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Ruling

Subject: Employment termination payment and genuine redundancy

Question 1

Is the payment in lieu of notice made to the employee under a Settlement and Release Deed, an employment termination payment in accordance with subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is any part of the payment in lieu of notice exempt from tax as a tax-free part of a genuine redundancy payment in accordance with section 83-170 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 2011.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

The employee commenced employment with the previous employer over four years ago.

In a letter sent from the previous employer in late July 20XX, the employee was advised of an appointment to a senior position. The employee was advised in this letter that the position was offered as a contract of several years. The employee accepted this appointment several weeks later.

A copy of the position description issued by the previous employer for this position has been provided. In the position description the level of appointment to the position was stated as 'contract'.

In a letter sent from the previous employer in mid May 20XX, the employee was advised of the impending transfer to the employer in the substantive position the employee held, at the commencement of the 20XX-XX income year.

It was confirmed in this transfer letter that the employee's entitlements and conditions would be protected, and the terms of the employee's employment would be honoured, when the employee transferred to the employer. The employee was also advised in this letter that the employee's entitlements would continue to accrue prior to and after the transfer.

In a letter sent from the employer in late May 20XX, it was confirmed that the employee was appointed to an executive position at the same time as the transfer.

The employee was advised in this appointment letter that the terms and conditions of the employee's employment would continue, and accordingly, the employee's employment conditions and entitlements would be protected. In addition, the position description for the previous position (including its level as 'contract') continued to apply to the new position the employee held. Hence the terms and conditions set out in the contract for the previous position were continued in the new position. The employee's contract of employment was due to expire in mid August 20XX.

Leading up to the employee's resignation, some performance issues concerning the employee were addressed. The employee entered into a Settlement and Release Deed (the Deed) with the employer after extensive negotiations related to the employee's performance and the trust held between the relevant parties. Both parties agreed to settle all matters between them on the terms and conditions contained in the Deed.

Under the Deed the employee agreed to resign with effect from the resignation date, and the employer agreed to accept the employee's resignation. The employee's resignation letter states the last day of employment with the employer as the resignation date.

The employee was not offered work in an alternative position with the employer prior to the resignation date. Rather, all employment was severed on the resignation date.

The employee's position was advertised as a vacancy and it has been filled.

The Deed provides for the payment to the employee of a Settlement sum, which comprises:

1) a payment in lieu of accrued but untaken leave (including Christmas Leave) and leave loading; and

2) a payment in lieu of notice.

The Deed contains no dissection of the payment in lieu of notice.

A Payment Advice subsequently issued by the employer discloses payments in lieu of accrued and unused annual leave (with loading), annual leave loading and Christmas Leave, payment of salary and the calculation of the payment in lieu of notice. Tax was withheld by the employer. After a superannuation contribution was deducted, a net payment was credited to the employee's bank account in late 20XX.

The employee had attained preservation age on the resignation date, and at the time the payment in lieu of notice was made.

The payment in lieu of notice was not made by the employer in lieu of superannuation benefits.

As at the resignation date, no arrangement existed between the employee and the employer, or between the employer and another person, to employ the employee after the termination of the employment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-10(2),
Income Tax Assessment Act 1997 Paragraph 82-10(3)(a),
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(e),
Income Tax Assessment Act 1997 Section 82-140,
Income Tax Assessment Act 1997 Section 82-145,
Income Tax Assessment Act 1997 Section 82-150,
Income Tax Assessment Act 1997 Section 83-170,
Income Tax Assessment Act 1997 Section 83-175,
Income Tax Assessment Act 1997 Subsection 83-175(1) and
Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision

Summary

The payment in lieu of notice is an employment termination payment.

No part of the payment is a tax-free part of a genuine redundancy payment. Rather the entire payment is a taxable component of a life benefit termination payment.

Consequently, the maximum rate (including Medicare levy) at which tax should be withheld from the payment is 16.5%.

Detailed reasoning

Employment termination payments

Employment termination payments are payments that are made in consequence of the termination of any employment of a taxpayer.

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:

(a) it is received by you:

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

(ii) after another person's death, in consequence of the termination of the other person's 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 be an employment termination payment, the amount received by the employee in late 2010 must satisfy all three conditions listed above.

