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Ruling

Subject: Genuine redundancy payment

Questions

1. Is the payment you received an employer termination payment as defined under section 82-130 of Income Tax Assessment Act 1997 (ITAA 1997)?

2. Is any part of the payment you received exempt from tax as a genuine redundancy payment in accordance with section 83-175 of the ITAA 1997?

3. Is the payment you received included in your assessable income under either section 6-5 or section 6-10 of the ITAA 1997?

Advice/Answers

1. No.

2. No.

3. Yes.

Relevant facts and circumstances

You were first appointed to a casual vacancy as a director on the Board of an entity (Entity A) several years prior to 1 July 1993.

At that time, there was no written contract made available to you and this was the case for all of your subsequent appointments on the Board of Entity A.

You stated the 'implied contract' was to serve as a director on the Board and (as required) on Board committees.

After your first term under the casual vacancy expired, you were appointed to the Board and subsequently re-elected to the Board for further terms, two of which were as Chairman.

The constitution of Entity A did not set any limits on the number of terms of "office" which could be served.

You provided a copy of the 'information document' in relation to the proposed merger between Entity A and Entity B.

The proposed merger was to give effect to the transfer by Entity A, of its business (total assets and liabilities), to Entity B under an Act.

The copy of 'information document' included the following details:

(a) If the members of each entity approve the proposed by special resolution at each of the entities' respective AGM (set for a date during the 2009-10 income year) and the merger is also approved by the Australian Prudential Regulation Authority (APRA), then the merger would take effect on a date during the 2009-10 income year (the effective merger date).

(b) If the merger is successful, members of Entity A will become members of Entity B on the effective merger date and Entity B's constitution would be adopted.

(c) The legal and practical effects of the merger were that while the legal merger was planned to take place on the effective merger date, from an operational perspective it would take many months to bring the two entities together (the transitional period).

(d) Entity B will be the legal name of the new, merged entity until it develops a new identity and brand.

(e) The new merged entity will continue to trade under the business names of both Entity A and Entity B. This means there will be little change for members until the operational integration is completed.

(f) The merger process is effected pursuant to an Act with Entity A the transferring body and Entity B the receiving body. The merger mechanism being the transfer of the whole business (total assets and liabilities of Entity A) to Entity B on the effective merger date.

(g) Each of the Boards of the two entities had eight directors prior to the proposed merger.

(h) The merged entity would initially have a Board of eight directors made up of four directors from Entity A and four directors from Entity B. The names of the directors for the proposed Board of the merged entity did not include your name.

(i) The four directors of Entity A and two directors of Entity B who would not become directors of the merged entity were to each receive a specified payment. You were named as one of the directors of Entity A who would not be a director of the merged entity.

(j) The specified payment equated to approximately two years of director fees and was calculated based on the remaining terms of office, the loss of potential earnings and the average of the annual director remuneration paid by both entities.

(k) The merger proposal would be effected only if the special resolution for the merger proposal was approved at the two entities' respective 2009 AGM on the specified date.

(l) The Board of directors of both entities recommended the merger.

You were not a member of the negotiation team which set out the parameters of the merger.

You stated that it was agreed that the Board of each entity would nominate four directors to the Board of the merged entity.

After the parameters of the termination arrangements were decided, the Board of Entity A agreed on a method of selecting the four directors which would form part of the Board of the merged entity.

You nominated yourself to be considered as a director on the Board of the merged entity but you were not selected.

At the 2009 AGM of Entity A, the returning officer declared that you had been re-elected to the Board for a term which began at the time of the declaration and would have run until the 2012 AGM. The 2009 AGM also set director fees for the 2010-11 financial year.

If the merger had not been approved, you would have commenced the three year term from the  2009 AGM and you would have been eligible to renominate as a director for further terms of office without limit.

The merger proposal was approved at the respective 2009 AGM, however the final was made not by the Board of each entity. The approved merger proposal meant you would not become a director of the post-merger entity as per the 'information document'.

You also received the specified payment on the effective merger date from the merged entity and a PAYG payment summary - employment termination payment for year ending 30 June 2010 with an amount of tax withheld.

You stated the merger took the form of a transfer of business from Entity A to Entity B so that while Entity A is still incorporated, all of its business is now part of the merged entity.

You stated that you are still technically a director of Entity A and the Board has not met since the merger, nor have any of the directors of Entity A received any remuneration since the merger took place.

