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Ruling

Subject: Salary sacrifice - unused annual leave and long service leave on termination

Questions

1. Can an employee salary sacrifice amounts of unused annual leave and unused long service leave payable on termination of employment?

2. If an existing salary sacrifice arrangement is in respect of 'future earnings' will this encompass amounts of unused annual leave and unused long service leave payable on termination of employment?

Advice/Answers

1. No.

2. No.

This ruling applies for the following period

Year ending 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

Early in the 2011-12 income year the Employer terminated the employment of its employee (the Employee).

At the time of termination of employment, the Employee had untaken annual leave and long service leave.

A payment for the untaken annual leave and long service leave was made to the Employees bank account a day later.

Subsequent to the payment being transferred to the Employee's bank account the Employer received an email requesting that a portion of the payment be paid to the Employee's superannuation fund as a salary sacrifice amount as per previous arrangements.

The Employee's most recent salary sacrifice arrangement (SSA) adjustment dated late in 2009-10 income year specifically asked the Employer to pay a certain amount from the Employee's salary as salary sacrifice and refers to salary only. In addition, the pre-existing SSA and the SSA adjustment make no reference to the payout of untaken annual leave and long service leave.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Superannuation Guarantee (Administration) Act 1992

Reasons for decision

Summary of decision

The salary sacrifice arrangement (SSA) between the Employer and the Employee specifically asked the Employer to pay a certain amount from their salary and refers to salary only. In addition, the SSA and the SSA adjustment make no reference to the payout of annual leave and long service leave.

There is little to support the contention that the SSA covered future leave accruals paid out upon termination. The facts indicate that the Employee only made the decision to sacrifice the leave payout into superannuation at the time of his termination. This constitutes an ineffective SSA.

Regardless of whether there is an effective or ineffective SSA, the character of the payment cannot be changed. The Employer has already paid out the leave entitlements as cash and an amount was not salary sacrificed into superannuation. Therefore, the Employee received his leave entitlements in the form of salary and wages and the payout should be taxed accordingly.

Detailed reasoning

The Commissioner's view on the taxation and superannuation implications of SSAs are discussed in Taxation Ruling TR 2001/10 Income tax: fringe benefits tax and superannuation guarantee: salary sacrifice arrangements.

TR 2001/10 defines an SSA to mean an arrangement under which an employee agrees to forgo part of his or her total remuneration that he or she would otherwise expect to receive as salary or wages, in return for the employer or someone associated with the employer providing benefits of a similar value. If the salary sacrifice is effective, the employee will only be liable for income tax on the reduced salary.

The type of benefits provided in SSAs by employers to employees includes employer superannuation contributions.

There are two types of SSAs:

1. Effective SSA - an effective SSA involves the employee agreeing to receive part of his or her total amount of remuneration as benefits before the employee has earned the entitlement to receive that amount as salary or wages.

2. Ineffective SSA - an ineffective SSA involves the employee directing that an entitlement to receive salary or wages that has been earned is to be paid in a form other than as salary or wages.

The Commissioner considers that superannuation contributions made by an employer under an effective arrangement are properly considered as employer contributions to the superannuation fund for the purposes of the Superannuation Guarantee (Administration) Act 1992 (SGAA). Further, superannuation contributions made by an employer under an ineffective arrangement are not.

The Commissioner does not give approval for SSAs and cannot comment on how employers and employees make their employment contracts or when they should be amended. However, if both the employer and employee wish to enter into salary sacrifice arrangement, for the agreement to be effective, it needs to be negotiated prior to performing the employment services.

In regards to leave and SSAs paragraph 27 of TR 2001/10 states:

… To deal with an entitlement to take leave that has already accrued will be an ineffective SSA. The exchange of an entitlement to take leave for another benefit will cause the entitlement to be paid as salary or wage and to be derived as ordinary income.

In contrast paragraph 28 states:

… Leave that will accrue from the provision of future services may be the subject of an effective SSA. Similarly, the taking of leave that accrued prior to the commencement of the SSA in the ordinary course of employment will not cause the SSA to be ineffective.

Further, paragraphs 89 to 92 which deals directly with the matter of SSAs that involve leave entitlements states:

89. Once an employee has completed the relevant qualifying period of employment and has an entitlement to take annual leave, long service or sick leave, the employee has an entitlement to be paid salary or wages. An entitlement to take leave is synonymous with an entitlement to be paid salary or wages because the employee has done everything necessary, apart from taking the leave, to be entitled to be paid.

90. It then follows that a SSA exchanging an entitlement to take leave that is accruing, or that has accrued, for past services performed in return for benefits is ineffective. Benefits paid under an ineffective SSA are payments of salary or wages and form part of the employee's assessable income under section 6-5 or 6-10 of the ITAA 1997.

91. We recognise that a SSA exchanging any expected entitlement to leave that will accrue for future services rendered in return for benefits will be effective. While benefits provided under an effective SSA may be derived as ordinary or statutory income by the employee (see paragraph 28 above), the income is exempt because of the operation of section 23L of the ITAA 1936.

