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Ruling

Subject: Employment termination payment

Question

Is the lump sum payment made to you by the Company considered to be an employment termination payment as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answer

Yes.

This ruling applies for the following period

For the year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

Previously you entered into an employment agreement (the Agreement) with a company (the Company).

In accordance with the Agreement, you were entitled to terminate your own employment. The Agreement states that you may terminate employment upon the occurrence of a specific event, and that on termination of employment you are entitled to a payment equal to the salary for a specified period.

In the income year, the specific event stipulated in the Agreement occurred.

You advised the Company secretary that, in accordance with the terms of the Agreement, you were terminating your employment with the Company and therefore entitled to a payment under the Agreement. Furthermore, you advised that you were willing to assist the Company until you were no longer needed.

An email was sent from the Company to a legal advisor, requesting advice on the total claim you had under the Agreement.

The legal advisor advised that, in respect of the Company, the specified event had occurred and in this circumstance you may terminate employment without notice, and not required to work any period of notice, nor is the Company required to make payment to you in lieu of a period of notice.

Furthermore, your monetary entitlements pursuant to law and the Agreement include a payment equal to salary for a specified period inclusive of superannuation, a payment in respect of Salary accrued up to the End Date and a payment in respect of any accrued untaken annual leave.

The legal advisor also recommended that, if the Company wanted to accept your offer of assistance, your resignation pursuant to the Agreement is acknowledged and that the period of your further services is confirmed (in writing) with a specified end date of employment.

For a specified period, your post-appointment with the Company was casual employment and you had no contract for this period. You received salary from the Company.

You have advised that your specified duties had ceased when you terminated employment with the Company.

You had discussions with the Company and your offer to assist was accepted. You were verbally advised to commence new employment duties which were different from your duties under the Agreement.

A payment advice consisted of pre-appointment and post-appointment wages. Furthermore, the payment advice would not reconcile with your Group Certificates, which will be issued in due course.

Within 12 months of the termination of employment, a termination payment (with an amount of tax withheld) was made to you by the Company, in accordance with the Agreement.

Subsequently, you entered into a new employment agreement with the Company. The Company later verbally terminated this new employment, giving you notice which you agreed to work out.

The Company later confirmed that your employment with the Company was terminated, and that under your employment contract you are entitled to a payment for unused annual leave, notice which you were working out which will be paid to you in the usual payroll, superannuation and in accordance with your employment contract, you are not entitled to redundancy pay.

The Company further advised that, if you agree with your pre-appointment entitlements as per the Company records, you will need to sign the form and return it back to the office.

You have reached preservation age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-10(3)

Income Tax Assessment Act 1997 Section 82-130.

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

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

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 Subsection 82-130(4).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 83-295

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Summary

The termination payment made to you by the Company in the income year is an employment termination payment as the payment was made in consequence of the termination of your employment. The total amount is a taxable component to be included in your income tax return for the income year.

Detailed reasoning

Employment termination payment

From 1 July 2007 the taxation treatment of payments made in consequence of the termination of any employment of a taxpayer changed. These payments, formerly known as eligible termination payments, are now called employment termination payments. Where the payment is made during the life of a taxpayer the employment termination payment is known as a life benefit termination payment in accordance with subsection 82-130(2) of the ITAA 1997.

Section 995-1 of the 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:

(a) it is received by you:

(i) in consequence of the termination of your employment; or

(ii) after another persons death, in consequence of the termination of the other persons 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.

To determine if a payment constitutes an employment termination payment, all the conditions in subsection 82-130(1) of the ITAA 1997 must be satisfied. Failure to satisfy any of the three conditions under subsection 82-130(1) will result in the payment not being considered an employment termination payment.

Even where all the conditions in subsection 82-130(1) of the ITAA 1997 have been satisfied, generally, to qualify as an employment termination payment, the payment must be received by the person within 12 months of termination (see paragraph 82-130(1)(b)). Generally, any termination payments received outside of the 12 months will be assessable at the person's marginal tax rates (section 83-295), unless the taxpayer is covered by a determination exempting them from the 12 month rule (see subsection 82-130(4)).

Payment is made in consequence of the termination of your employment

For a payment to be treated as an employment termination payment, the first condition that needs to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer (see subparagraph 82-130(1)(a)(i)).

