Edited version of private ruling

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Ruling

Subject: Tax treatment of a non-renewal benefit.

Issue 1

Question

Is the payment of a non-renewal benefit, where an employee is appointed to a senior executive position with the employer an employment termination payment for the purposes of the PAYG provisions?

Answer

No.

This ruling applies for the following period:

2010-11 income year

The scheme commences on:

1 July 2010

Issue 2

Question

Does the taking of the accrued value of a non-renewal benefit, where an employee is appointed to a senior executive position with the employer form part of the employee's assessable income?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Currently if an employee is promoted to a middle management position, they become employed under a fixed term appointment. In recognition for this reduced certainty of employment, employees are entitled to the payment of a Non Renewal Benefit (NRB), equal to 12.5% of total salary earnings for each completed term appointment. This NRB accrues after each completed term and is paid out either when the employee's employment is terminated or if they are promoted to a senior executive position.

The provisions governing the payment of the NRB are contained in a specific clause of an Award (the Award). The specific clause provides that middle management employees being subject to fixed term appointments shall accrue an entitlement to the payment of a benefit, equal to twelve and one half (12.5) percent of total; salary earnings for each completed fixed term appointment in accordance with the following:

· the entitlement to the NRB commences to accrue from the beginning of the first fixed term appointment;

· the benefit is only payable in respect of each completed first fixed term appointment;

· any middle management employee who resigns or retires (excluding certain medical retirements) the employer during the currency of a first fixed term appointment shall be regarded as not having completed that particular term and no benefit shall be payable in respect of that incomplete term. However, all accrued benefits from previously completed terms shall be payable;

· any entitlement to a benefit shall become payable upon termination of employment (including certain medical retirements) or termination as a result of a decision by the employer not to renew an expired fixed term or on accepting a senior executive appointment;

· middle management employees who are appointed to a senior executive position with shall have the amount of their benefit capped as at the date of such appointment and that benefit shall be available at that capped amount in accordance with the provisions of the specific clause of the Award.

Employees are employed in terms of a specific Act. Middle management employees are employed in terms of another Division of that Act. Senior executive employees are appointed under the provisions of a subsection of that Act.

When an employee is appointed to a senior executive position, their conditions of employment change from those prescribed under the Award to mirror those provided for under another Award.

When n employee is appointed to a fixed term appointment, they retain the status and employment conditions of an employee. Furthermore, while a review of the employee's performance is completed prior to the end of each fixed term, there is a general presumption in favour of renewal of fixed term appointments and that the appointments shall generally expire only by the effluxion of time. The only grounds for not offering a further fixed term would be if the employee was unable to meet the required standards of operational competence, discipline or integrity, in which event, the employee would be provided with at least six months notification of the decision not to offer a further term.

The e-mail also advised that when an employee is appointed to a senior executive position while they retain the status of an employee, their conditions of employment mirror those that apply to a State public service. Reappointment at the end of a contract is not automatic and only occurs after a rigorous performance review and certification by a review panel that the performance of the incumbent was of a high standard. There is also provision under a section of the Act for the senior executive to be removed from office at any time, for any or no reason and without notice.

If an employee is promoted to a senior executive position, the NRB payment ceases. Under a paragraph of the Award employees appointed to a senior executive position are provided with an one-off opportunity to cash out their accrued NRB. If the employee chooses not to cash it in, the value of the NRB is preserved and paid out at a later stage when employment is terminated.

On appointment to a senior executive position, middle management employees are provided with a one-off opportunity to cash out all or part of their annual and extended leave. If cashed out, the leave is paid at the employee's pre-senior executive salary and the leave is paid as salary and not as an employment termination payment. The payment is taxed at marginal rates as per the ATO's letter dated during the 2003-04 income year to the employer, which advised the following:

· A middle management employee accepting a senior executive appointment with the employer may not constitute a retirement or termination from an office or employment in terms of (former) section 26AC or 26AD of the Income Tax Assessment Act 1936 (ITAA 1936).

· The particular middle management employee to whom the letter referred may not be regarded as having terminated their employment with the employer. The middle management employee has had a change of duties and a promotion, however their employment with the employer is continuing.

