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Ruling

Subject : Transitional termination payment

Question

Is any part of a life benefit termination payment to be made to an employee whose employment was terminated due to redundancy a transitional termination payment pursuant to section 82-10 of the Income Tax (Transitional) Provisions Act 1997?

Answer

Yes, the part that represents a payment by the employer in lieu of notice

This ruling applies for the following period

Year ended 30 June 2012

The scheme commences on

Not applicable

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Some time before 2000 an employee (the Employee) commenced employment with a company (Company A).

According to an executive employment agreement (the 1^st EEA) signed for and on behalf of another company (Company B) within the same group as Company A and by the Employee:

o Company B was the 'Company' that employed the Employee; and

o the 1st EEA took effect from a specified date in 2002 and replaced all previous contracts, agreements and representation in relation to the Employee's employment.

The Commissioner has been advised that, in spite of Company B being the employing entity, the Employee was in fact working for Company A. The 1^st EEA provides that:

Mutual termination

Either party may terminate this agreement by giving to the other party written notice of the period set out in … the Schedule. In the case of termination by the Company, the Company may elect to pay the remuneration for that period in lieu of notice…

The required period of notice to be given by either party stated in the Schedule was a specified number of months.

The 1^st EEA also provides that:

Entitlements upon termination

On termination of this agreement, whether pursuant to clause … or otherwise, in addition to any amount due to the Executive [the Employee] under this agreement, the Company shall pay to the Executive:

(c) pay in lieu of any notice to which the Executive is entitled under this agreement;

Amendment

This agreement may only be varied or replaced by a document duly executed by the parties.

According to another executive employment agreement (the 2^nd EEA) signed for and on behalf of Company A and by the Employee:

(i) Company A was the 'Company' that employed the Employee; and

(ii) the 2^nd EEA took effect from a specified date in 2004 and replaced all previous contracts, agreements and representation in relation to the Employee's employment.

As the 1^st EEA, the 2^nd EEA also provides that:

Mutual termination

Either party may terminate this agreement by giving written notice to the other as set out in … the Schedule. In the case of termination by the Company, the Company may elect to pay the remuneration for that period in lieu of notice…

Entitlements upon termination

On termination of this agreement, whether pursuant to clause … or otherwise, in addition to any amount due to the Executive under this agreement, the Company shall pay to the Executive:

(b) pay in lieu of any notice to which the Executive is entitled under this agreement;

Amendment

This agreement may only be varied or replaced by a document duly executed by the parties.

In addition, the 2^nd EEA also provides that:

Redundancy

In calculating the remuneration payable to the Executive on a redundancy, the greater of the applicable statutory redundancy or monies payable upon termination in lieu of notice, will be used.

The required period of notice to be given by either party was stated in the Schedule as a specified number of months by the Employee and another specified number of months by the Company, with effect from a specified date in 2005.

Some time after May 2006 Company A advised the Employee by letter that from then on all employees of Company A would become employees of another company (the Employer) within the same group as Company A but would continue to work for Company A's business. The letter states that it was an administrative change for the purpose of aligning human-resources policies and processes within the group. The letter further states that the Employee's date of commencement for calculating annual leave, sick leave and long service leave will be the dates the Employee joined Company A and that all other terms and conditions will remain the same.

The Employee signed at the bottom of the letter to signify acceptance of the change.

The Employer has confirmed that:

(a) the changes made in 2005 were in respect of the Employee's salary, bonus potential and notice periods; and

(b) since then there has been no other changes to those terms and conditions of employment that relate to the Employee's termination entitlement and period in lieu of notice.

Some time in 2011 the Employee's employment was terminated by the Employer due to redundancy. The Employer will give the Employee a life benefit termination payment that consists of an ex gratia payment of a specified amount and an amount equivalent to a specified number of months of the Employee's salary in lieu of notice.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-130(1).

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

Income Tax Assessment Act 1997 Section 82-135

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

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

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

Income Tax (Transitional Provisions) Act 1997 Subsection 82-10(4)

Income Tax (Transitional Provisions) Act 1997 Subsection 82-10(6)

Summary

The ex-gratia payment is a life benefit termination payment that does not meet the requirements of a transitional termination payment (TTP). The amount in lieu of notice is a life benefit termination payment that qualifies as a TTP.

