Edited version of your written advice

Authorisation Number: 1051236904887

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Date of advice: 13 June 2017

Ruling

Subject: Tax treatment of payments made by the Trust

Question 1

Will the payments made by the entity to the workers be tax deductible?

Answer

Yes

Question 2

Will the payments made by the entity to the workers be subject to fringe benefits tax?

Answer

No

Question 3

Will the entity be required to register for, deduct and report PAYG withholding in relation to the payments to the workers?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The entity is the only shareholder in a business.

The business is wholly owned by the entity.

The entity merely acts as shareholder of the business and does not have any other investment assets or business activities.

The director is in the process of negotiating the sale of the business to a third party buyer. The negotiations suggest that this will take the form of a share sale with the entity selling its shares to the buyer. The sale is currently at due diligence stage with a contract to be drafted soon.

There is an estimated sale price for the shares. Currently, a portion of this is payable on settlement, with the remaining balance payable in 12 months subject to a retention arrangement.

There are a few key staff that have significantly contributed to the value of the business that will be realised on the sale of the shares by the taxpayer. In order to reward these key staff for their hard work over many years the taxpayer, the entity, intends to pay bonuses to these staff members.

It is intended that the entity will make payments to the following individuals:

● Employee A will be paid an amount on settlement on the sale of the shares in the business. A further amount will be paid to Employee A on receipt of the final retention amounts, 12 months after settlement. If the retention amount is not received in full, Employee A’s entitlement will be prorated based on the amount of the retention not received.

Employee A has been employed by the business since 200X. These payments relate to an unsigned informal bonus agreement which commenced around 20XX. This arrangement entitled Employee A to receive a percentage share of the sales proceeds in the event that the business was sold. It is expected that Employee A will agree to accept an amount as full and final satisfaction of this arrangement. The payments will be made to them by way of bonus.

● Employee B will be paid an amount as a bonus on settlement of the shares in the business.

● Employee C will be paid an amount as a bonus on payment of the final retention amount, 12 months after settlement.

All payments are to be made inclusive of any superannuation, payroll tax or other employer obligations.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Taxation Administration Act 1953 section 12-35 of Schedule 1

Fringe Benefits Tax Assessment Act 1986 subsection 136(1)

Reasons for decision

Question 1

Section 8-1 of the ITAA 1997 provides that:

8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

In your case, the entity is not carrying on a business. It wholly owns a business and is the shareholder of the company. Therefore the expense must be incurred in gaining or producing the assessable income of the entity.

For expenses to be an allowable deduction under section 8-1 of the ITAA 1997 there must be a sufficient connection between the outgoing and the activities directed at gaining or producing assessable income. The decision in Ronpibon Tin v. FCT (1949) 78 CLR 47; (1949) 8 ATD 431, confirms that for an outgoing to be deductible, a taxpayer has to establish that there is a sufficient nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of the assessable income.

In this case, the payments to the staff members are triggered by the sale of the shares in the business. This sale will give rise to a capital gains tax event and will result in assessable income for the entity.

The payment of the bonuses to the staff members of the business recognises their contribution to the value achieved on the disposal of the shares held by the entity.

Question 2

According to the definition of a fringe benefit under subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) it states in part:

In relation to an employee, in relation to the employer of the employee, in relation to a year of tax means a benefit:

…

In respect of the employment of the employee, but does not include:

(f) A payment of salary or wages that would be salary or wages if salary or wages included exempt income for the purpose of the Income Tax Assessment Act 1936 Act

…

Fringe benefits tax – a guide for employers states that not all benefits provided in respect of employment are fringe benefits. The fringe benefits tax legislation excludes certain benefits from being fringe benefits. This includes salary or wages.

Payments of salary or wages are not fringe benefits. The term salary or wages means a payment from which an amount must be withheld.

In your case, it has been determined at Question 1 that the payments representing salary or wage to a few key staff members satisfy the requirements of section 8-1 of the ITAA 1997 and are therefore deductible in the year they are incurred.

Furthermore, it was determined that these payments will have amounts withheld as in accordance of section 12-35 of the TAA.

Consequently, as the payment represents salary or wages to the key staff members, they are excluded as being a fringe benefit under paragraph 136(1)(f) of the FBTAA.

As they are excluded from the definition of fringe benefits, the payments are not subject to the fringe benefits tax.

Question 3

Section 12-35 of the TAA requires you to withhold tax from salary, wages, commission, bonuses or allowances paid to an individual as an employee whether or not such individual is employed by you or another entity.

Taxation Ruling TR 2005/16 provides the Commissioner's view on whether an individual is paid as an employee for the purposes of section 12-35 of the TAA and whether the paying entity has an obligation to withhold an amount from the relevant payment.

Paragraph 12 of TR 2005/16 states that payment does not necessarily have to be between employer and employee for the payment to be covered by Section 12-35 of the TAA. However, the payment made to the individual must be in their capacity as an employee, either of the payer or another entity. The essential element is the nature of any connection between the payment and the individual's employment with the payer or any other entity.

Paragraph 65 of TR 2005/16 goes on to say that if the payment is in respect of the employment of the individual, it is not relevant who actually made the payment. FC of T v. Dixon (1952) 86 CLR 540; 26 ALJ 505; 10 ATD 82 discusses whether a payment is in respect of a person's employment. In that case, Dixon CJ and Williams J stated:

Indeed, it is clear that if payments are really incidental to an employment, it is unimportant whether they come from the employer or from somebody else and are obtained as of right or merely as a recognized incident of the employment or work.

Paragraph 66 of TR 2005/16 provides that where the payment is a reward for services provided by the employee to the employer in the capacity of employee, the payment would be incidental to the employment regardless of whether the payment is made by the employer or another entity. If the payment is a payment of salary, wages, commission, bonus or allowance then the entity that made the payment will be required to withhold under section 12-35 of the TAA.

In your case, the entity will be required to register for PAYG Withholding, and deduct and report PAYG withholding accordingly.

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