Edited version of your written advice

Authorisation Number: 1012931453182

Date of advice: 22 December 2015

Ruling

Subject: Payment on termination and genuine redundancy

Questions

1. Is any part of the payment received by your client an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Is your client entitled to a tax offset under section 82-10 of the ITAA 1997 for the taxable component of the employment termination payment?

3. Is any part of the payment received by your client a genuine redundancy payment under section 83-175 of the ITAA 1997?

4. Is your client entitled to a tax offset under section 83-15 of the ITAA 1997 for an unused annual leave payment made in connection with a genuine redundancy payment?

Answers

1. Yes.

2. Yes.

3. Yes.

4. Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20WW

Relevant facts and circumstances

Your client commenced employment with an employer (the Employer) in an overseas country several years ago.

Your client's employment was terminated during the 20WW-XX income year.

Your client was a resident of Australia during the time your client was employed by the Employer.

Your client's position ceased to exist within the Employer's organisation and the duties previously performed by your client were reorganised and absorbed by continuing employees of the Employer.

Your client was not replaced by the Employer.

A letter from the Employer stated your client's period of employment with the Employer. The letter also advised that due to a company re-organisation your client's position was made redundant. Accordingly your client received a gross redundancy payment.

Some clauses in your client's contract of employment with the Employer stated the following:

APPOINTMENT

Your employment with the Employer will continue unless terminated in accordance with a clause of the contract.

…

Bonus

The Bonus is an important component of the Company's overall remuneration strategy…You will be eligible for an annual Bonus of up to a specific percentage of your Total Remuneration, payable on achievement of performance targets associated with your role.

…

TERMINATION OF EMPLOYMENT

Termination

(a) Either party may terminate this contract by giving xxx month's notice in writing.

(b) The Company may in its absolute and sole discretion may elect to do any combination of the following:

(i) make a payment in lieu of notice (or any part of notice)

(ii) require you to take annual leave during the notice period; subject to

a clause in the contract

(iii) require you to undertake such alternative duties and responsibilities as may be required during the notice period.

(c) Notwithstanding the above, the Company may terminate your employment immediately for serious misconduct…In such circumstances; payment shall be up to the time of dismissal only.

(d) If you are working out the notice period (or any part of it) you must continue to comply with your obligations under this Agreement.

…

Redundancy

(a) In the event of redundancy, in addition to the notice set out in a clause of the contract you will be entitled to a further XX months' pay as severance pay plus pro-rata payment of your bonus earned up to the end of your notice period.

(b) Severance pay will be calculated on your Total Remuneration payable at the time of the redundancy.

(c) With regards to your bonus, you will be paid the bonus for the pro rata period of the severance period and the notice period at the full bonus rate.

…

During the 20WW-XX income year your client received the following payments from the Employer on the termination of their employment:

Redundancy

Ex gratia payment of XX months' salary

Bonus on ex gratia payment

Bonus on pro-rated period

Bonus

Bonus payment per contract for year to a specified month during the 20WW-XX income year

Accrued Leave

Accrued annual leave

Salary

Tax was withheld from the payment.

At the time of dismissal, there was no arrangement between your client and the Employer, or between the Employer and another person to employ your client after the dismissal.

None of the payments made to your client includes a payment in lieu of superannuation benefits to which your client may have become entitled.

You state that paragraphs 83-240(1)(g) and (h) of the Income Tax Assessment Act 1997 do not apply to you client as the payments are not exempt foreign earnings.

Your client is under 65 years of age.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Section 82-10.

Income Tax Assessment Act 1997 Section 82-130.

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 83-10.

Income Tax Assessment Act 1997 Section 83-15.

Income Tax Assessment Act 1997 Section 83-175.

Income Tax Assessment Act 1997 Section 83-235.

Income Tax Assessment Act 1997 Section 83-240.

Reasons for decision

Summary

The termination payment made to your client is genuine redundancy payment under section 83-175 of the Income Tax Assessment Act 1997 (ITAA 1997).

