual leave and long service leave benefits. Furthermore, their continuing their employment from the Changeover Date would be taken to be their acceptance of Company B's offer of employment.

Company B employs a number of employees who commenced employment prior to 10 May 2006.

This ruling application relates to both:

· employees engaged on standard form contracts made before the second quarter of the 2004-05 income year who transferred from Company A to Company B on the Changeover Date under the terms set out in the Changeover Offer Letter, and

· those employees first employed by the group on standard form contracts made between the Changeover Date and 9 May 2006,who will be made redundant and receive a redundancy payment and potentially a payment in lieu of notice directly in cash within the 12 months of the cessation of employment and by 30 June 2012.

The Contract of Company B, made in the first quarter of the 2001-02 income year sets out the 'base compensation amount' and states that the company will pay a base compensation amount at the rate of per year. It may be increased at the discretion of the Directors and will be reviewed on 31 December each year. Your salary will not necessarily be increased following such a review.

The Contract, contains a notice period.

Furthermore, the Contract refers to redundancy.

It is noted that the Contract uses the terms 'base salary' and 'base compensation' which the applicant has been instructed that the intention was that the same concept would apply.

A copy of the Company Group severance policy has been provided and shows the number of months/years service for the amount of weeks severance and is shown in months for overseas employees.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-130.

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

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 995-1.

Income tax (Transitional Provisions) Act 1997 Section 82-10.

Income tax (Transitional Provisions) Act 1997 Subsection 82-10(1).

Reasons for Decision

Summary

A payment to be made to an employee in excess of the tax free amount of a genuine redundancy payment between 1 July 2007 to 30 June 2012 is a transitional employment termination payment as the payment is being made in relation to their contract which was in force before 10 May 2006.

Legal reasoning

Employment termination payments made on or after 1 July 2007

From 1 July 2007, the taxation treatment of payments made in consequence of the termination of any employment of the taxpayer has changed. These payments were formerly known as eligible termination payments (ETPs).

The Commissioner has considered in Taxation Determination TD 94/62 that a payment made in lieu of notice is considered to have been made in consequence of the termination of a taxpayer's employment. As such, the payment will be an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997) unless it is specifically excluded by any of the provisions contained in section 82-135.

Employment termination payment

Section 995-1 of the ITAA 1997 states that:

employment termination payment has the meaning given by section 82-130 of the ITAA 1997.

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

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 that termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135.

Section 82-135 of the ITAA 1997 excludes certain payments such as accrued annual and long service leave, the tax-free parts of a genuine redundancy payment and an early retirement scheme payment from being an employment termination payment.

For a payment to constitute an employment termination payment, all the conditions in section 82-130 of the ITAA 1997 must be satisfied. Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. Furthermore, any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule.

Transitional termination payment

A life benefit termination payment made between 1 July 2007 and 30 June 2012 may be a transitional termination payment under section 82-10 of the IT(TP)A.

Under subsection 82-10(1) of the IT(TP)A, a life benefit termination payment received on or after 1 July 2007 is a transitional termination payment in the following circumstances:

(a) the payment is received by you because you are entitled to it under a written contract, a law of the Commonwealth, a State, a Territory or another country, an instrument under such a law, a collective agreement within the meaning of the Fair Work (Transitional Provisions and Consequential Amendments) Act 2009 or an AWA within the meaning of that Act; and

(b) the entitlement is provided for under that contract, law, instrument or agreement as in force just before 10 May 2006.

The terms contract, law and agreement all connote circumstances that are binding on the employer. The circumstances as they exist just before 10 May 2006, must be such that the employer is obliged by force of a contract, law or agreement to pay a specific amount or to pay an amount according to the specifications of a method or a formula. As explained at paragraph 4.67 of the Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006, a person must be entitled as at 9 May 2006, to a payment on termination of employment.

In the facts of this case, a number of employees commenced employment with Company B prior to 10 May 2006.

A restructure of the group and the listing of the parent company on the Australian Stock Exchange occurred in the second quarter of the 2004-05 income year (the Changeover date).

Employees who commenced employment prior to the second quarter of the 2004-05 income year, were originally employed under a standard form employment contract (the Contract) with Company A.

In a letter made in the second quarter of the 2004-05 income year, (the Changeover Offer Letter) existing employees of Company A were offered employment with Company B from the Changeover Date. Employees who accepted the offer were employed 'on the same terms and conditions' as with their employment with Company A to be recognised in the calculation of service related benefits.

Those employees who transferred employment from the Changeover Date and those first employed by the group on standard form contracts made between the Changeover Date and 9 May 2006, who will be made redundant, will receive a genuine redundancy payment and potentially a payment in lieu of notice directly in cash within the 12 months of the cessation of employment and by 30 June 2012.

As noted in the facts, the Contract, which took effect in the first quarter of the 2001-02 income year, sets out the 'base compensation amount' which is reviewed on 31 December each year. At a particular clause, the Contract provides for one month's notice in writing to be provided by either party in the event that the Contract is terminated. If Company A terminates the Contract, it can make a payment in lieu of the unexpired period of notice.

Furthermore, a specified clause of the Contract, which deals with redundancy, makes reference to minimum standards for severance pay provided in any Company A policy from time to time.

The Contract was adopted by Company B on the Changeover Date and remains the policy which provides a methodology to calculate the redundancy based upon years of service and base compensation. The terms of the severance package that came into effect in the first quarter of the 2001-02 income year have not been amended in any way.

It is noted that another clause of the Contract uses the terms 'base salary' and 'base compensation' which intends to apply the same concept.

The Contract which was in force just before 10 May 2006, provides for an employee's entitlements in the event the employee is made redundant. At the specified clause of the Contract it refers to the severance package which would be used to calculate the employee's severance pay entitlement in the event of the employee terminating employment as a result of a genuine redundancy.

The payment to be made to an employee under the Contract is a Collective Agreement within the meaning of the Fair Work (Transitional Provisions and Consequential Amendments) Act 2009. It provides a method of calculating what an employee would be entitled to as a result of a genuine redundancy. The Contract was applicable from the first quarter of the 2001-02 income year. Therefore, the entitlement provided for under the Contract was in place before 10 May 2006.

Those employees who receive a payment (which includes a payment in lieu of notice) under the terms of their employment contract made just before 10 May 2006, in excess of the tax-free redundancy amount, will be a transitional termination payment as all the requirements under section 82-10 of the IT(TP)A will be satisfied.

Under the transitional arrangements, the employee may choose to direct an employment termination payment to be made on their behalf to a superannuation fund.

Transitional employment termination payments that are not directed into a superannuation fund

Transitional termination payments are made up of two components:

Tax fee component - this includes the post-June 1994 invalidity or pre-July 83 component (if any); and

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

The taxable component of a transitional termination payment paid in cash, forms part of a person's assessable income.

The amount of tax on the taxable component depends on the person's age and whether they received any earlier transitional termination payments, including directed termination payments, as shown in the following table:

* 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.

** The lower cap amount for the 2010-11 income year is $160,000 and is subject to annual indexation.

Both the lower cap amount and the $1 million (upper cap amount) are reduced by all amounts received by the person that have previously used the transitional termination payments concession.

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