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Whilst the courts have divergent views on the meaning of this 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 (TR 2003/13).

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 and the current provision under the ITAA 1997 both use the term 'in consequence of' in the same manner. As previously noted, eligible termination payments ceased to exist from 1 July 2007, being replaced by employment termination payments.

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.

In paragraph 6 of TR 2003/13, the Commissioner recognises that:

The phrase requires 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) 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).

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.

Therefore, 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 for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135.

There is also a broader view of the meaning of 'in consequence of the termination of employment'. Paragraph 29 of TR 2003/13 provides that a payment will be in consequence of the termination of employment if the termination is either a cause of the payment or an antecedent event.

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.

In the facts of this case, you entered into an employment agreement (the Agreement) with a company (the Company).

In accordance with the Agreement, you were entitled to terminate your own employment. The Agreement states that you may terminate employment upon the occurrence of an specified event, and that on termination of employment you are entitled to a payment equal to the salary for a specified period.

In the income year, the specified event occurred.

You advised the Company that in the terms of your contract you were terminating your employment and therefore entitled to a payment under the Agreement equal to the Salary payable for a specified period.

It is clear from the facts provided that the payment made under the Agreement is made to you after terminating your employment with the Company. Therefore, the payment was made 'in consequence of' your termination of employment. The termination of employment upon the occurrence of the specified event is a pre-condition to the making of the payment under the Agreement. As such, there is a direct causal connection between the termination of employment and the making of the payment.

If the termination of employment had not occurred, you would not have been entitled to the payment.

It is also noted that after terminating employment under your Agreement with the Company you had discussions where it was agreed that you would work and assist them. Furthermore, these new duties were different to the duties you previously performed under your original employment Agreement.

Your salary was paid by the Company until your services were no longer required.

However, the termination payment would not have been made had there been no termination of employment with the Company. The termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the payment under the Agreement would not have been made.

It is considered that there is sufficient nexus between the making of the payment and the termination of employment to say that the payment is made in consequence of your termination of employment.

Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

The payment is received no later than 12 months after termination

The second condition for the payment to meet the criteria, as an employment termination payment is stated under paragraph 82-130(1)(b) of the ITAA 1997. The payment made under the Agreement must be received within 12 months of the taxpayer's termination of employment, unless they are covered by a determination exempting them from the 12 month rule. If the payment is received more than 12 months after termination of employment and the taxpayer is not covered by a determination exempting him from the 12 month rule, the payment will not be an employment termination payment.

As already noted in the facts, the payment was made to you within the 12 months of your termination of employment with the Company.

Therefore, it is considered that the payment satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997.

The final requirement under paragraph 82-130(1)(c) of the ITAA 1997 is that the payment is not a payment mentioned in section 82-135 of the ITAA 1997.

Exclusions under section 82-135 of the ITAA 1997

Certain payments made on termination of employment are excluded from being an employment termination payment under section 82-135 of the ITAA 1997. These payments include any accrued annual and long service leave and the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments, which do not apply to this payment.

As stated above, the payment is considered to be a payment received in consequence of the termination of employment and is not a payment mentioned in section 82-135 of the ITAA 1997.

Thus, the requirement in paragraph 82-130(1)(c) of the ITAA 1997 is satisfied in this instance.

Consequently, the payment made to you is considered to be an employment termination payment as the payment satisfies all the requirements in section 82-130 of the ITAA 1997, and is not specifically excluded under section 82-135 of the ITAA 1997.

An employment termination payment made after 1 July 2007 will be comprised of the following components:

Tax fee component this includes the post-June 1994 invalidity or pre-July 83 component (if any); and

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

The taxable component is subject to tax, depending on the person's age.

A cap applies on concessionally taxed employment termination payments and is indexed annually to average weekly ordinary time earnings. For the income year, the cap is $150,000.

The taxable components of all life benefit employment termination payments received in an income year are counted towards this cap. Any tax-free amounts are not counted towards the cap.

In this case, you will have reached preservation age on the last day of the income year in which the payment was made. The payment is a taxable component of an employment termination payment therefore this amount is to be included in your assessable income for the income year.

As the payment is under the employment termination payment cap of $150,000, you are entitled to a tax offset that ensures that the rate of income tax on the amount does not exceed 15% in accordance with subsection 82-10(3) of the ITAA 1997. In addition, the Medicare levy may apply.