· As set out in Income Tax Ruling IT 2525, it is the Commissioner's view that in order for a taxation concession associated with retirement or termination to apply there must be an actual and not merely an ostensible retirement from, or termination of, employment. The Commissioner considers that it will be an exceptional case that a genuine retirement or termination occurs where contractual employment benefits continue to accrue following the "retirement or termination" of a taxpayer's office or employment.

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 Paragraph 82-130(1)(a).

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

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

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

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

Income Tax Assessment Act 1997 Subsection 995-1.

Income Tax Assessment Act 1997 Section 6-5.

Reasons for decision

Issue 1

Summary

The payment of a non-renewal benefit (NRB), where an employee is appointed to a senior executive position with the employer is not an employment termination payment for the purposes of the PAYG provisions.

Detailed 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).

Section 995-1 of the Income Tax Assessment Act 1997 (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.

…

Note 2: The holding of an office is treated as employment on this Part: see section 80-5…

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.

To determine whether the non-renewal benefit payments made by the employer are employment termination payments, all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

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

Paid as a consequence of the termination of your employment

To determine whether the payment is made in consequence of the termination of employment, we must first determine whether the employees' employment were terminated when he or she were appointed a senior executive position.

It should be noted that the phrase 'in consequence of the termination of your employment' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

In Taxation Ruling TR 2003/13 the Commissioner has considered the meaning of the phrase 'in consequence of'.

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.

The phrase 'in consequence of termination of employment' has been interpreted by the courts in several cases.

Of note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation (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 in the same case Justice Jacobs 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.

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.

Furthermore, in Le Grand v Federal Commissioner of Taxation (Le Grand), the issue before the court was whether an amount received by the applicant as a result of accepting an offer of compromise in respect of claims brought by him against his former employer, in relation to the termination of his employment was in whole, or in part, an ETP. It was held that a settlement payment for litigation in relation to a taxpayers dismissal was an ETP.

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. 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 earlier stated 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'.

The Full Federal Court in Dibb v Federal Commissioner of Taxation (Dibb), has applied the above decisions in finding that the payment received by the taxpayer under a deed of release to settle various causes of action against the employer following the termination of employment was an ETP.

In paragraph 31 of TR 2003/13 the Commissioner states:

It is clear from the decision in Le Grand, that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of the taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

The essence of this analysis is that 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.

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.

From the facts, if an employee is promoted, he or she is entitled to an NRB. The NRB accrues after each completed term. If the employee is promoted to a senior executive position, the NRB ceases to accrue.

In accordance with a specific paragraph of the Award, on appointment to the senior executive position, the employee is given a one-off opportunity to cash in their accrued NRB balance. If the employee chooses not to cash it in, the value of the NRB is preserved and paid out at a later stage when their employment is terminated.

In this case there is no termination of employment with the employer when the employee is appointed to the senior executive position. The employee is still employed with the employer.

The appointment to a senior executive position is also not considered to be a retirement from an office.

Employment under section 82-130 of the ITAA 1997 includes the holding of an office. Therefore, for the purposes of section 82-130, the ordinary meaning of employment has been extended to include the holding of an office.

The Butterworths Australian Legal Dictionary states the following regarding the meaning of the term 'office':

1. A position of authority to which duties and functions are attached

2. In relation to income tax assessment, a position of defined authority in an organisation (for example, company director, president of a club, holder of a position with statutory powers)

3. A post or employment that is subsisting, permanent position existing independently of the person who fills it, and that goes on and is filled in succession by successive holder

4. In relation to corporations, reference is made to the office of director in Corporations Law ss 224, 227 (vacation of office, removal from office). (emphasis added)

The term 'office' is not defined in the ITAA 1997 but it has been considered in a number of cases.

Clarification of the term 'office' is provided in Edwards (Inspector of Taxes) v. Clinch where it states:

… an office must be a post which exists independently of the office holder, being a post with a sufficient degree of continuance and permanence to enable it to be held by successive incumbents.

The Administrative Appeals Tribunal (AAT) considered the case of a woman who had been an Inspector of Schools and who became (when that position phased out) a Cluster Director in AAT Case 8603. At paragraphs 14 and 15 Deputy President McMahon made the following comments:

14. The word office is a word that had been considered in many cases but no satisfactory definition has emerged. As was pointed out in Grealys case the word usually connotes a position of defined authority in an organisation, such as a director of a company, or a tertiary education body. Their Honours held (at 4197 column 2) that it was not a word normally applicable to a relatively low level employee, such as a university lecturer. As the court observed the applicant, like many holders of professional employment, is not made an office holder merely because her position has a name.

