Edited version of your written advice

Authorisation Number: 1012931041559

Date of advice: 23 February 2016

Ruling

Subject: Death benefit termination payment

Question 1

Will the proposed payment by the Company to the taxpayer be considered a death benefit termination payment that is not assessable and is not exempt income pursuant to section 82-65 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the proposed payment by the Company to the taxpayer be considered a deemed dividend pursuant to section 109 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

This ruling applies for the following periods:

1 July 2015 - 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

The taxpayer and their spouse were co-directors of the Company.

The taxpayer's spouse (the deceased) passed away in 20XX, and the taxpayer then became the sole director of the Company.

The taxpayer is a shareholder of the Company.

The Company operates in partnership with X other companies.

The Partnership Agreement states that upon the death of the deceased, the Company is deemed to have given notice that it will retire from the partnership.

The Company is currently in the process of selling their partnership interest.

After the death of the deceased, the taxpayer in their capacity as sole director of the Company proposes to pay $X to them self on or before one year after the deceased's death.

The payment of $X is an arbitrary amount and is not calculated on the number of years the deceased worked in the Company.

During the period, the Company was a member of the partnership; the deceased did not receive any salary, wages or employee benefits such as sick leave or annual leave from the Company.

The Company receives partnership income and distributes this income as fully franked dividends to its shareholders.

The taxpayer submits the payment will be made due to their financial position and security declining as the Company will have a reduced capacity to make franked dividends to them when the Company is no longer a member of the partnership.

Reasons for decision

Question 1

Section 82-65 of the ITAA 1997 provides the tax treatment of a death benefit termination payment received after the death of a person and states:

Tax free component

82-65(1) The tax free component of a death benefit termination payment that you receive after the death of a person of whom you are a death benefits dependant is not assessable and is not exempt income.

Taxable component

82-65(2) If you receive a death benefit termination payment after the death of a person of whom you are a death benefits dependent:

a) The part of the taxable component of the payment mention in subsection (3) is not assessable and is not exempt income; and

b) The remainder of the taxable component (if any) of the payment is assessable income.

Subsection 82-130(3) of the ITAA 1997 defines a 'death benefit termination payment' as an employment termination payment to which subparagraph 82-130(1)(a)(ii) applies.

The conditions for an 'employment termination payment' are set out in subsection 82-130(1) of the ITAA 1997:

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.

In this case, the payment to the taxpayer will be considered a 'death benefit termination payment' if the following conditions are satisfied:

• The payment is received after another person's death, in consequence of the termination of the other person's employment.

• The payment is received no later than 12 months after the termination of employment

• The payment is not specifically listed in paragraph 82-130(1)(c).

'In consequence of'

The first condition requires that there is:

• a payment

• received by you

• in consequence of the termination of either your employment, or another person's employment

From the facts presented the first two requirements will be satisfied as there will be a payment of $X received by the taxpayer.

The third requirement refers to the phrase 'in consequence of the termination of your employment'. This phrase has not been defined in the legislation and therefore takes on its ordinary meaning. The Commissioner in Taxation Ruling TR 2003/13 Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of', considers the phrase 'in consequence of' in relation to eligible termination payments (ETPs), which was the predecessor of employment termination payments, as interpreted by the Courts. In paragraph 5-6 of TR 2003/13 it states:

5…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.

6. 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.

Paragraph 29 of TR 2003/13 further states:

29. The judgments in Reseck, McIntosh and Le Grand are all consistent in respect of the finding that the termination need not be the dominant cause of the payment for there to be a conclusion that a payment is made in consequence of the termination of employment. However, the judgments do diverge in that there appears to be two different interpretations of the meaning of 'in consequence of the termination of employment': one interpretation being broader than the other. The narrower interpretation requires that there be a causal connection in the sense that the payment follows as an effect or result of the termination of employment. That is, but for the termination of employment the payment would not have been made to the taxpayer. The broader view is that a payment will be in consequence of the termination of employment if the termination is either a cause of the payment or an antecedent event. The Commissioner considers that the narrower view accords more closely with the ordinary meaning of 'consequence' and is therefore to be preferred.

Under section 80-5 of the ITAA 1997, a person that holds an office position is considered the same as if they were employed. We accept that the deceased was employed by the Company by virtue of their directorship.

Under section 80-10 of the ITAA 1997, the termination of employment includes cessation of employment because of death (80-10(b) of the ITAA 1997). We accept that the deceased's employment was terminated upon their death.

The ATO's view as per the above paragraphs in TR 2003/13 state a narrower interpretation of the phrase 'in consequence of' should be taken. This means 'but for' the termination of employment, the payment would not have been made. There must be a causal connection, although it does not need to be the dominant cause of the payment.

In the case Advanced Prosthetic Centre Pty Ltd v Appliance & Limb Centre (Int) Pty Ltd [2002] NSWSC 515 (Advanced Prosthetic case), Bryson J stated at 63:

The terminations of their employment were elements in this chain of facts and events, and necessary elements for the whole series, but the connection between termination and the payments is highly attenuated by the causal operation of many intervening events and circumstances. The terminations cannot be completely excluded from the causative facts and circumstances leading to the payments, but their part in the outcome is so distant and attenuated that I do not regard it as a correct conclusion of fact, applying the terms of the definition to the facts, that the payment was made in consequence of the terminations.

