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Authorisation Number: 1011505210396

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Ruling

Subject: Employment termination payment and genuine redundancy

Question 1

Is the payment made to an employee a genuine redundancy payment in accordance with section 83-170 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

The employee was born many years ago.

The employer was established in sometime later.

The employee holds X% of the shares in the employer company and was appointed a director in the relevant year.

The employee had the role of managing director until recently.

The employee was then given a role with the responsibility of generating sales for a specific product and the management of a joint venture (the joint venture).

Due to circumstances, sales of the specific product (which provided around Y% of the employer's total revenue for the relevant financial year) have declined and the employee has only made minimal sales.

In the relevant year the employer had around full time staff full time contractors. As a consequence of reduced sales, the employer has been cutting costs and has made a number of staff redundant and reduced the hours of others.

The employer has since decided to make the employee's sales role redundant and close the joint venture and terminate the employee's employment. Responsibility for sales of the specific product will now be managed by the current managing director.

On termination the employee received an amount and a separate, lesser amount for unused annual leave and long service leave. No part of the first amount was in lieu of superannuation benefits.

Although the employee will become an unpaid non-executive director because of their X% shareholding in the employer, there is no arrangement to employ them after the termination.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-10(2).

Income Tax Assessment Act 1997 Subsection 82-130(1).

Income Tax Assessment Act 1997 Subparagraph 82-130(1)(a)(i).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(b).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(c).

Income Tax Assessment Act 1997 Subsection 82-130(2).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Paragraph 82-135(d).

Income Tax Assessment Act 1997 Paragraph 82-135(e).

Income Tax Assessment Act 1997 Section 82-145.

Income Tax Assessment Act 1997 Section 83-165.

Income Tax Assessment Act 1997 Section 83-170.

Income Tax Assessment Act 1997 Subsection 83-170(2).

Income Tax Assessment Act 1997 Subsection 83-170(3).

Income Tax Assessment Act 1997 Section 83-175.

Income Tax Assessment Act 1997 Subsection 83-175(1).

Income Tax Assessment Act 1997 Subsection 83-175(2).

Income Tax Assessment Act 1997 Paragraph 83-175(2)(a).

Income Tax Assessment Act 1997 Paragraph 83-175(2)(b).

Income Tax Assessment Act 1997 Paragraph 83-175(2)(c).

Income Tax Assessment Act 1997 Subsection 83-175(3).

Income Tax Assessment Act 1997 Subsection 83-175(4).

Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision

Summary

All of the requirements set out in the legislation are satisfied in relation to the payment the employee will receive in consequence of the termination of their employment. Based on their service the whole of the termination payment will be a tax-free genuine redundancy payment. This is not assessable income and is not exempt income.

Detailed reasoning

Employment termination payments

From 1 July 2007 the taxation treatment of payments made in consequence of the termination of any employment of a taxpayer has changed. These payments, formerly known as 'eligible termination payments', are now called employment termination payments.

Subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states:

employment termination payment has the meaning given by section 82-130.

Subsection 82-130(1) of the ITAA 1997 states:

A payment is an employment termination payment if:

- it is received by you:

- in consequence of the termination of your employment; or

- after another person's death, in consequence of the termination of the other person's employment; and

o it is received no later than 12 months after the termination (but see subsection (4)); and

o it is not a payment mentioned in section 82-135.

To be an employment termination payment, the amount you will receive must satisfy all three requirements listed above. The first condition requires that there is a payment received by you in consequence of the termination of your employment.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the words have been interpreted by the courts in several cases. The Commissioner has also issued Taxation Ruling TR 2003/13 (TR 2003/13) which discusses the meaning of the phrase. Paragraph 5 of TR 2003/13 states:

...the Commissioner considers that 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.

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 payment will be made in consequence of the termination of employment

The employer company was formed in and the employee commenced as managing director. They were continuously employed from this date until the termination date when the employer terminated their employment and paid him a lump sum amount.

It is evident that the payment has been made to the employee in consequence of the termination of their employment on the termination date. The payment would not have been made had there been no termination of employment. The termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the issue of making the payment would not have arisen. The payment to the employee follows as an effect or a result from the termination of their employment on the termination date.

The payment received by the employee is 'in consequence of the termination of their employment'. Therefore the requirement of subparagraph 82-130(1)(a)(i) of the ITAA 1997 is satisfied.

The '12 month rule'

To qualify as an employment termination payment, the lump sum payment must be received 'no later than 12 months after' the termination of employment. In this case, the payment was made on termination date. Therefore, the requirement of paragraph 82-130(1)(b) of the ITAA 1997 is also be satisfied.

Payments excluded from being employment termination payments

The payment will be an employment termination payment unless the payment is specifically excluded under section 82-135 of the ITAA 1997. The requirement specified in paragraph 82-130(1)(c) of the ITAA 1997 is that the employment termination payment is 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 payments include superannuation benefits, payments for unused annual leave or unused long service leave, and the tax-free part of a genuine redundancy payment (GRP) or an early retirement scheme payment.

