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Ruling

Subject: Genuine redundancy - pro rata exemption for overseas service

Questions

1. Is the portion of a genuine redundancy payment made in Australia but related to service overseas exempt from tax?

2. Is the portion of a payment for unused long service leave made in Australia but related to service overseas exempt from tax?

Advice/Answers

1. No.

2. Yes.

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences in:

The second quarter of the year ending 30 June 2011

Relevant facts and circumstances

You were employed by your employer (the employer) from the late 1990s continuously until you were made redundant during the 2010-11 income year.

You were assigned to work in Country A for several years and in Country B for several years. You advised that during these two periods of overseas assignment, you were not an Australian resident for tax purposes.

In a letter to you after your employment was terminated the employer confirmed that your position with them was redundant. That letter also confirmed the temporary offer of employment in a new role for a specified period of time, after which your new role would be made redundant.

During the 2010-11 income year you received the following payments on the termination of your employment:

· gross redundancy payment

· unused annual leave

· unused long service leave

The redundancy payment was calculated on the basis of a specified number of weeks' salary per completed year of service.

The tax free part of the genuine redundancy payment was determined to be a particular amount leaving the balance as an employment termination payment.

You advised that your unused annual leave was solely in respect of your service in Australia and that your unused long service leave was in respect of the entire period of your service, which included the periods of service overseas mentioned earlier.

You also advised that the employer had made no allowance for your years of service overseas in calculating the tax withheld from your redundancy entitlements.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2).

Income Tax Assessment Act 1997 Section 6-10.

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

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

Income Tax Assessment Act 1997 Subsection 82-10(4).

Income Tax Assessment Act 1997 Section 82-130.

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 Subsection 82-130(2).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 82-160.

Income Tax Assessment Act 1997 Section 83-70.

Income Tax Assessment Act 1997 Section 83-75.

Income Tax Assessment Act 1997 Section 83-80.

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 Section 83-235.

Income Tax Assessment Act 1997 Paragraph 83-235(a).

Income Tax Assessment Act 1997 Paragraph 83-235(d).

Income Tax Assessment Act 1997 Section 83-240.

Income Tax Assessment Act 1997 Paragraph 83-240(1)(a).

Income Tax Assessment Act 1997 Paragraph 83-240(1)(b).

Income Tax Assessment Act 1997 Paragraph 83-240(1)(e).

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

Income Tax Assessment Act 1936 Section 23AG.

Income Tax Assessment Act 1936 Subsection 23AG(1).

Income Tax Assessment Act 1936 Subsection 23AG(1AA).

Income Tax Assessment Act 1936 Subsection 23AG(2).

Income Tax Assessment Act 1936 Section 23AG(7).

International Tax Agreements Act 1953 Article 14 of Schedule 1.

International Tax Agreements Act 1953 Article 11 of Schedule 5.

Reasons for decision

Summary

A termination payment is exempt from tax if:

(a) it was received in consequence of the termination of an employment in a foreign country; and

(b) either:

(i) it relates only to a period of employment when the taxpayer was not an Australian resident; or

(ii) it relates only to a period of employment when the taxpayer was an Australian resident and the earnings from that employment were exempt from Australian income tax.

The payment made to you was not in consequence of the termination of employment in a foreign country. Further, the payment relates to the whole period of your employment rather than to your employment overseas only. Accordingly, the requirements under the legislation have not been met.

The tax-free part of the genuine redundancy payment is not included in your assessable income.

The taxable component of the employment termination payment is included in your assessable income for the 2010-11 income year.

That portion of the payment made to you in respect of unused long service leave relating to your service overseas is exempt from Australian tax.

Detailed reasoning

Employment termination payment

From 1 July 2007 the taxation treatment of payments made in consequence of the termination of 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 (subsection 82-130(2) of the Income Tax Assessment Act 1997 (ITAA 1997)).

Subsection 995-1(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.

Payment is made in consequence of the termination of employment

The first condition to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer. The phrase 'in consequence of' is not defined in the ITAA 1997. The Commissioner has issued Taxation Ruling TR 2003/13 titled: Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phase 'in consequence of' which discusses the meaning of the phrase.

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) 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.

Your employment was terminated when you were made redundant during the 2010-11 income year. You then received a redundancy payment from the employer. It is evident that the payment was made in consequence of the termination of your employment. The termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the payment would not have been paid.

The payment is, therefore, considered to be received by you in consequence of the termination of your employment.

The payment is received no later than 12 months after termination

The second condition for the payment to be an employment termination payment is stated in paragraph 82-130(1)(b) of the ITAA 1997. The payment must be received within 12 months of the employee's termination of employment, unless they are covered by a determination exempting them from the 12 month requirement.

Your employment was terminated during the 2010-11 income year, and the redundancy payment was made to you on the same day of your employment termination. The requirement under paragraph 82-130(1)(b) of the ITAA 1997 has therefore been met.

