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Ruling

Subject: Transitional termination payment

Questions:

Is the proposed 'length of service payment' a transitional termination payment?

Is the proposed payment 'referrable to a payment in lieu of notice' a transitional termination payment?

Advice/Answers:

1. Yes.

2. Yes.

This ruling applies for the following period:

1 July 2011 to 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts:

Your client is under 55 years of age.

Your client commenced employment with a subsidiary company (the Company) of an Entity which was a member of a group of companies.

Your client's most recent written contract with the Company was signed by him prior to 10 May 2006.

Your client's employment terminated and the Company intends to pay your client:

· A payment in respect of length of service; and

· A payment in lieu of notice.

You have advised that:

· the length of service payment was made in accordance with the Company Retrenchment Policy calculated with your client's length of service; and

· the payment in lieu of notice was calculated in accordance with the termination clause in your client's employment contract. The reason for the payment in lieu of notice is in the interests of an amicable separation.

Further you have advised that the second payment is not strictly a payment in lieu of notice as your client had worked in the notice period so it is an ex-gratia payment.

The termination of the your client's employment is not on account of a genuine redundancy.

You have advised that the Company has a well established practice of making a length of service payment to employees who were made redundant or treated as being so for the purposes of determining entitlements on termination.

Your client's employment contract specifies the following coverage under the specific provision headings:

· Human Resources Policies - While employed, your client would be covered by Company Group's Human Resources Policies including those which cover Occupational Health and Safety, Leave, Equal Employment Opportunity, Privacy and other matters.

Human Resources Policies may be varied from time to time and new policies may be introduced.

· Continuity - The nature of his role (including position title, duties and reporting lines) may be varied throughout his employment with the Company. It was agreed that irrespective of any such variations, by negotiation or otherwise, the terms and conditions set out in his employment contract will continue to apply as contractual provisions, unless otherwise amended by the Company in writing by the General Manager Human Resources.

· Termination - His employment with the Company may be terminated by either party giving the other three months notice of termination. Alternatively, the Company may terminate his employment by paying him three months salary in lieu of notice.

· Incentive Plan - Eligibility to participate in the Company's incentive plan

The Company's Retrenchment Policy (Staff Retrenchment Policy) included a redundancy policy with the following provisions:

· Contractual Notice i.e. the notice required by the Contract of Employment or otherwise reasonable notice.

· Four Weeks pay per completed year of service.

· Any payments under this Policy [apart from contractual notice and statutory entitlements] are discretionary and are conditional on prior signing of an appropriate release agreement.

In late 2006 the Company implemented some changes to the Staff Retrenchment Policy. The relevant primary clarifications on redundancy benefits were:

· The length of service entitlement is to be subject to a maximum ceiling of 120 weeks pay i.e. 4 weeks per year of service, pro-rated for part years and capped at 30 years service. Previously the service multiples were uncapped.

· Severance or notice payments are a sliding scale based on salary grade level.

Further you state that this provides confirmation of the employee's entitlement to 4 weeks payment per year of service (pro-rated for part years). You state that this puts beyond doubt that the Company has to make length of service payments to employees who have been made redundant or described as redundant.

The Company has provided clarification regarding the payments to be made to your client on account of his termination of employment. They have advised that:

The Company had an established practice of providing head office employees whose employment had been terminated by the Company without cause before 10 May 2006 with a length of service payment equal to four weeks pay per completed year of service, or part thereof (more particularly completed months), rather than (only) four weeks pay per completed year of service set out in the Company's Staff Retrenchment Policy; and

Head office employees whose employment was terminated by the Company without cause, before 10 May 2006 receiving a length of service entitlement of 4 weeks pay per completed year of service, or part thereof; and

The Company's practice in relation to Notice periods has been to pay out the full Notice period irrespective of the fact that an employee may have received notice of their termination some time prior to it being effective.

Further they state that your client's entitlement to length of service and a payment in lieu of notice which arose when his employment was terminated without cause was determined on the same basis as it would have been had his employment been terminated for the same reason before 10 May 2006.

You have advised the retirement incentive clause did not apply to your client but only to employees aged 55 or more whose employment will cease as a result of retirement, rather than employees whose termination (like your client's) was described as a redundancy.

You have advised that the cap of 30 years is not relevant to your client.

Relevant legislative provisions:

Income tax Assessment Act 1997 Section 82-10

Income tax Assessment Act 1997 Section 82-125

Income tax Assessment Act 1997 Section 82-130

Income tax Assessment Act 1997 Subsection 82-130(1)

Income tax Assessment Act 1997 Subsection 82-130(2)

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

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

Income tax (Transitional Provisions) Act 1997 Paragraph 82-10(1)(a)

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

Income tax (Transitional Provisions) Act 1997 Subsection 82-10(3).

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

Income tax (Transitional Provisions) Act 1997 Subsection 82-10C(3).

Income tax (Transitional Provisions) Act 1997 Subsection 82-10C(4).

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

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

Income tax (Transitional Provisions) Act 1997 Subsection 82-10D(2)

Reasons for decision

Summary

The 'length of service payment' and the a payment 'referrable to a payment in lieu of notice' are transitional termination payments received because of entitlements that were provided for under a contract, instrument or agreement as in force just before 10 May 2006 which specifies a way to work out the payment.

Detailed reasoning

Employment termination payment

Section 82-125 of the Income Tax Assessment Act 1997 (ITAA 1997) defines an employment termination payment as a payment made in consequence of the termination of a person's employment that is received no later than 12 months after the termination.

