CASE 25/97

Members:
GL McDonald DP
BH Pascoe SM
WG McLean M

Tribunal:
Administrative Appeals Tribunal

Decision date: 1 May 1997

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GL McDonald (Deputy President), BH Pascoe and WG McLean (Members)

These applications were previously before the Tribunal and a decision handed down on 11 October 1994 (AAT 9782, VT93/214 & 215). The applicants appealed to the Federal Court and, on 10 May 1996, Northrop J handed down a decision to set aside the Tribunal's decision (
McLean & Anor v FC of T 96 ATC 4443). His Honour ordered that the matter be remitted to the Tribunal to determine the issues of whether the applicants should have leave to amend the grounds stated in their objections, to enable the issue of whether payments in question constituted exempt income under section 25(1)(a) and section 23L of the Income Tax Assessment Act 1936 (``the Act''), and if so, to determine whether such payments constituted exempt income.

2. At the hearing of the remitted matters, the applicants were represented by Mr F Farrow of counsel and the respondent by Mr P Sest of counsel. No further evidence was called by either side and the matter proceeded with submissions. The applicant initially submitted that Senior Member Pascoe should not be a member of the Tribunal at the hearing. It was submitted that as he had been the member who heard the matter in the first instance there was a perceived apprehension in the applicants' minds

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that he had prejudged the issues adverse to the applicants. The Tribunal indicated that Senior Member Pascoe had decided only the question of whether the Tribunal should exercise the discretion to allow an amendment to the original grounds of objection. As a result of not granting such leave, he had not considered or expressed a view on the second and substantive matter remitted by the Court. Given the views expressed by Northrop J, the Tribunal stated that leave was granted for the applicants to amend their grounds of objection to include the ground that the payments in question were exempt income under section 25(1)(a) of the Act. As a consequence of this decision, the Deputy President directed that the constitution of the Tribunal for this proceeding be the members presently appointed for that purpose.

3. The matter in dispute was set out in the earlier decision of the Tribunal and the judgement of Northrop J and need not be dealt with in detail again. The transcript of the earlier hearing, together with the exhibits tendered and the documents provided pursuant to section 37 of the Administrative Appeals Tribunal Act 1975 were adopted as evidence in this hearing. A convenient summary of the background and the amounts in dispute can be taken from the reasons for judgement of Northrop J (at pages 4444 and 4445):

``There is no real dispute concerning the facts of each appeal. At all material times each taxpayer was employed by Simsmetal Services Pty. Ltd. (`Simsmetal'). Simsmetal was one of a group of companies controlled by Elders Resources NZFP Limited (`Elders Resources'). Elders Resources was intending to dispose of a number of its subsidiary companies, including Simsmetal. In order to obtain the best possible financial return from the disposition of its subsidiary companies, Elders Resources offered to make a lump sum payment described as a retention payment, to certain key employees of those subsidiary companies on the condition that the employees would continue their existing employment for a period of 12 months following the disposition. The offer was contained in a letter in common form addressed to each of the employees concerned. The letters to Mr. Dean and Mr. McLean were each dated 26 October 1990 and, with the exception of the amount of the retention payment, were in identical form. The letter, to Mr. McLean, omitting formal parts, is set out:-

`As you know, Elders Resources NZFP Ltd. (``the Company'') intends to divest itself of all its non-forestry assets. Simsmetal Holdings Pty. Ltd., its subsidiaries and/or their respective assets will, in due course, be sold to a new owner.

Your continued employment, involvement and support are seen by us as vital to the maintenance of the profit levels and health of the business.

The Company therefore offers to make to you a one-off retention payment of A$108,254 (``the retention payment''). This offer is subject to the following terms and conditions:

• 1. That you agree to remain in your current employment with Simsmetal Services Pty Ltd. or Simsmetal USA Corporation or their successors or assigns (``Simsmetal'') for a period of twelve months from the effective date of the forthcoming change of ownership of the part or parts of the Simsmetal business in which you are engaged and to give your full time attention, commitment and energy to the business of Simsmetal during that time. This requirement operates quite independently of your terms of employment and is not intended to have the effect of converting that employment into one for a fixed term. This offer, if accepted, will give rise to obligations between you and the Company only.
• 2. In the event that you resign your employment with Simsmetal before the completion of twelve months' service following the change of ownership, you agree to refund to the Company the amount paid to you under this agreement, less an abatement of one-twelfth of the total retention payment paid to you for each completed month of service or part thereof. No such refund will be payable if Simsmetal terminates your employment or you die or become permanently disabled before the

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  expiry of the 12 month retention period.
• 3. That you sign and return to Mr John Cornelius the attached copy of this letter to signify your acceptance of the terms and conditions set out in this letter.
• 4. The retention payment of A$108,254 will be made to you when:
  • (a) John Cornelius holds the attached copy of this letter duly signed by you and witnessed; and
  • (b) the contract of sale of the part or parts of the Simsmetal business in which you are engaged is for practical purposes completed and the purchase moneys paid.'

