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Ruling

Subject: transitional termination payments

Questions

1. Is the payment for length of service pursuant to the Human Resources Policies clause of the employment contract a transitional termination payment?

2. Is the payment for in lieu of notice pursuant to the termination clause of the employment contract a transitional termination payment?

3. Is the additional payment for in lieu of notice pursuant to the staff retrenchment policy a transitional termination payment?

Advice/Answers

1. Yes

2. Yes

3. No

This ruling applies for the following period:

Year ending 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Your client is under age 55.

He commenced employment during 19XX with Entity 1 (the Company) a subsidiary of another entity (Entity 2).

The Company has a number of trading names including Trading name 1.

Entity 2 is a member of a Group (Entity 3).

Your client was appointed in a certain position during 2006.

His most recent written employment contract is the 20XX Contract related to his previous role in the Company's commercial department.

The 20XX contract specified the following coverage under the specific provision headings:

§ Human Resources Policies - While employed, he would be covered by Trading name 1's Human Resources Policies including those which cover Occupational Health and Safety, Leave, Equal Employment Opportunity, Privacy and other matters.

§ Continuity - The nature of his role (including position title, duties and reporting lines) may be varied throughout his employment with the Company. It was agreed that irrespective of any such variations, by negotiation or otherwise, the terms and conditions set out in the 20XX Contract will continue to apply as contractual provisions, unless otherwise amended by the Company in writing by the Human Resources Director of the Company.

§ Termination - His employment with the Company may be terminated by either party giving the other three months notice of termination. Alternatively, the Company may terminate his employment by paying him three months salary in lieu of notice.

§ Incentive Plan - Eligibility to participate in the Company's incentive plan.

The terms and conditions under the 20XX Contract including the entitlements under the termination clause did not change after he was appointed in a certain position.

The Company sought a review of their approach/practice in relation to redundancy payments to ensure their approach to redundancy benefits was in step with market practice and equitable.

The Company clarified some aspects of their termination policy subsequent to receiving advice following the review in May 2006.

The clarifications were not formally documented or significant or material and the primary clarification was that the Company's plant based staff essentially enjoyed the same benefits as that applying to the unionised workforce.

The relevant primary clarifications on redundancy benefits were:

§ The length of service entitlement is to be subject to a maximum ceiling of 120 weeks pay ie 4 weeks per year of service, pro-rated for part years and capped at 30 years service. Previously the service multiples were uncapped.

§ Severance or notice payments are a sliding scale based on salary grade level.

These changes were implemented in November 2006.

You advised the retirement incentive clause did not apply to your client but only to employees aged 55 or more whose employment will cease as a result of retirement, rather than employees whose termination (like your client's) was for reason of redundancy.

Your client's employment was terminated in July 20XX.

He was under age 52 when he received the termination payments in September 2011 and he was under his preservation age.

His employment service was less than 30 years.

You advise the clarifications made to the Company's practice/approach to redundancy benefits did not alter or affect the way your client's entitlements were calculated for length of service as his service period was less than 30 years, and therefore the cap of 30 years did not apply.

The termination clause in the 20XX Contract referred to notice payments on termination but was silent on notice payments on termination by reason of redundancy.

You advised that his entitlement for the notice payment was paid under the Termination clause of his 20XX Contract (13 weeks salary).

You obtained assurances from the Company that the 'pro-rata basis for part-year of service under the 19XX Staff Retrenchment Policy was already in practice from February 19XX although not explicitly mentioned as such.

The Company's Benefits & Compensation Manager has confirmed the following in writing to you:

§ The Company had an established practice of providing head office employees whose employment had been terminated by reason of genuine redundancy before 10 May 2006 with a length of service payment equal to four weeks pay per completed year of service , or part thereof (more particularly completed months, rather than (only) four weeks pay per completed year of service set out in the 19XX Staff Retrenchment Policy (as clarified), and

§ He is aware of head office employees whose employment was terminated by reason of genuine redundancy before 10 May 2006 receiving a length of service entitlement of four weeks pay per completed year of service, or part thereof

§ Your client's length of service entitlement which arose when his employment was terminated by reason of genuine redundancy in July 2011 was determined on the same basis as it would have been had his employment been terminated for the same reason before 10 May 2006 ie four weeks pay per completed year of service, or part thereof.

The entitlement for length of service arose under his 20XX Contract pursuant to the coverage under Human Resources Policies clause. This entitled him to four weeks pay per completed year of service, pro-rated for part years.

He was also paid an additional entitlement (13 weeks salary) in recognition of the sliding scale based on salary level which gave him a total entitlement of 26 weeks salary for his level as a redundant employee.

