Edited version of private ruling

Authorisation Number: 1011784852574

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Ruling

Subject: Bonus payment

Question

Will the bonus paid by the company to an employee upon termination of employment be subject to tax as an employment termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period:

1 July 2010 to 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The employee was employed by the company pursuant to an employment contract.

One of the clauses in the employment contract provides that a performance bonus may be paid in accordance with the criteria determined by management from time to time. However, a bonus paid in one year does not constitute a precedent for subsequent years.

During the 2010-11 income year, the company gave the employee written notice of termination and did not require the employee to work out the period of notice.

The employee's total gross payment as calculated by the company comprised of several amounts, one of these being a bonus payment.

The company states that the bonus was calculated in accordance with its usual business practices having regard to the performance of the company's business and the performance of the employee measured against a range of key performance indicators. The period for measuring the performance and comparing that performance to the indicators was prior to the termination of the employment.

In a letter to the employee's solicitor, the company confirmed that:

1. it did not treat the situation as a bona fide redundancy; and

2. the bonus was not a 'golden handshake' but was a payment due under the employee's employment contract being determined by the company in the usual way and which was ordinarily due for payment around the time that it was in fact to be paid to the employee; and

3. the bonus was not paid in consequence of the termination of the employee.

Relevant legislative provisions

Income Tax Assessment Act 1997 Div 82.

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise specified

Payments such as bonuses made by an employer to an employee as a reward for personal services are generally income according to ordinary concept under section 6-5 unless they fall within the definition of employment termination payments (formerly known as eligible termination payments). The tax treatment of employment termination payments is governed by Div 82 as from 1 July 2007.

An employment termination payment is defined in subsection 82-130(1) as a payment that satisfies the following three conditions:

· the payment is received in consequence of the termination of the person's employment or, after another person's death, in consequence of the termination of the other person's employment; and

· it is received no later than 12 months after the termination (subject to the exception in subsection (4); and

· it is not a payment specifically excluded under section 82-135.

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment.

The phrase 'in consequence of termination of the person's employment' is not defined in the income tax legislation. However, the courts have considered the meaning of the words 'in consequence of' in relation to 'eligible termination payments', the predecessor of employment termination payments.

Of note are the decisions made by the Full 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').

In Reseck Justice Gibbs stated:

Within the ordinary meaning of the words a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination. It is not in my opinion necessary that the termination of the services should be the dominant cause of the payment.

Similarly, Justice Jacobs stated:

It was submitted that the words 'in consequence of' import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a following on.

The judiciary view in Reseck was reiterated by the full Federal Court in McIntosh. In essence, for a payment to be made in consequence of the termination of employment a causal nexus between the termination and payment was required, although it was not necessary that the termination be the dominant cause of the payment.

The phrase 'in consequence of' as interpreted by the courts has also been canvassed in Taxation Ruling TR 2003/13 in which paragraph 5 expresses a similar view:

… 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 in paragraph 6 of TR2003/13, 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.

Accordingly, if the payment follows as an effect of or a result from the termination of employment, the payment is made 'in consequence of' the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) and will be an employment termination payment unless the payment fails to satisfy the other two requirements in subsection 82-130(1).

In the present case, the employee was employed by the company pursuant to an employment contract. The contract provides that a performance bonus may be paid in accordance with the criteria determined by management from time to time. When the employee's service was terminated, he received a gross payment which included a bonus component payable under the relevant clause of the employment contract.

The bonus was a payment due under the employee's employment contract being determined by the company in the usual way and which was ordinarily due for payment at around the time that it was in fact to be paid to the employee. In calculating the amount of the bonus, the company followed its usual business practices having regard to the performance of its business and the performance of the employee measured against a range of key performance indicators ('KPI').

Notably, the period for measuring the performance and comparing that performance to the KPI was a period that was antecedent to the termination date of the employee's services. In other words, the entitlement to the bonus had already been earned by the employee before the termination of his employment.

The fact that the bonus was based on the employee's prior performance in pursuance of the employment contract shows that there was an absence of a cause and effect relationship between the termination of employment and the bonus payment. The payment was, in fact, made because the employee had achieved certain performance benchmarks and it was entirely unrelated to the termination event.

Therefore, it is considered that the bonus is not 'in consequence of' the termination of the employee's employment but as a consequence of the relevant clause of the employment contract. It is an additional reward for the employee's personal services having satisfied the criteria determined by the company.

Consequently, the bonus paid by the company to the employee is not an employment termination payment. It is assessable as ordinary income under section 6-5.