The first condition requires that there is a payment received by the employee in consequence of the termination of the 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 is made 'in consequence of' the termination of employment'

The employee was employed by the previous employer over several years until the end of the 2009-10 income year. In late July 2008, the employee was appointed to a senior position on a contract of several years. The employee accepted this appointment several weeks later.

In mid May 2010 the employee was advised of the impending transfer to the employer in the substantive position the employee held, at the commencement of the 2010-11 income year.

Several weeks later the employee was appointed on a continued contract to an executive position, with the appointment commencing at the same time as the transfer. The contract was due to expire in mid August 2011.

Leading up to the employee's resignation, some performance issues concerning the employee were addressed. After extensive negotiations related to the employee's performance and the trust held between the employer and the employee, the parties agreed to settle these issues by entering into a Settlement and Release Deed (the Deed). By entering into the Deed, both parties agreed to settle all matters between them on the terms and conditions contained in the Deed.

The Deed states that the employee will resign with effect from the resignation date, and that the employer will accept the employee's resignation. The employee's resignation letter states the last day of employment with the employer as being the resignation date.

The Deed provides that the employer will pay the employee a payment in lieu of notice less tax 'deductions as required by law'.

The Deed does not provide any dissection of the payment.

The facts show that the payment in lieu of notice is the result of a settlement the employee had reached with the employer in accordance with the provisions in the Deed. If not for the employee tendering the resignation, the payment would not have been made by the employer.

It is considered that the termination of the employment under the Deed and the payment in lieu of notice are all intertwined and connected. It follows that the payment was an effect or result of the cessation of the employment.

It is clearly evident that the payment in lieu of notice was made to the employee in consequence of the termination of the employment. Therefore the requirement of subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been 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 the taxpayer's employment. The employee resigned on the resignation date, and the payment in lieu of notice was made to the employee a number of days later. Therefore the requirement in paragraph 82-130(1)(b) of the ITAA 1997 also has been 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 payment in lieu of notice represents the tax-free part of a GRP. The facts show that the payment is a single undissected lump sum payment, which did not include any of the other payments listed in this section.

Genuine redundancy payment (GRP)

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. If it does, then a portion of the payment:

· 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.

Subsection 995-1(1) of the ITAA 1997 states:

genuine redundancy payment has the meaning given by section 83-175.

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.

The basic requirement for a genuine redundancy payment

In paragraph 233 of TR 2009/2 the Commissioner explains that the basic requirement for a GRP is described in subsection 83-175(1) of the ITAA 1997 as:

… 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. [Emphasis added].

Therefore it can be seen that under subsection 83-175(1), a genuine redundancy payment is one 'received by an employee who is dismissed from employment because the employee's position is genuinely redundant' (TR 2009/2, paragraph 10).

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.

However, the Commissioner states in paragraph 20 of TR 2009/2 that a dismissal can still occur even where an employee has indicated that they would be interested in having their employment terminated, provided that the final decision to terminate employment remains solely with the employer.

In this instance, the employment of the employee was terminated under the Deed at the initiative of the employer. It is evident from the facts presented that the cessation of the employment was intended by the employer. It is also evident that under the Deed, the employee did not resign voluntarily from the employment.

However after extensive negotiations concerning performance issues, the employee agreed to resolve these issues by resigning from the employment in accordance with the Deed.

Consequently, the employee tendered the resignation effective from the resignation date, and the employer agreed to accept the resignation. In this light, it is clear that the final decision to terminate the employment was made by the employer. Further, the facts clearly show that all employment was severed on the resignation date.

In this case, the employment termination was initiated by the employer. Therefore the employment termination involved the employee being dismissed 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 that the dismissal be caused by redundancy of the employee's position, and not for some other reason. In paragraphs 25 and 28 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]

….

28. A dismissal is not caused by redundancy where personal acts or default are the prevailing or most influential cause for the termination. For example, a person may be dismissed due to unsatisfactory performance or behaviour.

In this light, the question to be answered is whether the executive position the employee held was abolished by the employer. In this case the facts show that the employee's position was not abolished when the employment ceased.

The employee's position was advertised as a vacancy and it has been filled by the employer.

Hence the position the employee held at the time of the resignation was not abolished. Rather, the position still exists and is currently occupied by another employee. Accordingly it cannot be said that the position was genuinely redundant.