In Haggarty & Ors v FCT (1989) 20 ATR 538; 89 ATC 4485 (Haggarty's case) Wilcox J considered a case in which the relevant provision was s27A of the ITAA 1936. At ATR 547; ACT 4493 his Honour said:

In order to constitute an "eligible termination payment", a payment has to be made "in consequence of the termination" of employment. There must be a direct causal relationship between the termination and the employment. The mere existence of an employer/employee relationship is not enough.

We consider the proposed payment does not demonstrate a causal connection with the termination of the deceased's employment. Rather the termination of employment is an antecedent event that will precede the payment.

The deceased is deemed to be an employee by virtue of their directorship however, was not in receipt of any salary, wages or employee benefits while the Company operated in the partnership. In the absence of any employment benefits paid to the deceased it is difficult to conclude the payment will be in consequence of their termination of employment as they were not remunerated for performing employment related duties and the provision of the funds to the taxpayer is for some other reason.

Following on from the Court's statements in Haggarty's case which was further repeated in the Advanced Prosthetic case, the 'mere existence of an employer/employee relationship is not enough'. As mentioned above, the deceased is deemed to be an employee of the Company however, that in itself is not enough to prove a causal connection.

It is not in contention that the deceased's employment with the Company was terminated however, we consider its part in the proposed payment to be too remote. The death of the deceased triggered the Company to give notice that it would retire from the partnership. In anticipation of the Company retiring from the partnership, the proposed payment will compensate the taxpayer for the expected reduced dividend distributions they would receive. As the payment is replacement for future dividend distributions, it is indicative that the proposed payment is being made on the basis of being a shareholder rather than termination of employment related reasons and that a similar payment could have been made i.e. dividends.

In addition, the facts provide the proposed payment is being made by the sole director of the Company to them self. This arguably raises concerns on the arms-length basis the transaction is taking place on and questions the intention of the payment in the absence of any evidence supporting a termination of employment related reason.

We consider the facts provided do not support a causal connection between the proposed payment and the termination of employment, we therefore do not consider this requirement satisfied.

Conclusion

As the proposed payment is not made in consequence of the termination of employment, the next two following conditions in subsection 82-130(1) of the ITAA 1997 have not been considered:

• The payment is received no later than 12 months after the termination of employment

• The payment is not specifically listed in paragraph 82-130(1)(c).

The payment is therefore not a death benefit termination payment and will not be considered not assessable and not exempt income under section 82-65 of the ITAA 1997.

In addition, we consider there may be Division 7A implications which are further discussed in the section 'further issues for you to consider'.

Question 2

Section 109 of the ITAA 1936 considers excessive payments to shareholders, directors and associates that are deemed to be dividends.

Subsection 109(1) of the ITAA 1936 states:

109(1) If a private company pays or credits to an associated person an amount (in this subsection called the excessive amount) that is, or purports to be:

a) remuneration for services rendered by the associated person, or

b) an allowance, gratuity or compensation in consequence of the retirement of the associated person from an office or employment held by the associated person in the company, upon the termination of any such office or employment;

so much (if any) of the excessive amount exceeds an amount that, in the option of the Commissioner, is reasonable:

c) is not an allowable deduction; and

d) shall, for the purposes of this Act other that Division 11A of Party III, be deemed to be a dividend paid by the company:

i. to the associated person as a shareholder in the company;

ii. out of profits derived by the company; and

iii. on the last day of the year of income of the company in which is the excessive payment or credit is made.

An 'associated person' is defined in paragraph 109(2)(b) of the ITAA 1936 as:

i. a person who is, or has been, a shareholder in, or director of, the company; or

ii. a person who is an associate within the meaning of section 318, of a person who is, or has been, a shareholder in, or director of, the company.

In this case, the Company, which is a private company, is proposing to pay an amount to the taxpayer. The taxpayer is currently a shareholder and a director of the Company. It is considered that the taxpayer will fall within the definition of an 'associated person' under paragraph 109(2)(b) of the ITAA 1936.

The payment to the taxpayer will be considered excessive and thus a deemed dividend, if the payment purports to be remuneration for services the taxpayer has rendered or in consequence of the taxpayer's retirement or termination of employment.

From the facts provided, the taxpayer is not retiring or terminating their directorship with the Company and the Company is not remunerating the taxpayer for services rendered. Rather it appears the purpose of the payment is to compensate the taxpayer for the Company's loss of future earnings which is expected to result in the taxpayer receiving reduced dividend distributions.

The payment is not considered an excessive payment under section 109 of the ITAA 1997 and subsequently not a deemed dividend under that section.

Further issues for you to consider

Division 7A

Division 7A of the ITAA 1936 is a specific anti-avoidance measure designed to prevent private companies from making tax-free distributions of profits to shareholders.

If the proposed payment is not a consequence of your spouse's former employment, and instead, for example, you make the decision to pay yourself the amount because you are a shareholder or associate of the Company, the payment could be considered a deemed dividend under section 109C of the ITAA 1936, and would be assessable to you.

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