Relevant to this case is whether any part of the termination payment represents the tax-free part of a GRP. The facts show the payment does not include any of the other payments listed in this section.

Life benefit termination payment

Subsection 82-130(2) of the ITAA 1997 provides that where an employment termination payment is made during the life of a taxpayer, the payment is a life benefit termination payment.

Subsection 82-130(2) of the ITAA 1997 states:

A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies.

As the termination payment will be received in consequence of the termination of the employee's employment, the payment is a life benefit termination payment as defined under subsection 82-130(2) of the ITAA 1997. This is because it is an employment termination payment to which subparagraph 82-130(1)(a)(i) of the ITAA 1997 applies.

Genuine redundancy payment (GRP)

Consideration must now be given as to whether any portion of the termination payment represents the tax-free part of a GRP. If it does, then that portion:

- will not be an employment termination payment under paragraph 82-135(e) of the ITAA 1997; and

- is not assessable income and is not exempt income.

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

Section 83-175 of the ITAA 1997 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 employees 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 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)).

In addition to the basic genuine redundancy requirement that is specified in subsection 83-175(1) of the ITAA 1997, all of the other requirements of section 83-175 of the ITAA 1997 must be satisfied for a payment to qualify as a GRP.

The Commissioner has issued Taxation Ruling TR 2009/2 (TR 2009/2) entitled Income tax: genuine redundancy payments, which outlines the requirements to be satisfied before any payment made to a person whose employment is terminated qualifies for treatment as a GRP under section 83-175 of the ITAA 1997.

Under subsection 83-175(1) of the ITAA 1997, a GRP is a payment resulting from:

- a dismissal;

- the employee's position is genuinely redundant; and

- the payment 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 the dismissal.

Dismissal from employment

Dismissal is a particular mode of termination which requires the termination of employment at the initiative of the employer without the consent of the employee.

In this instance, the employer company had been adversely affected by circumstances. The sales of its leading product had greatly reduced since 200X and the employer was looking to reduce costs. This caused the employer to significantly reduce its staff numbers from 200X.

The employee was replaced as managing director and moved to a sales and management position however the new managing director then decided to close the office the employee was managing and move their sales' role to existing staff. This effectively made the employee's role redundant and the company had insufficient work to warrant their continuing employment. Clearly this termination is at the initiative of the employer. Although the employee and the managing director are related, the actions by the company in reducing costs since 200X still support termination at the initiative of the employer.

The Commissioner states in paragraphs 16 and 241 of TR 2009/2 that for a payment to qualify as a GRP, all employment with the employer must be severed. In this case, although the employee will become an unpaid non-executive director because of their X% shareholding in the employer, the company will not continue their employment in any capacity after the termination date. In light of these facts it is clear the employee's employment with the company was severed on the termination date.

In conclusion, the termination of the employee's employment was initiated by the company and the termination of their employment was 'dismissal' from employment.

Dismissal caused by 'genuine redundancy'

As stated by the Commissioner in paragraph 23 of TR 2009/2, section 83-175 of the ITAA 1997 requires the dismissal be caused by redundancy of the employee's position, and not for some other reason. In paragraphs 25 and 26 of TR 2009/2, the Commissioner also states the following regarding dismissal and redundancy:

25. An employee's position is redundant when an employer determines that it is superfluous to the employer's needs and the employer does not want the position to be occupied by anyone. Accordingly, it is fundamentally the employer's decision that a position is redundant. On occasion the decision may be unavoidable due to the circumstances of the employer's operations. [Emphasis added]

26. In some circumstances, an employer may re-allocate the duties and functions attached to a particular position to another position within the employer's organisational structure. In such cases the former position is redundant.

As stated earlier, the employer company had been adversely affected by circumstances. The sales of its leading product had greatly reduced since 200X and the employer was constantly looking to reduce costs. The employer had significantly reduced its staff numbers from 200X.

The employee was moved to a sales and management position however the new managing director then decided to close the office the employee was managing and move their sales' role to existing staff. In accordance with paragraph 26 of TR 2009/2 the fact the employee's sales' role was absorbed by existing staff does not change the position that their role was redundant.

The termination of the employee's employment was not on account of any personal act or default on their part. Rather, the decision to terminate their employment is due to a redundancy arising from the employer company abolishing the position they occupied at the time of their dismissal. Therefore it is evident the employee's dismissal was caused by the genuine redundancy of the position they occupied and not by some other reason.

Payment by reason of genuine redundancy

As noted above, the payment the employee has received results from a dismissal and a genuine redundancy, therefore the payment is made by reason of a genuine redundancy.

No benefits relevant to resignation or voluntary retirement (other than the termination payment) applied to the termination of the employee's employment on the termination date. In this light, it is accepted the payment exceeds the amount the employee could reasonably expect to receive if they had voluntarily resigned or retired from their employment in the position they held at the time of the dismissal. Thus in the context of paragraph 57 of TR 2009/2, the payment is specifically attributable to the fact the employee's employment was terminated because of redundancy. Therefore it is considered the payment of $100 000 satisfies the requirement of subsection 83-175(1) of the ITAA 1997.

