Disclaimer
This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your private ruling

Authorisation Number: 1012418531145

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Employment termination payment

Questions

1. Is any part of the payment received on the termination of your client's overseas employment but paid in recognition of your client's whole period of service including service in Australia, assessable in Australia where your client is a non-resident?

2. Is any part of the unused annual leave and long service leave related to service overseas exempt from income tax in Australia?

3. Is the portion of the unused long service leave that is related to services carried out in Australia exempt from income tax in Australia?

4. Is your client entitled to foreign tax credit for tax paid in the foreign country?

Answers

5. Yes.

6. Yes.

7. No.

8. Yes.

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

Your client was an employee of an entity (Entity 1).

Your client's employment commenced during the X income year.

Your client did not have an employment contract with Entity 1.

Most recently, your client worked in a foreign country with the employer, (Entity 2), a subsidiary company of Entity 1.

Your client is registered as a taxpayer in this foreign country (resident and ordinarily resident) since the Y income year.

Your client is paid and taxed by the employer. The payment was reimbursed by Entity 1.

Your client was on the staff of the Australian operation.

Your client took a voluntary redundancy package during the relevant income year.

In an email dated during the relevant income year, the employer indicated that any termination payments your client is entitled to should be fully taxable in the foreign country.

Your client's employment history in overseas and in Australia is as follows:

On termination of employment, your client received all their unused annual leave, unused long service leave and a termination payment.

Your client indicated that:

all of the annual leave was accrued while working in the foreign country;

long service leave has been accrued whilst serving in Australia and overseas.

they took some of their long service leave in the Z income year.

Your client stated that the termination payment of A was calculated on the basis of four weeks pay for each year of service, capped at 112 weeks. The statement provided shows the following components:

Your client's employment was terminated during the relevant income year.

Your client is under 60 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2).

Income Tax Assessment Act 1997 Subsection 6-5(3).

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Subsection 82-10(2).

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

Income Tax Assessment Act 1997 Subsection 82-10(4).

Income Tax Assessment Act 1997 Section 6-10(5).

Income Tax Assessment Act 1997 Paragraph 6-10(5)(a)

Income Tax Assessment Act 1997 Section 82-130.

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

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

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

Income Tax Assessment Act 1997 Subsection 82-130(2).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 83-10.

Income Tax Assessment Act 1997 Section 83-70.

Income Tax Assessment Act 1997 Section 83-235.

Income Tax Assessment Act 1997 Paragraph 83-235(a).

Income Tax Assessment Act 1997 Paragraph 83-235(b).

Income Tax Assessment Act 1997 Paragraph 83-235(c).

Income Tax Assessment Act 1997 Paragraph 83-235(d).

Income Tax Assessment Act 1997 Subsection 995-1(1).

Income Tax Assessment Act 1936 Section 26AC.

Income Tax Assessment Act 1936 Section 26AD.

Reasons for decision

Summary

The payment is an employment termination payment as it was paid in consequence of the termination of your client's employment, received no later than 12 months after termination of employment and is not a payment which is excluded from being an employment termination payment. The payment is therefore subject to Australian income tax and will be taxed accordingly.

The payment is not exempt from tax as a foreign termination payment as the payment does not relate solely to a period of employment during which your client was either solely a resident of Australia or solely a non-resident.

The portion of the payment made to your client in respect of unused annual leave and long service leave relating to your client's service overseas is exempt from Australian income tax. However, any long service leave accrued whilst your client was employed in Australia is assessable in Australia and will need to be apportioned accordingly.

Your client will be entitled to a foreign income tax offset in Australia in relation to tax paid in the foreign country as per the Double Taxation Agreement between the foreign country and Australia.

Detailed reasoning

Employment termination payment

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that:

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

Subsection 82-130(2) of the ITAA 1997 states:

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

To determine if a payment constitutes an employment termination payment, 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. Furthermore, any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule.

Essentially section 82-130 states that for a payment to be a life benefit employment termination payment, it must be made to the taxpayer in consequence of the termination of their employment.

Paid as a consequence of the termination of your employment

It should be noted that 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', 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.'

Thus 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 and will be an employment termination payment unless it fails to satisfy the other requirements of an employment termination payment under section 82-130 of the ITAA 1997.

In this case, your client was employed by the employer, Entity 2. You advised that your client took a voluntary redundancy package and their employment was terminated during the relevant income year.

A termination payment of A was be made to your client. It is evident that the payment was made in consequence of the termination of your client's employment. The termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the payment would not have been paid.

In view of the above, it is considered that the payment was made in consequence of the termination of your client's employment with the employer. Therefore, the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

The payment is received no later than 12 months after termination

The second condition for the payment to be an employment termination payment is stated in paragraph 82-130(1)(b) of the ITAA 1997. The payment must be received within 12 months of the employee's termination of employment, unless they are covered by a determination exempting them from the 12 month requirement.

Your client's employment was terminated during the relevant income year and a termination payment of A was made to your client shortly after. As the payment was made within 12 months after the termination of your client's employment, the requirement under paragraph 82-130(1)(b) of the ITAA 1997 has been met.