The amount of the genuine redundancy payment in excess of the tax-free amount is an employment termination payment.

Your client is entitled to a tax offset under section 82-10 of the ITAA 1997 for the taxable component of the employment termination payment.

Your client is entitled to a tax offset under section 83-15 of the ITAA 1997 for the unused annual leave payment as it was made in connection with a genuine redundancy payment.

Detailed reasoning

Employment termination payment

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 the termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135.

Failure to satisfy any of the three conditions in section 82-130 of the ITAA 1997 will result in a 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.

To determine if the payment made to your client constitutes an employment termination payment, the following examination has been made to determine whether all the relevant conditions in section 82-130 of the ITAA 1997 have been satisfied.

Paid as a consequence of the termination of your employment

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.

The facts show your client was employed by an employer (the Employer) in an overseas country and that due to their position being reorganised, that position ceased to exist within the Employer's organisation. Accordingly, your client's employment was terminated during the 20WW-XX income year.

During the 20WW-XX income year the Employer made payments to your client which included an amount which comprised an ex gratia payment of xx months' salary, a bonus on the ex gratia payment and a bonus on the pro-rated period to a specific date during the 20WW-XX income year.

In view of the facts provided it is considered that the payment of the bonus (a percentage of pro-rated salary) was not in consequence of your client's termination of employment as it represents a bonus earned by your client on their performance up to the date of their termination of employment.

As the bonus is not in consequence of termination of employment, and consequently does not satisfy subparagraph 82-130(1)(a)(i) of the ITAA 1997, it is precluded from being an employment termination payment. Further, this amount represents ordinary income which is taxed at marginal rates.

In relation to the xx months ex gratia payment and bonus on the ex gratia, and hereafter is referred to as the 'termination payment', the facts support that they were made in consequence of the termination of your client's employment. The termination of employment and the termination payment are all intertwined and connected. If not for the termination of employment, the termination payment would not have been paid.

As the termination payment was made in consequence of the termination of your client's employment with the Employer it satisfies the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997.

The payment is received no later than 12 months after termination

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

In your client's case the requirement under paragraph 82-130(1)(b) of the ITAA 1997 has been met as the termination payment was paid to your client when their employment was terminated.

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):

_ superannuation benefits;

_ unused annual leave or long service leave payments;

_ foreign termination payments covered under Subdivision 83-D of the ITAA 1997; and

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

Accordingly, in your client's case it is necessary to consider whether any amount of the termination payment should be excluded from being an employment termination payment as:

• a foreign termination payment; or

• the tax-free amount of a genuine redundancy 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:

In this case, section 83-235 does not apply as your client was an Australian resident during the period he was employed with the Employer

Further, section 83-240 of the ITAA 1997, which applies to termination payments received where the taxpayer was an Australian resident during the period of foreign employment to which the payment relates, does not apply to client as it states:

(1) A payment received by you is not assessable income and is not *exempt income if:

(a) it was received in consequence of:

(i) the termination of your employment in a foreign country; or

(ii) the termination of your engagement on qualifying service on an approved project (within the meaning of section 23AF of the Income Tax Assessment Act 1936 ), in relation to a foreign country; and

…

(g) for a period of employment - your foreign earnings from the employment are exempt from income tax under section 23AG of the Income Tax Assessment Act 1936 ; and

(h) for a period of engagement - your *eligible foreign remuneration from the service is exempt from income tax under section 23AF of that Act.

In view of the facts, your client's termination payment does not meet the conditions in:

(a) paragraph 83-240(1)(g) of the ITAA 1997, as the payment is not exempt from tax under section 23AG of the Income Tax Assessment Act 1936 (ITAA 1936); or

(b) paragraph 83-240(1)(h) of the ITAA 1997 as the payment is not exempt from tax under section 23AF of the ITAA 1936 as the income is not in respect of an approved overseas project.

We will now determine whether any part of the termination payment is a genuine redundancy payment.