All amounts were paid concurrently in September 2011 as follows:

Payment 1

Length of service payment (Gross amount of $X) pursuant to the19XX Staff Retrenchment Policy. The amount was calculated with reference to his length of service and his weekly salary.

Payment 2

$Y in lieu of notice payment pursuant to the termination clause of the 20XX Contract (three months salary in lieu of notice). This payment was equal to 13 weeks salary.

Payment 3

$Z in lieu of notice payment which represents an additional 13 weeks of salary.

You confirmed that as the 20XX Contract was silent on payments for in lieu of notice in event of redundancy, the Company made two separate payments to him in relation to in lieu of notice entitlements in consequence of his termination of employment:

§ Payment 2 - $Y is an in lieu of notice payment of three months salary pursuant to his 20XX Contract (under the termination clause).

§ Payment 3 - $Z is an additional further payment of an in lieu of notice payment of 13 weeks salary pursuant to the sliding scale of 26 weeks. You explain that Payment 3 is an additional payment referable to the level of seniority as a redundant employee.

The Company's view is that the income tax treatment for Payment 3 is a life benefit termination payment but is not a transitional termination payment as the Company's practice for employees in your client's scenario was to make the payment in lieu of notice for 13 weeks salary pursuant to the termination clause in the relevant employment contract which in your client's case was the 20XX Contract.

Therefore, the Company's inclusion of the additional further payment of 13 weeks salary (Payment 3) was not pursuant to the termination clause in the 20XX Contract.

Relevant legislative provisions

Income tax Assessment Act 1997 Section 82-10

Income tax Assessment Act 1997 Section 82-125

Income tax Assessment Act 1997 Section 82-130

Income tax Assessment Act 1997 Subsection 82-130(1)

Income tax Assessment Act 1997 Subsection 82-130(2)

Income tax (Transitional Provisions) Act 1997 Section 82-10.

Income tax (Transitional Provisions) Act 1997 Subsection 82-10(1).

Income tax (Transitional Provisions) Act 1997 Paragraph 82-10(1)(a)

Income tax (Transitional Provisions) Act 1997 Paragraph 82-10(1)(b).

Income tax (Transitional Provisions) Act 1997 Subsection 82-10(3).

Income tax (Transitional Provisions) Act 1997 Section 82-10C

Income tax (Transitional Provisions) Act 1997 Subsection 82-10C(3).

Income tax (Transitional Provisions) Act 1997 Subsection 82-10C(3).

Income tax (Transitional Provisions) Act 1997 Subsection 82-10C(4).

Income tax (Transitional Provisions) Act 1997 Section 82-10D.

Income tax (Transitional Provisions) Act 1997 Subsection 82-10D(1).

Income tax (Transitional Provisions) Act 1997 Subsection 82-10D(2)

Reasons for decision

Reasons for decision

Question

Summary of decision

Payment 1 and Payment 2

The two payments are transitional termination payments received because of entitlements that were provided for under a contract, instrument or agreement as in force just before 10 May 2006.

Payment 3

The payment is a life benefit termination payment and not a transitional termination payment because the entitlement was not provided for under a contract, instrument or agreement as in force just before 10 May 2006.

Detailed reasoning

Employment termination payment

Section 82-125 of the Income Tax Assessment Act 1997 (ITAA 1997) defines an employment termination payment as a payment made in consequence of the termination of a person's employment that is received no later than 12 months after the termination.

Subsection 82-130(1) defines a payment is an employment termination payment if:

§ it is received by the person in consequence of the termination of their employment (subparagraph 82-130(1)(a)(i));and

§ it is received no later than 12 months after that termination (paragraph 82-130(1)(b)); and

§ it is not a payment mentioned in section 82-135 (this sections lists the specific payments that are not employment termination payments).

A life benefit termination payment is an employment termination payment to which subparagraph 82-130(1)(a)(i) applies.

Transitional termination payment

Life benefit termination payments may qualify as a transitional termination payment under section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A).

Subsection 82-10(1) of the IT(TP)A states that:

This Division applies in relation to a life benefit termination payment received by you on or after 1 July 2007 if:

(a) the payment is received by you because you are entitled to it under a written contract, a law of the Commonwealth, a State, a Territory or another country, an instrument under such a law, a collective agreement within the meaning of the Fair Work (Transitional Provisions and Consequential Amendments) Act 2009 or an AWA within the meaning of that Act; and

(b) the entitlement is provided for under that contract, law, instrument or agreement as in force just before 10 May 2006.

Furthermore, at subsection 82-10(3) of the IT(TP)A it states:

This Division applies in relation to a life benefit termination payment only to the extent that the contract, law or agreement as in force just before 10 May 2006 specifies the amount of the payment, or a way to work out a specific amount of the payment.