The amount of retention payment offered to Mr. Dean was A$94,485.

Mr. McLean and Mr. Dean each accepted the offer by signing and returning to Mr. John Cornelius the attached letter. In due course Elders Resources disposed of Simsmetal and paid Mr. McLean the sum of $108,254 and Mr. Dean the sum of $94,485. The method of payment is not relevant for present purposes but it is noted that the amount of the retention payments were calculated by reference to the annual remuneration package of Mr. McLean and Mr. Dean respectively.

The Commissioner of Taxation calculated the sum of $108,254 as assessable income received by Mr. McLean for the financial year ending 30 June 1992 and the sum of $94,485 as assessable income received by Mr Dean for the financial year ending 30 June 1991. Each taxpayer gave notice of objection in relation to the inclusion of those amounts. The objections were disallowed. Each taxpayer sought a review by the Tribunal of the decisions disallowing the objections.''

4. At the first hearing of these applications, the primary argument for the applicants was that the amounts received were not income but receipts of a capital nature. During the course of the final submissions, counsel for the applicants raised the alternative argument that, if the amounts were income, they were exempt as being fringe benefits liable to tax under the Fringe Benefits Tax Assessment Act 1986 (``the FBT Act''). The Tribunal held that this alternative argument was not a ground stated in the objections and, given the lateness of the hour at which this new ground was raised, declined to exercise the discretion not to limit the applicants to the stated grounds of objection. The Tribunal then held that the retention payments constituted income derived by them within section 25(1)(a) of the Act. On appeal, Northrop J agreed that the alternative argument was not covered by the objections and that the retention payments were income under section 25(1)(a). Having now granted leave to amend the grounds of objection, the question now before this Tribunal is whether the payments were exempt income under section 23L(1) of the Act.

5. Section 23L(1) provides:

``23L(1) Where the taxpayer derives income by way of the provision of:

• (a) a fringe benefit within the meaning of the Fringe Benefits Tax Assessment Act 1986; or
• (b) a benefit (other than a benefit to which paragraph 26(eaa) of this Act applies) that, but for paragraph (g) of the definition of `fringe benefit' in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986, would be a fringe benefit within the meaning of that Act;

the income is exempt income.''

Neither paragraph (g) of subsection 136(1) nor paragraph 26(eaa) are relevant to this case so that the question to be determined is whether the retention payments were fringe benefits within the meaning of the FBT Act. Section 136(1) of that Act contains the relevant definition as:

```fringe benefit' , in relation to an employee, in relation to the employer of the employee, in relation to a year of tax, means a benefit:

• (a) provided at any time during the year of tax; or
• (b) provided in respect of the year of tax;

being a benefit provided to the employee or to an associate of the employee by:

• (c) the employer;
• (d) an associate of the employer; or

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• (e) a person (in this paragraph referred to as the `arranger' ) other than the employer or an associate of the employer under an arrangement between:
  • (i) the employer or an associate of the employer; and
  • (ii) the arranger or another person;

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

• (f) a payment of salary or wages or a payment that would be salary or wages if salary or wages included exempt income for the purposes of the Income Tax Assessment Act 1936;

...''

There are further exclusions which are not relevant to this matter. The other relevant definitions in section 136(1) are:

```benefit' includes any right (including a right in relation to, and an interest in, real or personal property), privilege, service or facility and, without limiting the generality of the foregoing, includes a right, benefit, privilege, service or facility that is, or is to be, provided under:

• (a) an arrangement for or in relation to:
  • (i) the performance of work (including work of a professional nature), whether with or without the provision of property;
  • (ii) the provision of, or of the use of facilities for, entertainment, recreation or instruction; or
  • (iii) the conferring of rights, benefits or privileges for which remuneration is payable in the form of a royalty, tribute, levy or similar exaction;
• (b) a contract of insurance; or
• (c) an arrangement for or in relation to the lending of money;
• ...

`salary or wages' means assessable income, being salary or wages within the meaning of section 221A of the Income Tax Assessment Act 1936;

...''

The section 221A(1) definition, as it applied from 24 December 1991, states:

```salary or wages' means salary, wages, commission, bonuses or allowances paid (whether at piece-work rates or otherwise) to an eligible person as such, and, without limiting the generality of the foregoing, includes any payments that are covered by Division 1AA of Part III, any payments of amounts to which paragraph 26(eb) or section 26AC applies, any payments of amounts that are assessable retirement amounts for the purposes of this definition, eligible termination payments and any payments made:

• (a) under a contract that is wholly or principally for the labour of the person to whom the payments are made, where:
  • (i) the person making the payments under the contract is not a natural person; or
  • (ii) the payments under the contract are not wholly or principally of a private or domestic nature;
• (b)...
• ...

but does not include:

• (p) payments of exempt income;''

This definition was amended by Act No 216 of 1991 with effect from 24 December 1991 by substituting ``an eligible person as such'' for ``an employee as such''. The same Act inserted a definition of ``eligible person'' into section 221A and the relevant part of the definition provides:

```eligible person' means:

• (a) a person who is an employee within the ordinary meaning of that expression;
• ...''