15. This view was consistently taken by the Boards of Review. For example, in Case K4, 78 ATC 29, Mr Dempsey suggested that an office connotes something more than substantial, something more in the nature of a continuing executive position, the holder of which has distinct responsibilities. In Grealys case itself, their Honours noted that the word office usually connoted a position of defined authority.

The decision in AAT Case 12,178 concerned a taxpayer who received a payment in respect of unused sick leave when he resigned from his position as a Branch Manager after having successfully won a position of Division Director for the same employer (a local council).

In making the decision, one of the issues raised was whether the taxpayer was the holder of an office and whether a retirement or termination had occurred. In that decision, Senior Member Block mentioned at page 422 (ATC):

The test as to whether a position is an office will no doubt usually be one involving questions of fact and degree...

In his findings, Senior Member Block also referred to a few previous cases which looked at the issue of office and at page 1189 (ATR); page 421 (ATC) he made the following observation:

In Great Western Railway Co v Bater 3 KB 266 Rowlett J had held that an office was a subsisting, permanent, substantive position which had an existence independent of the person who filled it, which went on and was filled in succession by successive holders.

I consider, with respect, that the meaning attributed to the term office by Deputy President Thompson in Case W31 is for Australian purposes, correct. That test would require that it is a position to which duties are attached, especially a place of trust, authority or service under constituted authority. It is thus clear that the restricted UK view is narrow, when contrasted with the less restricted Australian approach.

From the cases mentioned above, the test of whether a position is an office will be one involving questions of fact and degree. The position of a middle management employee is not necessarily a position of defined authority such as an executive position where the employee has distinct responsibilities. Also, it is unlikely that a middle management employee's position will exist independently of the employee. Therefore the position of a middle management employee is not considered to be the holding of an office.

This view that there is not a termination of employment or a termination of office with the employer when a middle management employee accepts an appointment to a senior executive position confirms the advice given in our letter to the employer during the 2003-04 income year. Although the letter concerned the payment of unused leave when a middle management employee is appointed to a senior executive position, the principle is still the same for the payment of a NRB when a middle management employee is appointed to a senior executive position. The letter advised:

· a middle management employee accepting a senior executive appointment with the employer may not constitute a retirement or termination from an office or employment in terms of (former) section 26AC or 26AD of the ITAA 1936;

· the particular middle management employee to whom the letter referred may not be regarded as having terminated their employment with the employer. The middle management employee has had a change of duties and a promotion, however their employment with the employer is continuing;

· as set out in Income Tax Ruling IT 2525, it is the Commissioner's view that in order for a taxation concession associated with retirement or termination to apply there must be an actual and not merely an ostensible retirement from, or termination of, employment. The Commissioner considers that it will be an exceptional case that a genuine retirement or termination occurs where contractual employment benefits continue to accrue following the "retirement or termination" of a taxpayer's office or employment.

As it is determined that there is no termination of employment or termination of office, the condition under paragraph 82-130(1)(a) has not been met.

As mentioned above, all the conditions in section 82-130 of the ITAA 1997 must be satisfied before the payment is considered an employment termination payment. Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment.

As it has been determined that the first condition has not been met, it is not necessary to discuss the other conditions of section 82-130 of the ITAA 1997.

Accordingly, the payment of the accrued value of a NRB that is paid when a middle management employee is appointed to a senior executive position with the employer is not an employment termination payment under section 82-130 of the ITAA 1997.

Issue 2

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

The value of the non-renewal benefit (NRB) accrues to the benefit of employees upon their promotion to middle management for the completion of each term of appointment and it is normally payable upon termination of employment. The payment, however, ceases to accrue upon their promotion to the senior executive level of employment and employees in this position are provided with a one-off opportunity to cash-out the value of the accrued NRB entitlement.

Where a middle management employee takes a cash-out of an NRB entitlement when they are promoted to the senior executive level, the NRB is considered to be ordinary income and is assessable under section 6-5 of the ITAA 1997.

As there has been no termination of employment the amount is not an employment termination payment.

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