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 include (among others):

· superannuation benefits;

· unused annual leave or long service leave payments;

· foreign termination payments covered under Subdivision 83-D of the ITAA 1997; and

· the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

Accordingly, it is necessary to consider the amount, if any, that will be excluded from being an employment termination payment as either a foreign termination payment or the tax-free part of a genuine redundancy payment.

Foreign termination payment

Subdivision 83-D of the ITAA 1997 deals with termination payments that arise out of foreign employment. These payments are not employment termination payments, and are generally tax-free.

Section 83-235 of the ITAA 1997 applies to termination payments received where the taxpayer was a foreign resident during the period of foreign employment to which the payment relates. It states that:

A payment received by you is not assessable income and is not *exempt income if:

(a) it was received in consequence of the termination of your employment in a foreign country; and

(b) it is not a *superannuation benefit; and

(c) it is not a payment of a pension or an *annuity (whether or not the payment is a superannuation benefit); and

(d) it relates only to a period of employment when you were not an Australian resident.

Section 83-240 of the ITAA 1997 applies to termination payments received where the taxpayer was an Australian resident during the period of foreign employment to which the payment relates. It states that:

(1) A payment received by you is not assessable income and is not *exempt income if:

(a) it was received in consequence of:

(i) the termination of your employment in a foreign country; or

(ii) the termination of your engagement on qualifying service on an approved project (within the meaning of section 23AF of the Income Tax Assessment Act 1936 ), in relation to a foreign country; and

(b) it relates only to the period of that employment or engagement; and

(c) it is not a *superannuation benefit; and

(d) it is not a payment of a pension or an *annuity (whether or not the payment is a superannuation benefit); and

(e) you were an Australian resident during the period of the employment or engagement; and

(f) the payment is not exempt from income tax under the law of the foreign country; and

(g) for a period of employment - your foreign earnings from the employment are exempt from income tax under section 23AG of the Income Tax Assessment Act 1936 ; and

(h) for a period of engagement - your *eligible foreign remuneration from the service is exempt from income tax under section 23AF of that Act.

(2) For the purposes of subparagraph (1)(a)(ii), treat the termination of engagement on qualifying service on an approved project as including:

(a) retirement from the engagement; and

(b) cessation of the engagement because of the person's death.

Both section 83-235 and section 83-240 of the ITAA 1997 require that for a payment to be tax-free as a foreign termination payment it must be received in consequence of the termination of the taxpayer's employment in a foreign country.

As previously discussed above, the payment was made in consequence of the termination of your employment with the employer. However, at the time of the termination of your employment, that employment was in Australia. Therefore, neither the requirement under paragraph 83-235(a) of the ITAA 1997, nor the requirement under paragraph 83-240(1)(a) have been satisfied.

Further, paragraph 83-235(d) of the ITAA 1997 requires that the payment 'relates only to a period of employment when you were not an Australian resident'. Similarly, paragraph 83-240(1)(b) requires that the payment 'relates only to the period of that [foreign] employment or engagement'.

In your case, as the redundancy payment was calculated by reference to your total period of employment with the employer, the payment clearly relates not only to your employment in the foreign countries concerned, but also to your employment in Australia.

It should be noted at this point that, unlike entitlements such as sick leave, annual leave and long service leave which accrue over the period of employment, a redundancy payment is made because an employment has been terminated. Although a redundancy payment may be calculated by reference to a period (or periods) of employment, it does not accrue over that period (or those periods) of employment.

Therefore, the payment is not a foreign termination payment and is not exempt under either section 83-235 or section 83-240 of the ITAA 1997.

Genuine redundancy payment

The next to be considered is whether the payment made to you by the employer on the termination of your employment was a genuine redundancy payment under section 83-175 of the ITAA 1997. That section 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 the 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 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 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)).

Based on the facts you provided, the Commissioner accepts that the requirements under section 83-175 of the ITAA 1997 have been met and that the payment you received is a genuine redundancy payment.

Subsection 83-170(2) of the ITAA 1997 provides that so much of the genuine redundancy payment that does not exceed the amount worked out using the formula prescribed in subsection 83-170(3) is not assessable income and is not exempt income. Any amount in excess of the tax-free amount is taxed as an employment termination payment. The formula for working out the tax-free amount is:

Base amount + (Service amount × Years of service)

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 2010-11 income year:

· Base amount means $8,126; and

· Service amount means $4,064.

The tax-free amount of a genuine redundancy payment you can receive in the 2010-11 income year under subsection 83-170(3) of the ITAA 1997 is based on the following formula:

· $8,126 + ($4,064 × years of service)

The tax-free amount of the genuine redundancy payment you received is excluded from being an employment termination payment by virtue of section 82-135 of the ITAA 1997. The remaining amount is an employment termination payment.

Payment of accrued unused long service leave

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the year. Salary and wages, including long service leave payments, is considered ordinary income as it is paid directly as a result of the personal services an employee renders for their employer.

However, unused long service leave (although acquired through personal services and thus characterised as ordinary income) is considered to be statutory income under section 6-10 of the ITAA 1997.