You stated you were advised that once certain affairs of Entity A is finalised, the Board will be asked to vote on a circular resolution which will propose the winding up of Entity A.

You also advised that:

· No portion of the specified payment was made in lieu of superannuation benefits.

· You were not offered a directorship in the proposed merged entity prior to the merger taking place.

· You did not resign from your office of director with Entity A.

Relevant legislative provisions

Income Tax Assessment Act 1936 repealed Section 27F

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 15-2

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Paragraph 82-135(e)

Income Tax Assessment Act 1997 Section 82-170

Income Tax Assessment Act 1997 Subsection 82-170(2)

Income Tax Assessment Act 1997 Subsection 82-170(3)

Income Tax Assessment Act 1997 Section 83-175

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

Income Tax Assessment Act 1997 Subsection 83-175(2)

Income Tax Assessment Act 1997 Paragraph 83-75(2)(a)

Income Tax Assessment Act 1997 Paragraph 83-75(2)(b)

Income Tax Assessment Act 1997 Paragraph 83-75(2)(c)

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

Income Tax Assessment Act 1997 Subsection 83-175(4)

Reasons for decision

Summary

The specified payment received by you on the effective merger date was not received in consequence of the termination of employment. Consequently, it is neither an employment termination payment nor a genuine redundancy payment and will not be subject to any concessional tax treatment.

The whole amount is assessable as statutory income and is subject to tax at your marginal rate of tax.

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 and defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997).

Section 82-130 states:

(1) 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.

(2) A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies.

If an employment termination payment is received by a person in consequence of the termination of that person's employment during their lifetime, it is known as a life benefit termination payment.

In accordance with section 80-5 of the ITAA 1997, the holding of an office is treated as employment for the purposes of section 82-130.

Payment is made in consequence of the termination of employment

The first condition to be met is that there must be an employment termination payment that is made in consequence of the termination of employment of the taxpayer.

In Taxation Ruling TR 2003/13 the Commissioner considered the meaning of the phrase 'in consequence of' as interpreted by the Courts. In paragraphs  5 and 6 of TR 2003/13 the Commissioner states:

1. The phrase 'in consequence of' is not defined in the ITAA 1936. However, the words have been interpreted by the courts in several cases. Whilst there are divergent views as to the correct interpretation of the phrase, the Commissioner considers that 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.

2. The phrase requires 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 11 of TR 2003/13 the Commissioner 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 McIntosh, looking at the phrase 'in consequence of', the Full Federal Court considered the decision in Reseck. McIntosh concerned a taxpayer who became entitled to a payment subsequent to his retirement. In doing so the Full Federal Court emphasised the importance of the causal connection between a payment and the termination of employment. However, this emphasis was founded upon the basis that a 'temporal progression of events' from the termination of employment to payment could be shown. That is, a payment may be in consequence of the termination of employment even though the termination is not the dominant cause of the payment.

In McIntosh ,Justice Lockhart considered the views of Justice Jacobs in Reseck:

In my opinion his Honour did not use the words "following on" as referring merely to a temporal progression of events. Rather His Honour had in mind a connection between the retirement from or the termination of employment and the payment in question as well as a temporal progression of events.' (emphasis added)

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.

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.

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), where Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicant's employment and the payment to warrant the finding that the payment was made in consequence of the termination of the applicant's 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. 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 both paragraphs 6 and 28 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 a life benefit employment termination payment unless the payment is specifically excluded under section 82-135 of the ITAA 1997.

Where a payment is made at about the same time, or after, a termination of employment, it may generally be accepted that the relevant payment is made in consequence of the termination of employment. For example, where it is the employer's policy for a payment to be made to a retiring employee at a farewell function a week prior to the employee's last working day. In such a case, the payment would be treated as 'in consequence of the termination of employment'. In effect, the payment has been made at about the same time with the termination of employment. On the facts of that particular case, the payment could therefore be said to 'follow on' from such termination.

In contrast, it would be difficult to conclude that a payment made well in advance of the termination of any employment is made 'in consequence of' that termination as it would not be considered the payment 'follows on' from the anticipated event (termination of any office or employment). This is because it cannot be said that such a payment 'follows on' from the termination itself if the termination has not occurred at the time when the payment was made.

In your case, you commenced to hold an office as a director in a casual vacancy on the Board of Entity A several years prior to 1 July 1993. You have confirmed you are still a current director of that entity notwithstanding the merger of the two entities has been effected on the effective merger date.