6. The primary thrust of submissions concerned the question of whether or not the retention payments were ``salary or wages'' and, therefore, excluded from the definition of ``fringe benefits''. It was submitted for the applicants that salary or wages were amounts payable under a contract of employment. It was said that the applicants were employed by Simsmetal and that there was no suggestion of any contract of employment with Elders Resources who was the payer of the retention payments. Consequently, it was said, the payment could not be regarded as salary but could clearly fit within the definition of a fringe benefit, being something in addition to salary to which an employee is entitled from his employer under a contract of employment.

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7. For the respondent it was submitted that each of the retention payments constituted salary or wages and therefore excluded from the definition of fringe benefits. It was said the definition of salary and wages in section 221A of the Act is deliberately wide and designed to embrace all amounts paid as a reward for services rendered by the employee. The relational status of the recipient which actuates the payment was said to be the critical factor and the payer need not be the direct or immediate employer. It was further argued that the retention payments were a bonus, being a payment made to the applicants in excess of that which is ordinarily payable in return for the provision of services. Alternatively, it was argued that the retention payment was an allowance, being a reward additional to an ordinary payment of salary for the purpose of meeting some particular requirement connected with an employee's service or as compensation for unusual conditions of that service. Finally, it was said that the retention payments were payments made under a contract that was wholly or principally for the labour of the applicants and fell within the definition of salary or wages.

8. There was no dispute that the retention payment fell within the primary definition of fringe benefit. It was a benefit provided to an employee by the employer or an associate of the employer, in respect of the employment of that employee. The question to be resolved is whether such a benefit is excluded from being a fringe benefit by paragraph (f) of the definition as being a payment of salary or wages. The extension of the wording of paragraph (f) to a payment that would be salary or wages if salary or wages included exempt income for the purposes of the Act, is simply there to avoid the circular argument that the definition of salary or wages excludes payments of exempt income. Section 23L of the Act provides an exemption from income tax of a fringe benefit within the meaning of the FBT Act and, therefore, the exclusion of paragraph (f) can never apply.

9. There is no doubt in our minds that the retention payments were made to Mr McLean and Mr Dean in their capacity as employees of Simsmetal. Northrop J said (at page 4447):

``In my opinion all the facts of this case point to the conclusion that the receipt of the retention payments by the taxpayers was related to their activities as employees and as continuing to be employees with the result that in substance and reality the amounts received were the product of the income-earning activity on the part of each taxpayer.

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 voluntarily left his employment, the amount of the payment was reduced but otherwise the payment was for the specified sum. The fact that this was not to be paid on a periodic basis does not detract from the true nature of the receipt of the payment. The continual employment was at the very heart of the receipt of the payment the amount of which was calculated having regard to the salary of the taxpayer.''

However, it was strongly argued by Mr Farrow that the definition of salary and wages requires more than the payments being made to a person in his capacity as an employee. He maintained that for amounts to be salary or wages there must be an employer-employee relationship between the payer and the recipient. Here, it was said, there was no such relationship.

10. In a consideration of this matter it needs to be recognised that the definition of salary and wages for the purposes of section 136 of the FBT Act is that contained in section 221A of the Act. That section is contained within Division 2 of Part VI of the Act dealing with ``Collection by Instalments of Tax on Persons other than Companies'' generally described the PAYE provisions. These provisions are designed to place an obligation upon ``an employer'' to deduct instalments of income tax from payments of salary or wages. In
Newcastle Club Limited v FC of T 94 ATC 4594, Hill J was required to consider these provisions in the context of the payments made by the Club to employees out of the Staff Christmas Fund to which voluntary contributions were made by members. His Honour said (at page 4595):

``The obligation upon `an employer' to deduct amounts from payments of salary or wages that employees receive or are entitled to receive arises under s. 221C(1) of the Act. For present purposes `an employer' is defined in s. 221A(1) of the Act, unless a contrary intention appears, as a person who

