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Ruling

Subject: Employment termination payment - extension of 12 month rule

Questions

1. Is there an effective termination of employment if the employee ceases work as an ongoing employee and recommences the following day on a fixed term contract?

2. Will the Commissioner determine, in writing, under subsection 82-130(5) of the ITAA 1997 that the 12 month rule under paragraph 82-130(1)(b) will not apply?

Answers

1. Yes.

2. Yes, provided the payment is made within six weeks from the date of this ruling.

This ruling applies for the following period:

Year ended 30 June 2011.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

· The employee is currently employed by an entity (the Employer) within a particular industry.

· The employee's role up until the 2010-11 income year was in a managerial position.

· When the employee resigned the abovementioned role was effectively terminated and the employee was re-employed as a Director of a division within the Employer.

· The following applies to the employee's managerial role:

· Employment commenced in the 1981-82 income year.

· Over 25 years of service at time of cessation.

· Based on an Award and an Industrial Agreement in force at the time the employee commenced employment.

· Original contract states that accumulated sick leave shall be transferable on change of employment from employer to employer within the particular industry up to a certain number of weeks, provided that an employee shall only be entitled to transfer sick leave accumulated since the employee's last anniversary date on a pro rata basis. Such accumulated sick leave shall only be transferable if the period of cessation of service with the Employer and appointment to the service of another employer within the industry does not exceed a specified period. The sick leave entitlement transferred shall not exceed the maximum amount transferable as prescribed by the appropriate award at the time of transfer.

· The Industrial Agreement replaced a clause in the original contract dated and applied to accumulated sick leave. The replacement clause, which applies to the client, provides that when an employee's services are terminated by resignation, retirement or death and that employee has completed a minimum number of years of service with the Employer, the employee or their legal representative shall be paid the full monetary value of accumulated untaken sick leave standing to their credit.

· All conditions of employment were governed by the above mentioned Award and Industrial Agreement (including salary and award increases)

· The above does not apply to the employee's current employment as a Director.

· You have advised in this position as Manager, the employee had defined authority within the organisation. This is based on the employee's delegation authority and the position carrying with it significant duties and functions pertaining to business services, policies and general operations in the Employer.

· You have also advised there were a number of reporting staff allocated to the Employer and in the role as Manager the employee would delegate certain business function tasks and oversee the performance of such tasks.

The following applies to the employee's role as Director.

· Employed on a fixed term performance based contract.

· Contract for a maximum number of years.

· Entitlements and responsibilities as Director are set out in employment contract.

· Remuneration increases are determined by client's performance in the position by way of annual review.

· Contract is independent of any changes in any award conditions.

· The contract is a standard contract for 'Senior Staff' of employers in the particular industry.

· Accrued but unused sick leave will not be paid out on the termination of this contract.

· Functional duties for this role include the following:

· Act as interface between the General Manager and a division (the Division) within the Employer.

· Act as the Director of a branch within the Employer and leader of the Division's Management Team.

· Be an active member of the General Manager's Executive Management Team.

· Manage and control the Division to achieve and adhere to the Employer's policies, resolutions and approved Corporate Strategic Plan, Management Plan, Annual Operating Plan and Budget and Function Plans of the Division.

· As required, act as General Manager of the Employer.

You have provided a rough outline of the Employer's organisational structure.

You have stated that there was some lack of clarity with regards to the entitlement of the payment for unused sick leave. As a result, legal advice was sought as to how the balance of unused sick leave should be treated in relation to the employee's contract.

You have stated legal advice was also sought in relation to the quantum of payment of untaken sick leave as it relates to an Industrial Relations Act as it now stands, and the Industrial Agreements that the Employer has in place.

Advice on the above issues has only recently been received and as such, the payment was not made within 12 months of the date of termination of employment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 995-1.

Income Tax Assessment Act 1997 Section 80-50.

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(4).

Income Tax Assessment Act 1997 Subsection 82-130(5).

Income Tax Assessment Act 1997 Subsection 82-130(7).

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

Income Tax Assessment Act 1997 Section 82-135.

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)(b).

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

Reasons for decision

Summary

There has been an effective termination of employment.