The merger process was the transfer of business from Entity A to Entity B pursuant to an Act. You did not relinquish your office as non-executive director prior to or after the effective merger date.

Therefore, on the basis of all the facts as presented, it is considered you have not ceased to hold the office on the Board of Entity A as you are still currently a non-executive director of the entity and retain that office until Entity A is wound up in the future. You have stated you have been advised this will be when certain affairs of Entity A is finalised and the Board will be asked to vote on a circular resolution which will propose the winding up of Entity A at that time.

As discussed earlier, in accordance with section 80-5 of the ITAA 1997, the holding of an office is treated as employment for the purposes of section 82-130 of the ITAA 1997. Hence, if the holding of an office has not ceased, there will not be a termination of employment for the purposes of section 82-130.

Accordingly the specified payment you received from the merged entity on the effective merger date is not an employment termination payment as defined in subparagraph 82-130(1)(a)(i) of the ITAA 1997. This is because the payment was not made to you in consequence of the termination of any office or employment as you have not relinquished your office of non-executive director and you still currently hold that office on the Board of Entity A.

It is considered the payment has been made to you well in advance of the anticipated event (the termination of your office on the Board when Entity A is to eventually wound up). The specified payment you received on the effective merger date did not 'follow on' as an effect or result of the termination of an office as you still currently hold the office.

As the payment is not considered to have been received by you in consequence of termination of employment, therefore the requirement of subparagraph 82 130(1)(a) of the ITAA 1997 has not been met and it does not become necessary to consider the other conditions in paragraphs 82-130(1)(b) and 82-130(1)(c) of the ITAA 1997.

Genuine redundancy payment

Section 83-175 of the ITAA 1997 sets out the criteria to be met in order for a payment to be considered a genuine redundancy payment. One of the criteria to be met is that the payment is 'received by an employee who is dismissed from employment' (subsection 83-175(1)) of the ITAA 1997. If there is no termination of employment there cannot be a dismissal from employment.

In the present case there has not been a termination of employment. Consequently, no part of the specified payment can be considered a genuine redundancy payment under section 83-175 of the ITAA 1997.

Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

The courts have identified a number of factors which indicate whether an amount is regarded as ordinary income. Characteristics of ordinary income that have evolved from case law include receipts that:

· are earned;

· are expected;

· are relied upon; and

· have an element of periodicity, recurrence or regularity.

Generally speaking, a receipt will be income according to ordinary concepts if it is a receipt arising out of a taxpayer's employment, business activities or income producing activities. This will be so even if the receipt is not directly related to any service provided by the recipient to the donor.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 26 ALJ 505; (1952) 10 ATD 82; [1953] ALR 17; [1952] HCA 65). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Commission of Taxation v. Inkster (1989) 24 FCR 53; (1989) 89 ALR 137; (1989) 20 ATR 1516; (1989) 89 ATC 5142, Tinkler v. Commissioner of Taxation (Cth) (1979) 40 FLR 116; (1979) 29 ALR 663; (1979) 10 ATR 411; (1979) 79 ATC 4641, and AAT Case 7328 (1991) 22 ATR 3422; (1991) 91 ATC 433).

In Scott v. Federal Commissioner of Taxation (1966) 117 CLR 514; (1966) 40 ALJR 205; [1967] ALR 561; (1966) 14 ATD 286; [1966] LB Co's Tax Serv 79, Justice Windeyer expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient.

In your case, you received the specified payment following the merger of the two entities. Although the payment provides you with income which can be relied on for your day to day living expenses, the payment is a lump sum and not regular. The full circumstances surrounding your case indicate that the payment is not ordinary income and not assessable under subsection 6-5(2) of the ITAA 1997.

Statutory income

Section 6-10 of the ITAA 1997 includes amounts of statutory income in assessable income, that is, amounts that are specifically listed as assessable income in Division 10. The provision applicable in your case is section 15-2 of the ITAA 1997

Section 15-2 of the ITAA 1997 states that your assessable income includes the value to you of all allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you.

In your case, you received the specified payment following the merger of the two entities. .The specified payment is in relation to your services as a director. As such the payment is assessable under section 15-2 of the ITAA 1997.

Conclusion

The specified payment received by you on the effective merger date is neither an employment termination payment nor a genuine redundancy payment. Therefore, the payment will not be subject to any concessional tax treatment.

The payment is assessable in full as statutory income and is subject to tax at your marginal rate of tax.

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