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Ruling

Subject: Transitional termination payment

Question

Is any part of the payment to be made by a company on the termination of employment a transitional termination payment as defined in section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA)?

Answer

Yes.

This ruling applies for the following period:

2010-11 income year

The scheme commences on:

1 July 2010

Relevant facts and circumstances

A Director of a company intends to retire at the Annual General Meeting to be held during the 2010 to 2011 income year. On termination of the Director's appointment, the Director will be entitled to receive a retirement benefit.

The Director was employed in 19XX and has been the chair of the board of directors since 19XX. The minutes of a meeting of a board of directors in December 19XX forms the basis of the Director's employment with the company.

The amount of the retirement benefit payable to the Director on termination of employment was fixed at the 20XX Annual General Meeting. The terms of the retirement benefit have not altered or varied since that date.

The Notice of Annual General Meeting during the 20XX-XX income year states as follows:

Changes to Retirement Allowances for Directors

If Resolution 2 is passed, shareholders are asked to consider and, if thought fit, pass the following resolution as an ordinary resolution:

"THAT approval is given for the following changes in relation to retirement allowances for non-executive directors:

a) on their retirement or resignation, each person who is a non-executive director on the date of this meeting will be entitled to receive from the company an amount calculated by reference to their accrued retirement allowance, calculated during the 20XX-XX income year as set out in the Explanatory Memorandum accompanying this Notice of Meeting; and

b) except for the payments referred to in (a) above, the existing retirement allowance scheme for non-executive directors be terminated with effect from the 20XX-XX income year.

The Explanatory Memorandum to the Notice of Annual General Meeting states that the Applicant's non-executive retirement allowance scheme was approved by shareholders at the Annual General Meeting in 19XX. Under the retirement allowance scheme, directors who retire from the board are paid a retirement allowance of up to three years of director's fees (less all superannuation contributions made on the director's behalf), subject to having served a minimum term of three years. Directors who have served on the board for more than three years are entitled to the equivalent of a year of director's fees on retirement. This amount increases pro-rata where it is capped at the equivalent of three years of director's fees for directors who have served nine years or more on the board of directors. Directors who do not meet the three year threshold at the time of their retirement are not entitled to a retirement allowance.

At the board meeting held during the 20XX-XX income year, the board of directors approved a change in the amount the non-executive directors are renumerated. The increase in remuneration did not alter the Director's terms of employment or the amount of the retirement benefit he is entitled to on termination of employment.

The amount accrued by the Director, is set out in the General Ledger Reconciliation during the 20XX-XX income year for the company. This represents more than 10 years service during the 20XX-XX income year, when the allowance scheme was terminated and the amount of the retirement allowance fixed.

The Director intends to direct the company to pay the transitional termination payment to a complying superannuation fund. The Director intends to lodge a directed termination payment request with the company.

The company intends to pay the transitional termination payment to a complying fund as directed within 12 months of the employment of the Director being terminated.

The Director is entitled to receive a fixed amount on termination of employment. This contractual entitlement is set out in writing in the Notice of Annual General Meeting for the 20XX-XX income year. The contractual arrangement between the company and the Director has continuously governed the relationship between the parties from the 19XX-XX income year.

The Director is over 60 years of age.

Relevant legislative provisions

Section 82-130 of the Income Tax Assessment Act 1997

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

Section 82-10 of the Income Tax (Transitional Provisions) Act 1997

Subsection 82-10(1) of the Income Tax (Transitional Provisions) Act 1997

Subsection 82-10(2) of the Income Tax (Transitional Provisions) Act 1997

Subsection 82-10(3) of the Income Tax (Transitional Provisions) Act 1997

Subsection 82-10(4) of the Income Tax (Transitional Provisions) Act 1997

Section 82-10F of the Income Tax (Transitional Provisions) Act 1997

Section 82-10G of the Income Tax (Transitional Provisions) Act 1997

Subsection 292-25(1) of the Income Tax (Transitional Provisions) Act 1997

Subsection 292-25(2) of the Income Tax (Transitional Provisions) Act 1997

Subsection 295-190(1) of the Income Tax Assessment Act 1997

Reasons for decision

Summary

The payment that will be paid to the Director by the company is a transitional termination payment because it was provided for under a contract, instrument or agreement that came into force on or after 10 May 2006.

Detailed reasoning

Employment Termination Payments

From 1 July 2007, payments made to individuals who retire or stop working are referred to as 'employment termination payments' (formerly eligible termination payments). Where the payment is made during the life of a taxpayer it will be known as a life benefit termination payment.

An employment termination payment is defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997) as a lump sum payment made in consequence of the termination of an individual's employment.

The phrase 'in consequence of' termination of employment is not defined in the legislation but the courts have considered the meaning of the words 'in consequence of' in relation to 'eligible termination payments'.

Of note are the decisions made by the Full 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).

Suffice it to say that both Courts' views were that for a payment to be made in consequence of the termination of employment it had to follow on as a result or effect of the termination of employment. Additionally, 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.

To qualify as an employment termination payment, the payment must be made 'in consequence of' the termination of employment and be received within 12 months of the taxpayer's termination of employment. Payments received outside 12 months will be taxed as ordinary income at marginal tax rates.

Employment termination payments made from 1 July 2007 can not be rolled into superannuation.

