Edited version of your written advice

Authorisation Number: 1051515439863

Date of advice: 24 May 2019

Ruling

Subject: Incentive payment and assessable income

Questions

Question 1

Is the amount, proposed to be paid to you by Company A under an agreement, an employment termination payment as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No

Question 2

Is the payment received considered income and taxable at marginal tax rates?

Answer 2

Yes.

Question 3

Is the payment tax free on the basis of case law Federal Commissioner of Taxation v Dixon [1952] HCA 65?

Answer 3

No.

Question 4

Is the payment to be treated on capital account?

Answer 4

No.

This ruling applies for the following periods:

For the year ended 30 June 2020

For the year ended 30 June 2021

The scheme commences on:

1 July 2019

Relevant facts and circumstances

● In March 201X Company A announced to the Australian Stock Exchange (ASX) that it was exiting personal financial advice.

● Company A also announced that an unrelated business, Company B would make offers to some Company A staff. All remaining staff would be made redundant.

● You received an offer from Company B. Your position within Company A meant you were entitled to a base salary and a share of the revenue from advisors in your team.

● The offer you received provided two choices:

● Decline an employment offer with Company B and receive 100% of redundancy entitlements, or

● Accept an ‘incentive payment from Company A’ to transition to Company B on the basis that current entitlements would be transferred to Company B and nil redundancy payments would be made by Company A.

● Company A instead made an ‘incentive offer/ex gratia payment/golden handshake’ to entice employees to sign new employment contracts with Company B.

● In your case, the proposed payment is payable in July 201X (50%) and July 20XX (50%).

● The payment will be made post termination of Company A employment contract and during new employment with Company B.

● The criteria for this payment are continued compliance enforcement.

● The basis for the calculation of the payment is a proxy for the forgone redundancy and other factors such as the value of the income stream being purchase by Company B.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6-5(2)

Income Tax Assessment Act 1997 section 15-2

Income Tax Assessment Act 1997 section 83-130

ATO view documents

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'

Taxation Ruling TR 2009/2 Income tax: genuine redundancy payments

ATO ID 2003/373: Retention bonus payments paid to Bougainville Peace Monitoring group

Reasons for decision

Meaning of received ‘in consequence of’ the termination

The phrase ‘in consequence of’ is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Taking into account the courts decisions on the meaning of the phrase, the Commissioner’s view on the meaning and application of the ‘in consequence of’ test are set out 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'.

While TR 2003/13 considered the meaning of the phrase ‘in consequence of’ in the context of the eligible termination payments, TR 2003/13 can still be relied upon as both the former provision under the Income Tax Assessment Act 1936 (ITAA 1936) and the current provision under the ITAA 1997 both use the term ‘in consequence of’ in the same manner.

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 further stated by the Commissioner in paragraph 6 of TR 2003/13, there must be:

… 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.

The phrase in consequence of termination of employment has been interpreted by the courts in several cases.

Of note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation (1975) 133 CLR 45 (Reseck) and the Full Federal Court in McIntosh v. Federal Commissioner of Taxation (1979) 25 ALR 557; (McIntosh).

In Reseck Justice Gibbs stated:

Within the ordinary meaning of the words, a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination... It is not in my opinion necessary that the termination of the services should be the dominant cause of the payment....

While Justice Jacobs stated:

It was submitted that the words ‘in consequence of’ import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a ‘following on’.

In looking at the phrase ‘in consequence of’ the Full Federal Court in McIntosh considered the decision in Reseck. Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment.

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 question of whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case.

An agreement dated DDMMYY from Company A outlined an offer to pay you an incentive payment following the acceptance of the offer, to be made in two payments.

In this case, the purposed payment was not made in consequence of the termination of employment. Rather, the incentive payment is to be made as a contractual obligation made in an agreement entered into on DDMMYY.

Accordingly, there is no causal connection between the termination and the incentive payment. The incentive payment was not conditional on the termination of your employment. It cannot be said that the incentive payment followed on as an effect or a result of the termination of employment.

In this case, as the incentive payment is not made in consequence of the termination of employment, the purposed payment cannot be treated as a genuine employment termination payment.

Conclusion

A payment is an employment termination payment if it satisfies all the requirements in section 82-130 of the ITAA 1997.

One of the main requirements that must be satisfied is that the payment must be made in consequence of the employee’s termination of employment (subparagraph 82-130(1)(a)(i) of the ITAA 1997).

In this case, as previously mentioned, the incentive payment is not considered to be received in consequence of the termination of employment. Hence, the requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has not been satisfied and the incentive payment is not considered to be an employment termination payment.

Accordingly, the proposed incentive payment that you will receive is assessable as ordinary income.

Incentive payment

To determine the correct tax treatment of the lump sum payment, it must first be considered whether the payment is assessable as ordinary income under section 6-5 of the ITAA 1997.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes the ordinary income (i.e. income according to ordinary concepts) the resident derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

The legislation does not define what is meant by income according to ordinary concepts, however there is a substantial body of case law that provides guidance on relevant factors to be considered.