92. Whether the conditions necessary for the taking of leave have been met is a question of fact. Statute, award conditions, individual contracts, enterprise workplace agreements or similar agreements may be relevant to determining whether the conditions have been met. Where there is a lengthy qualifying period which must be completed before any entitlement to leave accrues (as is generally the situation for long service leave entitlements), until that qualifying period has been completed, the conditions have not been met. Most employees must complete a minimum period of service before any entitlement to long service leave accrues. If the employee terminates employment prior to completing the required minimum period of service, the employee has no enforceable right to payment in lieu of long service leave. Some employees' employment conditions give a pro rata entitlement to be paid salary or wages once a lesser period of service has been completed, if employment terminates after that lesser period but before the full qualifying period. An employee who has not completed sufficient service to be entitled to take long service leave or receive a pro rate entitlement of salary or wages on termination of employment can enter into an effective SSA. Once the conditions for taking long service leave have been met, the employee can only enter into an effective SSA in respect of future entitlements to take long service leave.

TR 2001/10 includes two examples involving leave and an SSA:

Example 6 - partially effective SSA involving leave

140. David Citizen negotiates a SSA for the 2000-01 year of income with his employer at the close of business on 30 June 2000 in relation to his annual leave. The SSA seeks to apply to his leave that has already accrued, together with future leave that will accrue. There are no restrictions under the relevant industrial law, etc., that limit the amount of annual leave that David can forego in exchange for other benefits. As at 30 June 2000, David has an entitlement to annual leave of 4 weeks for services performed in the period 1 January 1999 to 31 December 1999. David has also accrued annual leave of 2 weeks for the period 1 January 2000 to 30 June 2000, although he is not entitled to take this leave until 1 January 2001. David would, however, receive payment of the leave entitlement if he were to resign prior to 1 January 2001.

141. Expense payment reimbursements received by David in exchange for his accrued leave of 2 weeks annual leave and the presently available 4 weeks of annual leave represent the payment of entitlements to leave which have been earned. They cannot be the subject of an effective SSA. The expense payment reimbursements are taken by subsections 6-5(4) and 6-10(3) of the ITAA 1997 to be derived as income. David's employer will have no liability to pay FBT on the benefits provided but will be required to withhold an amount to meet the PAYG withholding obligations.

142. Expense payment reimbursements received by David in lieu of the entitlement that he has foregone for leave accruing after 30 June 2000 represent benefits received under an effective SSA and do not form part of David's assessable income. David's employer is liable to pay FBT on the benefits provided.

Example 9 - dealing with leave that causes a SSA to be ineffective

147. Aaron has accrued an entitlement to take 12 weeks annual leave. Aaron's employer directs him to take a minimum of 8 weeks annual leave. Aaron does not wish to take the leave and receives permission from his employer to enter into a SSA to exchange the remuneration that he would receive if he took 8 weeks leave for a superannuation contribution of equal value. Aaron continues to attend work, however his accrued annual leave has been reduced by 8 weeks.

148. The SSA which has exchanged an entitlement to take leave for a superannuation contribution is ineffective. The whole amount contributed to the superannuation fund is Aaron's salary or wage and forms part of his ordinary income. His employer has a PAYG withholding obligation. Aaron or his employer should ensure that the superannuation fund is aware that the superannuation contribution is an undeducted contribution so that it can be properly accounted for by the superannuation fund (income tax and superannuation surcharge).

From the above it is clear leave that has already accrued outside of an SSA cannot be exchanged for superannuation contributions on the basis of an SSA adjustment. The leave must be incorporated within the SSA prior to it being accrued.

An SSA is part of the contract between Employer and Employee. There should be certainty in the terms and conditions. It is not open to an Employee to add in terms to suit their changing circumstances. Before the leave accrued the SSA must have included the detail of the leave payout into superannuation. This would include a specific amount of the leave entitlement to be paid out to a specific superannuation fund. The SSA would be ineffective if the employee could decide at the time of the payout how much of the leave should be sacrificed into superannuation and how much would be received in cash. If a specific amount of leave is described in the terms of the SSA it must have accrued after the arrangement was made.

The SSA between the Employer and the Employee specifically asked the Employer to pay a certain amount the Employee's salary and refers to salary only. In addition, the SSA and the SSA adjustment make no reference to the payout of annual leave and long service leave.

There is little to support the contention that the SSA covered future leave accruals paid out upon termination. The facts indicate that the Employee only made the decision to sacrifice the leave payout into superannuation at the time of his termination. This constitutes an ineffective SSA.

Regardless of whether there is an effective or ineffective SSA, the character of the payment cannot be changed. The Employer has already paid out the leave entitlements as cash and an amount was not salary sacrificed into superannuation. Therefore, the Employee received his leave entitlements in the form of salary and wages and the payout should be taxed accordingly.