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 the present case, the Director was employed during the 19XX-XX income year and has been the chair of the board of directors since the 19XX-XX income year. It is evident that the Director's retiring allowance to be made to by the company when the Director retires at the annual general meeting to be held during the 2010-11 income year is made in consequence of the Director's termination of employment. The payment is made as a direct result of the Director's retirement. The payment would not be made if there is 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 amount would not have arisen.

For these reasons, it is considered that the Director's proposed retiring allowance payment is an employment termination payment.

Transitional termination payment

Subsection 82-130(2) of the ITAA 1997 defines an employment termination payment that is received by a taxpayer in consequence of the termination of their employment as a 'life benefit 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 Income Tax (Transitional Provisions) Act 1997 (IT(TP)A).

Transitional employment termination payments may be:

· rolled-over (in full or in part) to a superannuation fund, ADF or RSA; or

· used (in full or in part) to buy a superannuation income stream before 1 July 2012.

Under subsections 82-10(1) and (2) of the ITTPA, a life benefit termination payment received between 1 July 2007 and 30 June 2012 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.

Subsection 82-10(3) of the ITTPA limits that entitlement by specifying:

This Division applies in relation to a life benefit termination payment only to the extent that the contract, law or agreement as in force just before 10 May 2006 specifies the amount of the payment, or a way to work out a specific amount of the payment.

Subsection 82-10(4) of the ITTPA identifies how the specific amount referred to in subsection 82-10(3) can be worked out. Subsection 82-10(4) states:

For the purpose of subsection (3), a specific amount can be worked out in ways including either or both of the following:

(a) by a method or formula for working out the amount;

(b) by provision for you or another person (or entity) to make a choice between forms of payment allowing amounts to be worked out as provided by subsection (3) and paragraph (a) of this subsection.

The proposed payment to the Director will be a transitional termination payment to the extent the pre 10 May 2006 contract, law, instrument or agreement specifies an amount of the payment, or a method or formula by which a specific amount of the payment can be determined.

Written employment contract and entitlement to payment

Subsection 82-10(1) of the ITTPA requires that the payment is received because of an entitlement under a written contract, a law of the Commonwealth, a State or a Territory or another country, a collective agreement or an Australian Workplace Agreement (AWA).

In this case the Notice of Annual General Meeting during the 20XX-XX income year is considered to be a written contract between the Director and the company which determined the calculation of the amount that the Director would be paid on the termination of employment. The Explanatory Memorandum to the Notice of Annual General Meeting explains that the Director of the company non-executive retirement allowance scheme was approved by shareholders at the Annual General Meeting in 19XX.

At the board meeting held during the 20XX-XX income year, the board of directors approved a change in the amount the non-executive directors are renumerated. The increase in remuneration did not alter the Director's terms of employment or the amount of the retirement benefit he is entitled to on termination of employment.

Therefore, the Notice of Annual General Meeting is a written contract, and was in force as at 9 May 2006 (subsection 82-10(1) of the Income Tax (Transitional Provisions) Act 1997) (ITTPA).

Accordingly, the payment will be a transitional termination payment under section 82-10 of the ITTPA.

Taxation of a transitional termination payment

The taxation treatment of a transitional termination payment depends on a taxpayer's age when the payment is received. In this case, the Director is over 60 years of age and has therefore reached preservation age when the payment will be made. If the payment is not rolled over into a superannuation fund the taxable component will be assessed as follows:

· Up to $140,000 - taxed at a maximum rate of 15%.

· The amount above $140,000 - taxed at a maximum rate of 30%.

plus any applicable amount of Medicare levy and Medicare levy surcharge.

Directed termination payment

If the Director directs a transitional termination payment to be made into a complying superannuation fund it becomes a directed termination payment under section 82-10F of the ITTPA. Under section 82-10G of the ITTPA a directed termination payment is not assessable income and is not exempt income of a taxpayer.

Directed termination payments are taxable contributions and are included in a superannuation fund's income for the financial year in which they are made. Generally contributions that are taxable in a superannuation fund form part of a taxpayer's concessional contributions for an income year.

However, subsection 292-25(1) of the ITTPA states that the taxable component of a directed termination payment is not included in a taxpayer's concessional contributions for the financial year, to the extent that the component does not exceed the amount mentioned in subsection 292-25(2) of the ITTPA.

The amount referred to in subsection 292-25(2) of the ITTPA is $1 million. This amount is reduced by the taxable component of every previous transitional termination payment made to the taxpayer since 1 July 2007.

This means that any directed termination payments made in relation to a taxpayer will not be counted towards their concessional or non-concessional cap, up to the amount mentioned in subsection 292-25(2) of the ITTPA. Any transitional termination payment that is over this amount is included in the taxpayer's concessional contributions for the financial year.

A directed termination payment is included in the assessable income of the entity receiving the payment as set out in the table under subsection 295-190(1) of the ITAA 1997. Item 3 of the table shows the taxable component of a directed termination payment (within the meaning of section 82-10F of the ITTPA is assessable income of a complying superannuation fund, a complying approved deposit fund (ADF) and a retirement savings account (RSA) provider.

The taxable income (that is, the assessable income less allowable deductions) of a complying superannuation fund, a complying ADF or an RSA provider is subject to tax at the rate of 15%.

Conclusion

The retirement payment the Director will receive from the company on the termination of the Director's employment will be a transitional termination payment. The Director may direct that the transitional termination payment be directed to a complying superannuation fund or RSA, in accordance with the ITTPA.

If the Director directs the payment to be made into a complying superannuation fund it will be non assessable non exempt income. It will not be included in the Director's concessional contributions cap for amounts up to $1 million.

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