In taking steps to determine the correct treatment and amount of the payment, the Employer sought professional legal advice. In view of this, together with the fact that the employee had no control over the timing of receiving the advice and payment, the Commissioner has determined that the time taken between the termination of the employee's employment as Manager and the payment is deemed to be reasonable. As such the 12 month rule will not apply to the payment for unused sick leave.

Based on the above, the payment for unused sick leave received by employee is an employment termination payment as all the conditions have been satisfied.

Detailed reasoning

Employment termination payment

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.

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

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

The above three conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. Any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates.

Termination of employment

The first requirement under section 82-130 of ITAA 1997 is that the payment must be made in consequence of the termination of the employment.

For a termination of employment to be effective, the termination must be real and not merely illusory.

In Reseck v. Federal Commissioner of Taxation (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 75 5ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 (Resecks Case), Justice Gibbs made the following comments:

In most cases in which a workman ceased his employment on a Friday and commenced employment again with the same employer on the following Monday it would be impossible to say that his employment had ever been terminated. If there were a contract agreement or arrangement whereby the employment of the workman was terminated and re-commenced it would no doubt be possible to invoke the provisions of s 260 of the Act, but even without the aid of that section in many cases when all the facts had been regarded the proper conclusion to be drawn would be that there had been no termination of the workmans employment at all.

Therefore, if a person purports to resign from their employment and is subsequently re-employed with the same employer the following working day then it would be considered unlikely that there was an effective termination of employment.

It should also be noted that a mere change in the terms of employment (for instance, a reduction in hours) or a re-negotiation of a new contract of employment will generally not be sufficient for a termination of employment to have occurred.

In Taxation Board of Review decision Case B19 70 ATC 88, a woolclasser was for the whole of the income year employed by a graziers shearing company under a general contract of employment as resident overseer for the shearing programme in the locality. For this he received a retainer, there being mutual obligations on the parties to offer and accept work when available.

Under the award, a separate contract had to be signed for the work at each shed and on its completion the classer had to be paid pro-rata holiday pay, in addition to the award wage. The Board held there was no cessation of the obligations between employer and taxpayer and the mere fact that a separate contract had to be made for each shed did not mean that there was a termination of employment on each occasion.

In the present case, the employee held a managerial role up until sometime in the 2010-11 income year. On this date the abovementioned role was effectively terminated and the employee was re-employed by the same employer as a divisional Director. Based on the Resecks Case above, it would be considered unlikely that there was an effective termination of employment.

However, for the purposes of subparagraph 82-130(a)(i) of the ITAA 1997 stated previously, section 80-5 extends the ordinary meaning of employment 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).

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

In the Administrative Appeals Tribunal (AAT) decision AAT Case 8603 (1993) 93 ATC 148; (1993) 25 ATR 1082, Deputy President BJ McMahon dealt with a case of a woman who had been an Inspector of Schools and who became (when that position phased out) a Cluster Director. Paragraphs 14 and 15 read as follows:

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 Grealy's case [Grealy v. Commissioner of Taxation (1989) 24 FCR 405; (1989) 20 ATR 403; (1989) 89 ATC 4192] 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 [(1978) 22 CTBR (NS) 212], 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 Grealy's case itself, their Honours noted that the word "office" usually connoted a position of defined authority. [additional case citations added]

AAT Case 12,178 (1997) 97 ATC 407; (1997) 37 ATR 1174 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 determining the case, 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 case, Senior Member J Block stated:

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 (ATC) 421; (ATR) 1189, he made the following observation:

In Great Western Railway Co v. Bater [1920] 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 W31 [Case No VT 87/3438 (1989) 20 ATR 3509; (1989) 89 ATC 307] 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. [bold emphasis and additional case citations added]

In the present case, the employee held a managerial position which was governed by an Award and an Industrial Agreement in force at the time the employee commenced employment.

With regards to the Employer's organisational structure, we can characterise the Managerial Position as being in the middle of Employee's hierarchy. In the employee's position as Manager, you have stated the employee was vested with substantial powers and duties including delegation authority. The employee also had a number of reporting staff who the employee delegated certain business function tasks to and oversaw the performance of such tasks. As such, the designation of 'Manager' is not a descriptive term without meaning. Rather, it aptly describes the managerial functions performed by the employee.