Not a payment mentioned in section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments. These include (among others):

Accordingly in your client's case, it is necessary to consider whether there is any amount that should be excluded from being an employment termination payment as a foreign termination payment.

Foreign termination payment

Subdivision 83-D of the ITAA 1997 deals with termination payments that arise out of foreign employment. These payments are not employment termination payments, and are generally tax-free.

Section 83-235 of the ITAA 1997 applies to termination payments received where the taxpayer was a foreign resident during the period of foreign employment to which the payment relates. It states that:

Section 83-235 of the ITAA 1997 require that for a payment to be tax-free as a foreign termination payment it must be received in consequence of the termination of the taxpayer's employment in a foreign country.

As previously determined, the employment termination payment was made to your client in consequence of the termination of their employment. At the time of the termination of your client's employment, that employment was located overseas. In addition, the payment was not a superannuation benefit and was made to your client as a one-off lump sum. Consequently, the requirements in subsections 82-235(a), (b) and (c) of the ITAA 1997 have been satisfied.

Further, paragraph 83-235(d) of the ITAA 1997 requires that the payment 'relates only to a period of employment when your client was not an Australian resident'.

A lump sum termination payment was made to your client. The amount of the termination payment was calculated by reference to your client's total period of employment in Australia various overseas countries from X to the relevant year. Accordingly, the payment clearly relates not only to a period of employment when your client was not an Australian resident

Apportionment of employment termination payment

In Case [2000] AATA 1080; (2000) 46 ATR 1025; (2000) 2000 ATC 243 the issue of whether or not a redundancy payment made to a taxpayer related 'solely' to a period of employment during which the taxpayer was not a resident of Australia was examined.

In that case the taxpayer was originally employed in 1983 as a graduate bank trainee in Sydney. In 1986 he was seconded to work for the bank in England, including a posting in New York between 1990 and 1992. In 1994 he was appointed as a senior manager in London (under an Australian expatriate contract) until he was made redundant in 1996. The applicant remained as a resident of the United Kingdom following his redundancy. The taxpayer's employment was based on Australian terms and conditions, including his redundancy payment which was calculated under a Bank/Financial Sector Union (FSU) agreement according to his total bank service of 13 years and 7 months.

The bank deducted PAYE tax instalments from the payment on the basis that it was an eligible termination payment (ETP) and assessable income, except for the bona fide redundancy component. The taxpayer appealed to the tribunal against the decision of the Deputy Commissioner of Taxation to disallow his objection. The taxpayer argued that the payment was not taxable as it was an 'exempt non-resident foreign termination payment' under subsection 27A(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

The taxpayer submitted that the character of redundancy payment was to compensate him for the loss of his position (or office) as a senior manager in the bank's London office which was unrelated to his service with the bank in Australia. The taxpayer also argued that, although the payment was calculated according to his entire service period, the formula used under the Bank/FSU agreement was simply for convenience and any other method could have been used.

It was held that:

The term 'solely' signifies 'exclusively'.

The redundancy payment was calculated according to the taxpayer's entire service period under the Bank/FSU agreement, which included service as a resident. Therefore, the payment did not relate 'solely' or 'exclusively' to a period of employment during which the taxpayer was not a resident of Australia.

Whilst the facts of this Administrative Appeals Tribunal decision are not identical to the present taxpayer's case they do share many common grounds and, as such, the decision made in Case [2000] AATA 1080; (2000) 46 ATR 1025;(2000) 2000 ATC 243 can be applied to the present taxpayer's circumstances.

It should noted that as part of the Federal Government's Simplified Superannuation reforms, eligible termination payments ceased to exist from 1 July 2007, being replaced by employment termination payments and superannuation lump sums. Clause 4.3 of the Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 states that:

The case quoted above, which were in respect of ENRFTP under subsection 27A(1) of the ITAA 1936, would therefore apply to foreign termination payments under Division 82 of the ITAA 1997.

It should also be noted at this point that, unlike entitlements such as sick leave, annual leave and long service leave, which accrue over the period of employment, an employment termination payment is made because an employment has been terminated. Although an employment termination payment may be calculated by reference to a period (or periods) of employment, it does not accrue over that period (or those periods) of employment.

As was already indicated previously, the payment does not relate wholly to the foreign employment of your client. Therefore, this coupled with the decision made in Case [2000] AATA 1080 would indicate that the payment does not relate solely to the period of employment during which your client was not a resident of Australia.

Based on the above, no portion of the employment termination payment received by your client was a foreign termination payment and could, therefore, be exempt under section 83-235 of the ITAA 1997.

Genuine redundancy payment

A payment made to an employee is a genuine redundancy payment (GRP) if it satisfies all conditions under section 83-175 of the ITAA 1997.

Your client received a voluntary redundancy package of A from the employer. The employer determined the tax-free amount of the genuine redundancy payment is B.

The Commissioner accepts the employer's determination that B is the tax-free part of the genuine redundancy payment.