Genuine redundancy payments

A payment made to an employee is a genuine redundancy payment if it satisfies all the conditions set out in section 83-175 of ITAA 1997. This section states:

(1)   A genuine redundancy payment is so much of a payment received by an employee who is dismissed from employment because the employee's position is genuinely redundant as exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of dismissal.

(2)   A genuine redundancy payment must satisfy the following conditions:

(a) the employee is dismissed before the earlier of the following:

(i) the day he or she turned 65;

(ii) if the employee's employment would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be);

(b) if the dismissal was not at arm's length - the payment does not exceed the amount that could reasonably be expected to be made if the dismissal were at arm's length;

(c) at the time of the dismissal, there was no arrangement between the employee and the employer, or between the employer and another person, to employ the employee after the dismissal.

(3)   However, a genuine redundancy payment does not include any part of a payment that was received by the employee in lieu of superannuation benefits to which the employee may have become entitled at the time the payment was received or at a later time.

Payments not covered

(4)  A payment is not a genuine redundancy payment if it is a payment mentioned in section 82-135 (apart from paragraph 82-135(e)).

The requirements to be satisfied before any payment made to a person whose employment is terminated qualifies for treatment as a genuine redundancy payment under section 83-175 of the ITAA 1997 are discussed in Taxation Ruling TR 2009/2 Income tax: genuine redundancy payments (TR 2009/2).

With regard to the first requirement set out in subsection 83-175(1) of the ITAA 1997, the Commissioner considers that there are four necessary components within this requirement:

• the payment must be received in consequence of an employee's termination;

• the termination must involve the employee being dismissed from employment;

• dismissal must be caused by the redundancy of the employee's position; and

• the redundancy payment must be made genuinely because of a redundancy.

Payment received 'in consequence of' the termination

In this case, your client's employment was terminated during the 20WW-XX income year and, as previously discussed, the termination payment your client received from the Employer was received in consequence of the termination of their employment.

Meaning of 'dismissal' and 'redundancy'

The terms 'dismissal' and 'redundancy' are not defined in the ITAA 1997 therefore, consistent with basic principles of statutory interpretation, their meaning must be determined according to the ordinary meaning of the words, having regard to the context in which they appear.

Accordingly, the Commissioner's view, as stated in Taxation Ruling TR 2009/2, is that dismissal means a decision to terminate employment at the employer's initiative without the consent of the employee. This stands in contrast to employment that is terminated at the initiative of the employee, for example in the case of resignation.

A position is redundant when the functions, duties and responsibilities formerly attached to the position are determined by the employer to be unnecessary to the current needs and purposes of the organisation. A dismissal is not caused by redundancy where personal acts or default are the cause for termination for example, unsatisfactory performance or behaviour.

Contrived cases of redundancy will not meet the conditions in section 83-175 of the ITAA 1997. The fact that an employer and employee have an understanding that a payment on termination is caused by redundancy, or that the employer treats the payment as a redundancy payment for tax purposes, does not of itself establish genuine redundancy.

Applying the above to your client's circumstances, it is considered that your client received the termination payment, and the payment for unused annual leave, because your client's position was genuinely redundant. This view is based on the following:

• Your client's employment was terminated at the Employer's initiative and without your client's consent;

• Your client was terminated because your client's position was no longer needed following a reorganisation by the Employer;

• There is nothing to indicate that your client's employment was terminated because of any personal acts or default on your client's part; and

• There is nothing to indicate that the redundancy was in any way contrived.

Does the payment exceed the amount that could reasonably be expected?

As there was a dismissal because your client's position was made redundant, part of the condition under subsection 83-175(1) of the ITAA 1997 has been met.