More specifically, section 15-2 of the ITAA 1997 provides that the assessable income of a person shall include:

‘the value to you of all allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you’

There are a number of factors which can assist in determining whether a particular receipt is ordinary income. These include:

● whether the payment is the product of any employment, services rendered, or any business ( FC of T v. Harris 80 ATC 4238; (1980) 10 ATR 869)

● the quality or character of the payment in the hands of the recipient ( Scott v Federal Commissioner of Taxation (1966) 117 CLR 514; (1966) 10 AITR 367; (1966) 14 ATD 286)

● the form of the receipt, that is, whether it is received as a lump sum or periodically (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; (1952) 10 ATD 82 (Dixon's Case )), and

● the motive of the person making the payment. Motive, however, is rarely decisive as in many cases a mixture of motives may exist (Hayes v. Federal Commissioner of Taxation (1956) 96 CLR 47; (1956) 6 AITR 248; (1956) 11 ATD 82).

A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity, even if the receipts are not directly attributable to employment or services rendered (FC of T v Dixon (1952) 86 CLR 540 and FC of T v Blake 84 ATC 4661).

However, periodicity, recurrence or regularity is not always essential for an amount to be income. For example, the proceeds of an isolated transaction, even if received as a lump sum, may be income (FC of T v Myer Emporium Ltd 87 ATC 4363), while instalments of a capital sum, even though received regularly from one source, are not income. Equally, an unsolicited lump sum payment which is unlikely to be repeated is generally not income according to ordinary concepts (FC of T v Harris 80 ATC 4238), while lump sum damages will nevertheless be assessable where they are compensation for losses of an income nature only.

Whether a voluntary payment is assessable income was considered in Dixon's Case.

In holding that the amount was assessable income Dixon CJ and Williams J held that four factors were relevant:

● the payments were regular and periodical

● the payments arose out of circumstances attending the taxpayer's war service

● the payments formed part of the receipts that the taxpayer depended upon for regular expenditure for himself and his dependants, and

● the payments were made for that purpose.

Courts have often held that incentive payments or inducements can be assessable income. For example, in McLean & Anor v. Federal Commissioner of Taxation 96 ATC 4443 the Federal Court held that lump sum payments made to a taxpayer to remain in the employment of their employer were held to be assessable income. Northrop J held, at page 4447:

The nature of the payments is made clear by a reference to the contents of the letters written to them by Elders Resources. The payment was made as an inducement to each taxpayer to continue in his employment for a period of at least one year. If the taxpayer left his employment, the amount of the payment was reduced but otherwise the payment was for the specified sum. The continual employment was at the very heart of the receipt of the payment. (emphasis added)

In Pickford v. Federal Commissioner of Taxation 98 ATC 2268, the taxpayer was an employee who had been granted options to purchase shares in his employer’s parent company under an employee share scheme. However the options would lapse immediately if they ceased to be employed by the employer. Another company made an offer of employment to the taxpayer, which included a payment of $20,000 said to be compensation for the potential capital gain that may have been available to the taxpayer in relation to the shares they would have been entitled to if they had remained with the original employer. The AAT held the $20,000 lump sum payment was assessable income:

A consideration of all the material including the letter containing the offer (T3) leads the Tribunal to the conclusion that, irrespective of the description furnished to the amount in contention, it represented a straightforward inducement for the applicant to enter the employment of W Ltd. Furthermore, the Tribunal is satisfied that the source of the payment is to be found in the service to be rendered by the applicant to W Ltd and that it was in the nature of a benefit for future service.

ATO ID 2003/373: Retention bonus payments paid to Bougainville Peace Monitoring group also outlines the ATO view that lump sum retention bonuses paid by the Australian Defence Forces in order to encourage serving members to remain for a fixed period are assessable as ordinary income. In this ATO ID, where the members failed to complete the required period of service, they were contractually obliged to repay part of the retention bonus based on the incomplete part of the service.

Capital payments

As we have determined that the incentive payment is assessable income, there is no need to discuss whether the payment is of a capital nature.

Further matter for consideration

As discussed above, the payment is assessable as ordinary income. It is assessable when it is derived. It is considered that the income was derived when it was received. Therefore, the payment is included in assessable income in the income year it was received, that is, the 2019/20 and 2020/21 income years.

In similar cases, submissions have been made to the Commissioner that the lump sum incentive/inducement payment should be assessed over the period of the agreement. These submissions have relied on the decision in Arthur Murray (NSW) PTY Ltd v. Federal Commissioner of Taxation (1965) 114 CLR 314 (Arthur Murray).

However, unlike in Arthur Murray, the lump sum payment in this situation is not a pre-payment for services to be rendered, rather it is an inducement to enter into the agreement. Therefore, we consider that Arthur Murray is clearly distinguishable.

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