Further, the Managerial Position is ongoing, having separate existence and is a position of authority within the Employer.

When the nature of the employee's position as Manager, and the authorities and duties pertaining to it is analysed in light of the Employer's organisational structure, it is considered the Managerial Position constituted holding an office within the meaning of section 80-5 of the ITAA 1997.

The phrase 'in consequence of termination of employment' in subparagraph 82-130(a)(i) of the ITAA 1997 above is not defined in the legislation. However, the courts have considered the meaning of the words 'in consequence of' in relation to eligible termination payments (ETPs), the predecessor of employment 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.

The Commissioner in Taxation Ruling TR 2003/13 considered the phrase 'in consequence of' as interpreted by the Courts. 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 the employee's unused sick leave payout follows as an effect or a result from the termination of employment, it is considered that the payment will be made in consequence of the termination of employment. As such, the requirement under subparagraph 82-130(a)(i) of the ITAA 1997 is satisfied.

Payment received no later than 12 months after the termination

The second requirement under section 82-130 of ITAA 1997 is that the payment be made within12 months of the termination of employment. However, subsection 82 130(4) of the ITAA 1997 provides that the 12 month rule does not apply if a determination under subsection (5) or (7) is made.

Subsection 82-130(7) provides that the Commissioner may determine, by legislative instrument that the 12 month rule will not apply to a class of payments or a class or recipient. The Commissioner has issued legislative determination SPR 2007/1 which states that the 12 month rule will not apply where legal action commenced within 12 months of the termination or the payment was made by a liquidator, receiver, receiver/manager or trustee in bankruptcy provided they were appointed within 12 months of the termination. These circumstances do not apply to the employee's situation.

However, the Commissioner may also make a determination on a case by case basis pursuant to subsection 82-130(5) of ITAA 1197.

Subsection 82-130(5) of the ITAA 1997 states:

The Commissioner may determine, in writing, that paragraph (1)(b) does not apply to you if the Commissioner considers the time between the employment termination and the payment to be reasonable, having regard to the following:

(a) the circumstances of the employment termination, including any dispute in relation to the termination;

(b) the circumstances of the payment;

(c) the circumstances of the person making the payment;

(d) any other relevant circumstances.

Paragraph 4.19 of the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Act 2007 states that the 12 month rule exists to prevent abuse of the tax concessions offered for these payments by using a series of payments over a number of income years. The provisions dealing with the Commissioners ability to issue a determination are provided to allow flexibility where delays in payments are reasonable and not constructed with the intention of delivering a tax advantage.

The employee's employment in the Managerial Position was terminated in the 2010-11 income year. You have stated there was a lack of clarity with regards to the entitlement of the payment for unused sick leave. As a result, legal advice was sought as to how the balance of unused sick leave should be treated in relation to the employee's contract and the quantum of the payment based on an Industrial Relations Act as it now stands, and the Industrial Agreements that the employer has in place.

Advice on the above issues has only recently been received and, as such, the payment was not made within 12 months of the date of termination of employment.

Based on the fact that:

· steps were taken to determine the correct treatment and amount of the payment by way of seeking professional legal advice; and

· the employee had no control over the timing of receiving the advice and payment;

the Commissioner determines that the time taken between the termination of employment and the payment is deemed reasonable.

Therefore the 12 month rule will not apply to the payment for unused sick leave made to the employee by the Employer provided the payment is made within six weeks from the date of this ruling.

Employment termination exclusions

Section 82-132 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

· payment for unused annual leave or unused long service leave;

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

· reasonable capital payments for personal injury.

The above does not apply to the payment for unused sick leave and as such paragraph 82-130(1)(c) is satisfied.

Conclusion

As all of the conditions have been satisfied, the amount paid to the employee as payment for unused sick leave by the Employer will be treated as an employment termination payment provided the payment is made within six weeks from the date of this ruling..

Please note, the payment of $X is to be included in the employee's tax return in the income year in which it was paid, being the 2011-12 income year.

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