Age-based limit

Paragraph 83-175(2)(a) of the ITAA 1997 prescribes the employee must be dismissed before the earlier of:

- the day they or she turned 65; or

- 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 applicable).

The employee was 63 years of age at the time of dismissal. There was no agreed date for the cessation of their employment prior to this time. In addition, there was no early retirement agreement in place between the employee and the company. These being the facts, the requirements of paragraph 83-175(2)(a) of the ITAA 1997 have been satisfied.

Arm's length amount

In paragraph 40 of TR 2009/2, the Commissioner states the following regarding the arm's length amount requirement in paragraph 83-175(2)(b) of the ITAA 1997:

40. The arm's length amount requirement in paragraph 83-175(2)(b) stipulates that the actual payment made should not exceed what could reasonably be expected if the parties had been dealing at arm's length. This condition only needs to be met if it is established that the employer and employee are not dealing at arm's length in relation to the dismissal. [Emphasis added]

As the employee is a shareholder and director of the company, their relationship with the company is not at arm's length. Although this may be the case, as stated in paragraph 41 of TR 2009/2 it does not necessarily follow that any dealing between the employee and the company is not at arm's length. Rather, the circumstances specified in paragraph 46 of TR 2009/2 are relevant in this case.

In paragraph 46 of TR 2009/2 the Commissioner states that:

46. In any case, the years of service provided by the dismissed employee and the value of their remuneration package at the time of the dismissal are the most influential factors in determining what could reasonably be expected under an arm's length dealing.

The amount paid to an employee with nearly X years service who has held the position of managing director in the past could not be considered unreasonable.

It is clear from the facts and the financial circumstances of the employer, the employee's entitlement under the redundancy payment was determined in an arm's length manner. This means the amount is an arm's length amount because it is no greater than the amount that could reasonably be expected had the employee been dealing with the company at arm's length. Therefore it follows the payment satisfies the requirement under paragraph 83-175(2)(b) of the ITAA 1997.

No arrangement to employ after the termination date

As previously mentioned, although the employee will become an unpaid non-executive director because of their X% shareholding in the employer, the employer company will not be continuing their employment in any capacity after the termination date. Therefore, it follows there is no arrangement between the company and another person to employ or re-employ the employee after the termination date. This means the requirement under paragraph 83-175(2)(c) of the ITAA 1997 has also been satisfied.

The requirements under subsections 83-175(3) and 83-175(4) of the ITAA 1997

Subsection 83-175(3) of the ITAA 1997 provides that a GRP does not include any part of a payment that is received in lieu of superannuation benefits. Further, subsection 83-175(4) provides that a payment is not a GRP if it is a payment for unused long service leave mentioned in paragraph 82-135(d) of the ITAA 1997.

The facts indicate the payment is not in lieu of superannuation benefits and that the employee has received a separate smaller payment for unused annual leave and long service leave. Therefore it is accepted the payment satisfies the requirements of subsections 83-175(3) and 83-175(4) of the ITAA 1997.

The payment is a GRP under sections 83-170 and 83-175 of the ITAA 1997

An examination of the information provided shows the termination payment satisfies all the relevant conditions set out in section 83-175 of the ITAA 1997 and therefore is a GRP for the purposes of section 83-170 of the ITAA 1997.

Tax-free treatment of this GRP

Section 83-165 of the ITAA 1997 states that any part of a GRP that is not tax-free under Subdivision 83 will normally be an employment termination payment.

The tax-free treatment of a GRP is determined under section 83-170 of the ITAA 1997. This section places a limit on the amount of a GRP that is eligible for concessional tax treatment. Subsection 83-170(2) of the ITAA 1997 provides that so much of the GRP as does not exceed the amount worked out using the formula prescribed in subsection 83-170(3) of the ITAA 1997 is not assessable income and is not exempt income. Any amount in excess of the tax-free amount is taxable as an employment termination payment. The formula for working out the tax-free amount is:

Base amount + (Service amount × Years of service)

where: ...

years of service means the number of whole years in the period, or sum of periods, of employment to which the payment relates.

For the purposes of subsection 83-170(3) of the ITAA 1997, the base amount for the 2009-10 income year is $7,732 and the service amount is $3,867. Any amount that the taxpayer receives which falls within this limit will attract no tax, i.e the amount will be tax-free.

As noted previously, the employee's employment commenced on the relevant date and was later terminated meaning they completed X whole years of service.

In accordance with subsection 83-170(3) of the ITAA 1997, the tax-free part of a GRP The employee can receive for the year ended 30 June 2010 equals $X.

As this exceeds the amount the employee actually received, the whole of their payment is tax-free and is not assessable income and is not exempt income under subsection 83-170(2) of the ITAA 1997.