Long service leave means long service leave, long leave, furlough, extended leave or leave of a similar kind (however described) to which a person is entitled by law, award or contract (section 83-70 of the ITAA 1997). It also covers leave made available to a taxpayer as a privilege, rather than as an entitlement, where the availability of the leave is determined by reference to similar criteria (section 83-70).

Payments for unused long service leave on termination of employment are not employment termination payments as they are specifically excluded under section 82-135 of the ITAA 1997. Instead the lump sums are included as assessable income and taxed in accordance with section 83-80.

Apportionment of unused long service leave

Generally, Australian courts have held that the source of employment income is where the employee performs their duties (Commissioner of Taxation (NSW) v. Cam and Sons Ltd (1936) 36 SR (NSW) 544; (1936) 53 WN (NSW) 172; (1936) 4 ATD 32 and Federal Commissioner of Taxation v. French (1957) 98 CLR 398; (1957) 31 ALJ 689; (1957) 11 ATD 288; [1958] ALR 49; [1957] HCA 73.

The courts also confirmed that it is appropriate to apportion income earned to reflect the source of income. Thus, employment income earned while carrying out duties in Australia is considered to be sourced in Australia. Employment income earned while being carried out overseas is considered to be sourced in that overseas country, unless it is merely incidental to the performance of the taxpayer's duties in Australia.

You were a resident earning Australian source income when a portion of the unused long service leave accrued.

You were a non-resident earning salary and wage income from sources out of Australia when the remaining portion of the unused long service leave accrued.

As the long service leave accrued during service both overseas and in Australia, its source is considered to be both overseas and in Australia. As the long service leave accrues on a service basis, the portion attributable to the service performed overseas can be separated from the portion attributable to service performed in Australia.

Subsection 23AG(1) of the Income Tax Assessment Act 1936 (ITAA 1936) applies to exempt from tax any foreign earnings derived from certain activities by a resident individual taxpayer for at least 91 days of continuous employment in a foreign country. Where an individual taxpayer performs relevant foreign service while a foreign resident but receives (and therefore derives) a payment in respect of such service after becoming an Australian resident, the exemption may apply to that part of the payment.

Foreign earnings are defined under subsection 23AG(7) of the ITAA 1936 as meaning:

… income consisting of earnings, salary, wages, commission, bonuses or allowances, or of amounts included in a person's assessable income under Division 83A of the Income Tax Assessment Act 1997 (about employee share schemes), but does not include any payment, consideration or amount that:

(a) is included in assessable income under Division 82 or Subdivision 83-295 or Division 301, 302, 304 or 305 of the Income Tax Assessment Act 1997; or

(b) is included in assessable income under Division 82 of the Income Tax (Transitional Provisions) Act 1997; or

(c) is mentioned in paragraph 82-135(e), (f), (g), (i) or (j) of the Income Tax Assessment Act 1997; or

(d) is an amount transferred to a fund, if the amount is included in the assessable income of the fund under section 295-200 of the Income Tax Assessment Act 1997.

It should be noted at this point that Division 82 of the ITAA 1997 refers to the taxing provisions in relation to employment termination payments.

Foreign service is defined under subsection 23AG(7) of the ITAA 1936 as meaning:

· service in a foreign country as the holder of an office or in the capacity of an employee.

Resident individual taxpayers have to satisfy the conditions in subsection 23AG(1AA) of the ITAA 1936 in relation to foreign earnings derived on or after 1 July 2009 from foreign service performed on or after that date in order to qualify for the exemption. Broadly, the foreign service must be directly attributable to Australia's overseas aid program, a relief fund, an exempt institution or a disciplined force.

However, resident individual taxpayers do not need to satisfy the additional requirements under subsection 23AG(1AA) of the ITAA 1936 in relation to foreign earnings:

· derived before 1 July 2009 from foreign service performed before, on or after 1 July 2009; and

· derived on or after 1 July 2009 from foreign service performed before 1 July 2009.

Under subsection 23AG(2) of the ITAA 1936 the exemption from Australian tax will not apply where the income is exempt from income tax in the foreign country only because of one or more of the following:

· the income is exempt under a double taxation agreement (DTA) or a law of a foreign country that gives effect to a DTA;

· the foreign country exempts from income tax, or does not provide for the imposition of income tax on, income derived in the capacity of an employee, income from personal services or similar income;

· a law of a foreign country, or an international agreement to which Australia is a party, dealing with privileges and immunities of diplomats or consuls or of persons connected with international organisations applies.

In your case you were previously employed in both Country A and Country B. Each of those countries has a DTA with Australia which contains an article dealing with the taxation of salaries, wages and other remuneration in respect of employment.

The relevant article in each DTA concerned effectively states that the salaries, wages and other remuneration in respect of employment will be subject to tax in the country in which the employment is performed.

As the portion of the unused long service leave relating to the periods of employment in Country A and Country B are, by virtue of the respective DTAs, taxable in those countries, and is derived after 1 July 2009 from foreign service performed before 1 July 2009, subsection 23AG(1) of the ITAA 1936 would apply to exempt that portion from Australian tax.