From the information provided, it is evident the two payments (Payment 1 and Payment 2) received by your client in September 2011 were in consequence of the termination of his employment and therefore each payment will meet the requirements in subparagraph 82-130(1)(a)(i)) as an employment termination payment.

Both Payment 1 and Payment 2 also meet the definition of a life benefit termination payment as they are employment termination payments to which subparagraph 82-130(1)(a)(i) applies.

Therefore to further consider if the life termination payments are transitional termination payments, it becomes necessary to consider whether the payment for length of service (Payment 1); and the payment for in lieu of notice under the termination clause of the 20XX Contract (Payment 2) both meet the requirement of being entitlements that are provided for under a written contract as in force just before 10 May 2006.

The explanatory memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 which introduced section 82-10 of the IT(TP)A states:

4.68 In order to ensure that the transitional provisions are not open to abuse, they are only available in situations where the payment was able to be determined as at 9 May 2006. This will encompass arrangements where the contract refers to the amount of the payment by way of a formula which can be objectively determined, or to payments made in kind (eg, shares). [Schedule 2, item 2, subsections 82-10(3) and (4)]

Contract in force before 10 May 2006

Paragraph 82-10(1)(b) of the IT(TP)A requires that the entitlement is provided for under that contract as in force just before 10 May 2006. Furthermore, subsection 82-10(3) provides that the division applies to a payment only to the extent that the contract as in force just before 10 May 2006 specifies the amount of the payment, or a way to work out a specific amount of the payment.

Payment 1

The 19XX Staff Retrenchment Policy in relation to redundancy benefits for length of service entitlement ('Four weeks pay per completed year of service') was clarified to be' Four weeks pay per completed year of service, pro-rated to part years and capped at a maximum of 30 years). This did not alter or affect the way your client's entitlements were calculated. As his service period was less than 30 years, therefore the cap of 30 years did not apply in any case.

Payment 2

You stated the in lieu of notice payment was determined pursuant to the 20XX Contract. (Termination clause - three months salary in lieu of notice).

From the information provided, your client's termination entitlements (Payment 1 and Payment 2) and the formulas to calculate the payments are stated in the 20XX Contract and the redundancy policy provisions under the 19XX Staff Retrenchment Policy.

The Company has also confirmed your client's length of service entitlement was determined on the same basis as it would have been had his employment been terminated for the same reason before 10 May 2006 ie four weeks pay per completed year of service, or part thereof.

Therefore, both Payment 1 and Payment 2 both satisfy the requirement in paragraph 82-10(1)(a) of the IT(TP)A that the payment is received by a taxpayer because they have an entitlement under a written contract to the payment as in force just before 10 May 2006 . The contract refers to the amount of the payment by way of a formula which can be objectively determined. That is, the requirement to specify the amount of the payment, or a way to work out a specific amount of the payment has been met. Consequently, they are transitional termination payments.

Payment 3

In your Private ruling application and in telephone discussion in November 2011, you stated Payment 3 was an additional in lieu of notice payment made to your client which was over and above his contractual entitlement which entitled him to a payment of 13 weeks salary.

It is accepted that on termination because of redundancy, the Company viewed your client was entitled to receive a payment of 26 weeks salary pursuant to the sliding scale based on his level. The additional 13 weeks salary (Payment 3) was to recognise he was entitled to the additional payment in event of redundancy referrable to the level of seniority of the redundant employee.

Therefore it is accepted that Payment 3 is an employer termination payment made in consequence of the termination of his employment and a life benefit termination payment but does not qualify for further concessional treatment as a transitional termination payment.

Tax treatment of transitional termination payments -recipient under preservation age

The tax free component of the transitional termination payment is not assessable income and not exempt income. The taxable component of the transitional termination payment is assessable income.

Subject to the Upper cap amount ($1 million), the total taxable components are subject to a tax offset that ensures the rate of income tax does not exceed 30%. The remainder of the taxable components are taxed at the top marginal rate of tax (section 82-10C IT(TP)A)).

If another life benefit termination payment is received in the same income year (or in an earlier income year) that is not a transitional termination payment, the entitlement to a tax offset under the section is not affected by an entitlement (if any) to a tax concession for the other payment under section 82-10 of the Income Tax Assessment Act 1997 (ITAA 1997).

Payment 3

The third payment is a life benefit termination payment and not a transitional termination payment. The tax free component is not assessable income and not exempt income.

The taxable component is assessable income and is subject to the ETP cap amount provisions in subsection 82-10(4) of the ITAA 1997. A tax offset may apply to ensure that the rate of income tax does not exceed 30%. The remainder of the taxable component is taxed at the top marginal rate of tax.(subsection 82-10(3) of the ITAA 1997).