Subsection 83-175(1) of the ITAA 1997 also requires that for a payment to be a genuine redundancy payment, it must exceed the amount that would have been received by the employee on voluntary termination of employment. That is, only that part of the payment that exceeds the amount that could reasonably be expected to be received by the employee had the employee voluntarily terminated their employment at the time of dismissal is treated as a genuine redundancy payment. To that effect, TR 2009/2, at paragraph 61 states:

It would generally be expected that a greater amount would be paid on redundancy than voluntary termination. This recognises the purpose of redundancy payments, being primarily to compensate for loss of non-transferable entitlements (for example accrued sick leave and accrued long service leave prior to 10 years service) and the peculiar hardship associated with being made redundant.

In this case, the termination payment was paid to your client because their employment was terminated by the Employer. As shown in the contract of employment this amount would not have been paid to your client had your client resigned voluntarily. Therefore, the termination payment is in excess of the amount that would have been reasonably expected if your client voluntarily resigned from employment with the Employer.

Other conditions

As previously discussed, the termination payment, to qualify as a genuine redundancy payment, must also meet the remaining conditions pertaining to subsections 83-175(2), 83-175(3) and 83-75(4) of the ITAA 1997.

In your client's case it is considered that all of the remaining conditions have been satisfied as:

• Your client was dismissed before your client turned 65 years of age and there was nothing in the contract of employment that your client's employment would have been terminated on completing a particular period of service;

• Your client's dismissal was at arm's length;

• At the time of dismissal, there was no arrangement between your client and the Employer, or between the Employer and another person to employ your client after the dismissal;

• The termination payment does not include a payment in lieu of superannuation benefits to which your client may have become entitled;

• The termination payment is not excluded from the definition of a genuine redundancy payment.

As all the conditions under section 83-175 of the ITAA 1997 are satisfied, it is accepted that the termination payment (which comprises of an amount for an ex-gratia payment of two month's salary and an amount for a bonus on the ex-gratia payment) is a genuine redundancy payment.

Taxation of genuine redundancy payments

Section 83-170 of the ITAA 1997 provides that so much of the genuine redundancy payment that does not exceed the amount worked out using the formula in subsection 83-170(3) is not assessable income and is not exempt income, that is, it is tax-free. The formula for working out the tax-free amount is:

Base amount + (Service amount x Years of service)

The Base amount and the Service amount for the 20WW-XX income year are:

Base amount $9,246

Service amount $4,624

Years of service for the purposes of subsection 83-170(3) of the ITAA 1997 means the number of whole years in the period, or sum of periods, of employment to which the payment relates. It should be noted that six months, eight months or even eleven months do not count as a whole year for the purposes of this calculation.

As the termination payment exceeds the tax-free amount of a genuine redundancy payment, an amount is excluded from being an employment termination payment by virtue of section 82-135 of the ITAA 1997. The remaining amount is an employment termination 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 employment termination payment, which also a LBTP (subsection 82-130(2) of the ITAA 1997), is the amount in excess of the genuine redundancy payment's tax-free amount.

An LBTP may be comprised of the following components:

• Tax free component - this includes the pre-July 83 segment (if any) and/or the invalidity segment (if any); and

• Taxable component - the amount remaining after deducting the tax free component from the total payment.

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 after 1 July 1983, the LBTP does not have a pre-July 83 segment.

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, there exists a taxable component to be included in your client's income tax return for the 20WW-XX income year. As your client has reached their preservation age, and the amount is under the employment termination payment cap of $180,000 (for the 20WW-XX income year), this amount will be taxed at a rate not exceeding 15% plus Medicare levy (paragraph 82-10(3)(a) of the ITAA 1997).

Taxation treatment of unused annual leave

Subsection 6-5(3) of the ITAA 1997 provides that ordinary income derived by an Australian resident directly or indirectly from all sources whether in or out of Australia, during the income year is assessable.

Unused annual leave payments would ordinarily be included in assessable income under section 83-10 of the ITAA 1997 and be subject to marginal rates of tax.

However, in your client's case, as the unused annual leave payment was made in connection with a genuine redundancy payment, section 83-15 of the ITAA 1997 applies to allow a tax offset which ensure that the rate of tax on the unused annual leave payment do not exceed 30% plus Medicare levy.

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