Subsection 82-130(1) defines a payment as an employment termination payment if:

· it is received by the person in consequence of the termination of their employment (subparagraph 82-130(1)(a)(i));and

· it is received no later than 12 months after that termination (paragraph 82-130(1)(b)); and

· it is not a payment mentioned in section 82-135 (this sections lists the specific payments that are not employment termination payments).

A life benefit termination payment is an employment termination payment to which subparagraph 82-130(1)(a)(i) applies.

Transitional termination payment

Life benefit termination payments may qualify as a transitional termination payment under section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A).

Subsection 82-10(1) of the IT(TP)A states that:

This Division applies in relation to a life benefit termination payment received by you on or after 1 July 2007 if:

(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.

Furthermore, at subsection 82-10(3) of the IT(TP)A it states:

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.

From the information provided, it is evident the two payments (Payment 1 - length of service and Payment 2 - ex-gratia payment) to be paid to your client are in consequence of the termination of his employment and therefore each payment will meet the requirements in subparagraph 82-130(1)(a)(i)) as an employment termination payment. This is because the payments would not have been made but for the termination of your client's employment.

The second condition for the payment to meet the criteria, as an employment termination payment is stated under paragraph 82-130(1)(b) of the ITAA 1997, is that the employment termination payment was paid to the taxpayer no later than 12 months after their employment was terminated.

In this case if the employment termination payment is paid to the employee within 12 months after his termination of employment, the requirement under paragraph 82-130(1)(b) of the ITAA 1997 will be met.

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

· an unused annual leave payment;

· an unused long service leave payment; or

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

The proposed payments are none of those included under this section, therefore paragraph 82-130(1)(c) of the ITAA 1997 will be met.

As all the conditions will be met, the payments will be an employment termination payments.

Both payments also meet the definition of a life benefit termination payment as they are employment termination payments to which subparagraph 82-130(1)(a)(i) applies.

Therefore to further consider if the life benefit termination payments are transitional termination payments, it becomes necessary to consider whether both payments meet the requirement of being entitlements that are provided for under a written contract as in force just before 10 May 2006.

The explanatory memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 which introduced section 82-10 of the IT(TP)A states:

4.68 In order to ensure that the transitional provisions are not open to abuse, they are only available in situations where the payment was able to be determined as at 9 May 2006. This will encompass arrangements where the contract refers to the amount of the payment by way of a formula which can be objectively determined, or to payments made in kind (eg, shares). [Schedule 2, item 2, subsections 82-10(3) and (4)]

Contract in force before 10 May 2006

Paragraph 82-10(1)(b) of the IT(TP)A requires that the entitlement is provided for under that contract as in force just before 10 May 2006. Furthermore, subsection 82-10(3) provides that the division applies to a payment only to the extent that the contract 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.

Payment 1

The 1998 Staff Retrenchment Policy in relation to redundancy benefits for length of service entitlement ('Four weeks pay per completed year of service') was clarified to be' Four weeks pay per completed year of service, pro-rated to part years and capped at a maximum of 30 years). This did not alter or affect the way your client's entitlements were calculated. As his service period was less than 30 years, therefore the cap of 30 years did not apply in any case.

Payment 2

In a letter you have stated your client was equitably entitled to his notional payment. Further you have stated that if an employee in the same position as your client had terminated employment before 10 May 2006 that employee would have reasonably expected to receive the payment in lieu of notice amount, not withstanding the ex gratia nature of the payment.

In your client's employment contract signed prior to 10 May 2006, the 'Termination' clause states that the Company may terminate his employment by paying three months salary in lieu of notice.

Therefore clearly this entitlement exists in a written contract prior to 10 May 2006.

As your client worked the period of notice the payment is not strictly a payment in lieu of notice. However, it is an ex-gratia payment paid on termination of employment.

From the information provided, your client's termination entitlement (Payment 1) and the formula to calculate the payment is stated in the employment contract and the redundancy policy provisions under the Staff Retrenchment Policy.

The Company has also confirmed your client's length of service entitlement was determined on the same basis as it would have been had his employment been terminated for the same reason before 10 May 2006 i.e. four weeks pay per completed year of service, or part thereof.

The Company has clarified that its practice has been to pay out the full notice period irrespective of the fact that an employee may have received notice of their termination some time prior to it being effective.

Therefore, both Payment 1 and Payment 2 satisfy the requirement in paragraph 82-10(1)(a) of the IT(TP)A that the payment is received by a taxpayer because they have an entitlement under a written contract to the payment as in force just before 10 May 2006 . The contract refers to the amount of the payment by way of a formula which can be objectively determined. That is, the requirement to specify the amount of the payment, or a way to work out a specific amount of the payment has been met. Consequently, they are transitional termination payments.

Tax treatment of transitional termination payments - recipient under preservation age

The tax free component of the transitional termination payment is not assessable income and not exempt income. The taxable component of the transitional termination payment is assessable income.

For people under preservation age such as your client, the transitional termination payment it is taxed as follows:

Subject to the upper cap amount ($1 million), the total taxable components are subject to a tax offset that ensures the rate of income tax does not exceed 30%. The remainder of the taxable components are taxed at the top marginal rate of tax (section 82-10C IT(TP)A)).

Medicare levy is added to the rate of tax that applies.

Where another life benefit termination payment is received in the same income year (or in an earlier income year) that is not a transitional termination payment, the entitlement to a tax offset under the section is not affected by the entitlement (if any) to a tax concession for the other payment under section 82-10 of the ITAA 1997.

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