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pays or is liable to pay any salary or wages. Somewhat unhelpfully the expression `employee' is defined in the same sub- section relevantly as meaning a person who receives, or who is entitled to receive, salary or wages. Given these definitions and the fact that the definition of `salary or wages' clearly contemplates payments made by a person who is not in the ordinary legal sense an employer to a person who is not in the ordinary legal sense an employee, it would seem clear that no employment relationship need as such exist between an employer and an employee before the obligation to deduct group tax arises, provided that the payment made from the one to the other is a payment comprehended within the definition of `salary or wages' also contained in the same sub-section. That definition, as relevant for present purposes, is expressed as follows:

```salary or wages'' means salary, wages, commission, bonuses or allowances paid... to an employee as such...'

The word `employee' as used in the composite expression `employee as such' clearly means a person in an ordinary employer/employee relationship and to this end presents a contrary intention to the defined meaning in s 221A(1). The consequence, as has been emphasised in cases, most of which concern the corresponding definition in State payroll tax legislation, is that it is not sufficient for the amount to be merely received by a person who happens to be an employee, the amount in question must be paid to the employee in that employee's capacity as employee.''

Having found that the retention payments were made to the applicants in this capacity as employees and, in the words of Hill J, the definition ``clearly contemplates payments made by a person who is not in the ordinary legal sense an employer to a person'' the sole question is whether the payments can be appropriately described as salary, wages, commission, bonuses or allowances. In relation to the question of whether the payments were made by an employer, it is indicative but not determinative, that the group certificates issued to the applicants in respect of the retention payments were not in the name of Elders Resources, the company with whom they entered into the agreements for the payments. The group certificate to Mr McLean was in the name of NZFP Resources Ltd and that issued to Mr Dean was in the name of Collex Waste Management Pty Ltd. The evidence does not indicate which company provided the actual funds for the payment of the agreed amounts.

11. In
Roads and Traffic Authority of NSW v FC of T 93 ATC 4508, Hill J said (at page 4512-4513):

``The language of the definition of `salary or wages' in s. 221A(1) is deliberately wide. The legislative purpose was to include in the definition, and so that tax could be deducted by the employer and ultimately remitted to the Commissioner as an anticipatory payment of the employee's tax liability, all amounts paid as a reward for services rendered by the employee:
FC of T v J Walter Thompson (Australia) Pty Ltd (1944) 7 ATD 401; (1944) 69 CLR 227 and at ATD 405-406; CLR 233-234. The description of the payment, for example as a fee, will not be determinative. Nor, as the J Walter Thompson case reminds us, will it be determinative that, for the purposes of legislation such as the Truck Act (1896) (UK), the word `wages' was limited to payments made to manual workers as the context of that legislation is substantially different to the present. Thus Latham CJ said (at ATD 406; CLR 234), speaking of the comparable definition in the Pay-roll Tax Assessment Act 1941:

`In my opinion... the word ``wages'' should be held to include any remuneration paid or payable to an employee as a reward for his services as an employee.'

...''

Here we are satisfied that the retention payments did constitute remuneration paid to the applicants as a reward for services as an employee. They were paid in consideration of the applicants providing their services for a period of twelve months. The applicants were entitled, pursuant to the agreement, to receive the specific amounts on their agreement to remain in their employment for that period after the sale of Simsmetal or its business. It is difficult not to regard a payment of money to a person as a reward for services in employment as salary or wages in respect of that employment.

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12. It was submitted by the respondent that each payment constituted a bonus or allowance. In
Mutual Acceptance Co Ltd v FC of T (1944) 7 ATD 506; (1944) 69 CLR 389, dealing with a comparable definition in the Payroll Tax Assessment Act 1941, Dixon J said (at ATD page 514; CLR page 403):

``In the definition of `wages' the two first words `wages' and `salary' refer to ordinary forms of remuneration for work done. `Commission' covers percentage rewards and `bonuses' occasional or periodical additions whether contracted for or voluntary. The next word `allowances' seems to me naturally to follow as an attempt to make sure that any other kind of gain or reward allowed or conceded by the employer to the employee for his work is brought within the definition. In language borrowed from Lord Esher, it is intended to cover any payment beyond the agreed salary of the employee for services or additional services rendered by him:
Burgess v. Clark (1884) 14 Q.B.D. 735 at p. 738.''

In that same case, Latham CJ considered that the word ``allowances'' means ``a grant of something additional to ordinary wages for the purpose of meeting some particular requirement connected with the service rendered by the employee or as compensation for unusual conditions of that service'' (ATD page 510; CLR pages 396-397). In that case their Honours were considering the question of the weekly payment of a fixed amount intended to represent two-thirds of the cost of the employee using his motor vehicle. Whilst that type of payment can more readily be described and accepted as an ``allowance'', the retention payments with which we are concerned can be seen to constitute a reward over and above the normal periodic salary for services as an employee. As such, they can be regarded as bonuses or allowances.

13. As a consequence we find that the retention payments in question constituted salary and wages as defined in section 136 of the FBT Act and, therefore, are excluded from being fringe benefits under that Act. The Tribunal is satisfied that the amounts represented assessable income under section 25(1)(a) of the Act and were not exempt income. It follows that the decisions under review are affirmed.