As explained in paragraph 264 of TR 2009/2, the decision to make the position redundant is made by the employer. In this light, the facts show that the employer did not make the position redundant when the employee resigned from the employment.

The Commissioner considers that genuine redundancy must be the reason for termination by way of dismissal. In this instance, it is clear that reasons relating to the employee personally, and not the genuine redundancy of the position the employee occupied, are the prevailing or most influential cause for the termination of the employment.

Although there was a dismissal, the dismissal was not caused by the redundancy of the position the employee occupied at the time of the resignation. Therefore the payment in lieu of notice was not made by reason of a genuine redundancy.

The payment is not a GRP and no part of the payment is tax-free

As noted earlier, all of the conditions set out in section 83-175 of the ITAA 1997 must be satisfied for the payment to qualify as a GRP. In this case, because the basic genuine redundancy requirement has not been satisfied, it is not necessary to examine if either the other requirement of subsection 83-175(1) or the other requirements of section 83-175 of the ITAA 1997 are satisfied in this situation.

In view of all the above, it is considered that the payment in lieu of notice is not a GRP under section 83-175 of the ITAA 1997. Consequently, no part of the payment is tax-free under section 83-170 of the ITAA 1997.

The payment is an employment termination payment and a life benefit termination payment

Therefore, no part of the payment made by the employer under the Deed is excluded from being an employment termination payment in accordance with paragraph 82-135(e) of the ITAA 1997.

Accordingly the requirement in paragraph 82-130(1)(c) of the ITAA 1997 is satisfied in respect of this payment.

Because all the requirements in subsection 82-130(1) of the ITAA 1997 have been satisfied, the payment in lieu of notice is an employment 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 employee received the payment in lieu of notice in consequence of the termination of the employment, the payment is a life benefit termination payment as defined under subsection 82-130(2) of the ITAA 1997, because it is an employment termination payment to which subparagraph 82-130(1)(a)(i) of the ITAA 1997 applies.

Taxation of the life benefit termination payment

A life benefit termination payment is comprised of the following components:

· Tax-free component - this includes the pre-July 83 segment of the payment (if any) and/or the invalidity segment (if any); and

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

As the period of employment to which the life benefit termination payment relates commenced after 1 July 1983, the payment does not have a pre-July 83 segment.

In addition, as the payment in lieu of notice was not made because the employee ceased being gainfully employed as a result of suffering from ill-health, there is also no invalidity segment for the purposes of section 82-150 of the ITAA 1997.

Therefore the life benefit termination payment contains no tax-free component as defined in section 82-140 of the ITAA 1997. Rather all of the payment in lieu of notice is a taxable component as defined in section 82-145 of the ITAA 1997.

Subsection 82-10(2) of the ITAA 1997 provides that the taxable component of a life benefit termination payment is assessable income. Hence the taxable component is subject to tax and is included in full in the employee's assessable income in the 2010-11 income year, the year of income in which the employee received the payment, in accordance with subsection 82-10(2) of the ITAA 1997.

For recipients aged at or above the preservation age, the taxable component of a life benefit termination payment is taxed at a maximum rate of 15% (plus Medicare levy) for amounts below the employment termination payments cap (ETP cap) amount of $160,000 for the 2010-11 income year, and at the top marginal rate (plus Medicare levy) for amounts above the ETP cap amount.

Preservation age is the age at which retirees can access their superannuation benefits. In this case, the employee has attained preservation age on the last day of the 2010-11 income year.

In addition, the amount of the taxable component is less than the ETP cap amount of $160,000 specified for the 2010-11 income year.

Therefore, the employee is entitled to a tax offset under paragraph 82-10(3)(a) of the ITAA 1997, to ensure that the rate of tax on the taxable component does will not exceed 15%. Consequently, the maximum rate (including Medicare levy) at which the employer should withhold tax from the taxable component is 16.5%.

Conclusion

As discussed above, the payment in lieu of notice is an employment termination payment, and no part of this payment is exempt from tax as a tax-free part of a genuine redundancy payment.

Rather the entire payment is a taxable component of a life benefit termination payment. Therefore, the employer should withhold tax (including Medicare levy) from this payment at the rate of 16.5%.