Taxation treatment of as a Life Benefit Termination Payment (LBTP)

As previously mentioned, the tax-free amount of a genuine redundancy payment is specifically excluded from being an employment termination payment under paragraph 82-135 of the ITAA 1997. Therefore, any amount of the redundancy payment in excess of the tax-free amount will be an employment termination payment.

In your client's case, the employer's determined that the LBTP is E.

LBTPs are comprised of the following components:

The tax free component is not assessable income and is not exempt income.

The taxable component is included, in full, as assessable income.

In your client's case, as the period of employment to which the LBTP relates commenced before 1 July 1983, the LBTP does have a pre-July 83 segment.

The pre-July 83 segment worked out by your client's employer is C.

In addition, as the LBTP was not made because your client ceased being gainfully employed as a result of suffering from ill-health, there is no invalidity segment for the purposes of section 82-150 of the ITAA 1997.

Therefore, the amount of C represents a pre-July 83 segment included in the employment termination payment which is tax free. The remaining D (that is, E less the tax-free amount of C) is a taxable component to be included in your client's income tax return for the relevant income year. As your client has not yet reached their preservation age, the amount up to the employment termination payment cap of $175,000 will be taxed at a maximum rate of 30% plus Medicare levy.

The amount of F, which is in excess of the $175,000 cap, will be taxed at the top marginal tax rate plus Medicare levy.

Payment of accrued unused annual leave and long service leave

Subsection 6-5(3) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that ordinary income derived by a foreign resident directly or indirectly from Australian sources, as well as other ordinary income included by a provision on a basis other than having an Australian source, is assessable.  Statutory income from all Australian sources, or included by a provision on a basis other than having an Australian source, is also included in a foreign resident's assessable income under subsection 6-10(5) of the ITAA 1997.

Sections 83-10 and 83-70 of the TAA 1997 provide that any amount paid to a taxpayer in lump sum in consequence of termination of employment, being an amount that is paid in respect of accrued unused annual leave (section 83-10 of the ITAA 1997) and accrued unused long service leave (section 83-70 of the ITAA 1997), are to be included in their assessable income.

Generally, Australian courts have held that the source of employment income is where the employee performs their duties. Thus, employment income earned while carrying out duties in Australia is considered to be sourced in Australia.  Employment income earned while being carried out overseas is considered to be sourced in that overseas country.

However, in determining the liability to tax on income received by a foreign resident, it is necessary to consider not only the income tax laws but also any applicable tax treaty contained in the International Tax Agreements Act 1953.

Australia has a tax treaty with the foreign country which operates to avoid the double taxation of income received by Australian and the foreign country's residents.

An article of the foreign country convention provides that salaries, wages and other similar remuneration derived by an individual who is a resident of the foreign country in respect of an employment shall be taxable only in the foreign country unless the employment is exercised in Australia. If the employment is so exercised, such remuneration as is derived from that exercise may be taxed in Australia.

Your client is a resident of the foreign country for taxation purposes and the employment with the Australian employer is performed there. Therefore under the relevant article of the convention, the portion of the unused annual and long service leave payments which accrued from your client's service in the foreign country is taxable only in the that country. 

Accordingly, the lump sum payment for annual leave and long service leave accrued while your client was both a non resident of Australia and working overseas is not assessable in Australia under subsection 6-5(3) of the ITAA 1997.

As all of your client's annual leave entitlements were accrued in the foreign country, this payment is not assessable income for Australian taxation purposes.

However, your client's long service leave entitlements accrued over a period whereby your client was working in Australia and overseas. Therefore, the long service leave portion accrued whilst your client was working in Australia is assessable income for Australian taxation purposes under subsection 6-5(3) of the ITAA 1997.

Foreign tax credit

As previously mentioned, in determining liability to tax on Australian sourced income received by a foreign resident, it is necessary to also consider the applicable tax treaty.

An Article in the Convention allocates taxing rights in relation to income not dealt with by the preceding Articles of the Convention. Employment termination payments are not dealt with by any of those Articles and therefore they fall within the scope of a different Article.

As your client was a resident of the foreign country at the time of receiving the ETP the Article allocates a taxing right over the ETP to the foreign country. However, the Article also allocates Australia a taxing right over the ETP as it is from Australian sources.

The Convention provides that, subject to the provisions of the laws of Australia, a credit against Australian tax payable shall be allowed for foreign tax paid (in accordance with the law of Australia) where tax has been paid under foreign law and in accordance with the Convention.

The general rule under section 770-10 of the ITAA 1997 is that, to qualify for an offset for an income year, the taxpayer must have paid foreign income tax on an amount that is included in its assessable income for that year, though there are exceptions in certain situations, such as where the tax has been deducted at source, or otherwise paid on the taxpayer's behalf (section 770-130 of the ITAA 1997).

As your client has paid foreign tax on the same income that is subject to tax in Australia, Australia is required to provide taxation relief under the Convention. Division 770 of the ITAA 1997 allows a foreign income tax offset for foreign tax that a taxpayer has paid on income that is included in the taxpayer's assessable income.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).