Reasons for decision

Employment termination payment

From 1 July 2007 the taxation treatment of payments made in consequence of the termination of any employment of a taxpayer changed. These payments, formerly known as eligible termination payments, are now called employment termination payments.

Section 995-1 of the Income Tax Assessment Act 1997 (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:

in consequence of the termination of your employment; or

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.

Life benefit termination payment

Where an employer termination payment is made during the life of a taxpayer, the employment termination payment is known as a life benefit termination payment under subsection 82-130(2) of the ITAA 1997.

Payment in consequence of the termination of employment

The phrase 'in consequence of' is not defined in the ITAA 1997. However, 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.

The Commissioner has issued Taxation Ruling TR 2003/13 (TR 2003/13) which discusses the meaning of the phrase, taking into account the views of the courts.

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.

Therefore, if a payment follows as an effect of, or results from, the termination of employment, the payment will be considered as made in consequence of the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997.

It should also be noted that a payment received in consequence of the termination of employment does not arise from the performance of services under a contract of employment. Rather, the payment arises from the termination of those services.

Payment to be made to the Employee

In relation to the termination of the Employee's employment due to redundancy, the Employer will make a payment (the Payment) to the Employee that will consist of an ex-gratia payment and an amount in lieu of notice based on the Employee's current salary.

Payment is made in consequence of the termination of employment

As is required by sub-paragraph 82-130(1)(a)(i) of the ITAA 1997, for a payment to be an employment termination payment there must be a payment that is made in consequence of the termination of employment of the taxpayer.

The termination of employment and the Payment to be made are all intertwined and connected. If not for the termination of employment, the Employer would not have made the Payment to the Employee. The Commissioner, therefore, accepts that the Payment to be made to the Employee is in consequence of the termination of his employment.

Payment is received no later than 12 months after termination

The second condition for a payment to be an employment termination payment, as is stipulated in paragraph 82-130(1)(b) of the ITAA 1997, is that 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 rule.

The Employee's employment was terminated in 2011. Provided that the Payment is made within 12 months from the date of termination of the employment, the requirement of paragraph 82-130(1)(b) of the ITAA 1997 will be met.

Not a payment mentioned in section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 lists payments that are not employment termination payments. These include (among others):

o superannuation benefits; and

o unused annual leave or long service leave payments.

As the Payment does not fall within the exceptions listed in section 82-135 of the ITAA 1997, the requirement under paragraph 82-130(c) of the ITAA 1997 has therefore been met.

As all the requirements under subsection 82-130(1) of the ITAA 1997 are met, the Payment to be made to the Employee by the Employer on termination of the Employee's employment will be an employment termination payment.

Transitional termination payment

Division 82 of the Income Tax (Transitional Provisions) Act 1997 (the ITTPA) provides for transitional arrangements to apply to a life benefit termination payment payable to a person if the person was, on 9 May 2006, entitled contractually to a payment on termination of employment. Subsection 82-10(1) of the ITTPA 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 or a workplace 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.

Subsections  82-10(3), (4) and (6) of the ITTPA state that:

(3) 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.

(4) For the purpose of subsection (3), a specific amount can be worked out in ways including either or both of the following:

(a) by a method or formula for working out the amount;

(b) by provision for you or another person (or entity) to make a choice between forms of payment allowing amounts to be worked out as provided by subsection (3) and paragraph (a) of this subsection.

Example:

For paragraph (b), a specific amount of a life benefit termination payment that you receive on 1 July 2007 can be worked out from the terms of your written contract if the contract provided (just before 10 May 2006) for you to choose between payment in the form of a cash amount of $100,000 or the transfer to you of 10,000 shares in a specified company.

(6) In this Division:

transitional termination payment means:

a life benefit termination payment to which this Division applies; or

if this Division applies to only part of a life benefit termination payment - that part of the payment.

The Employer has provided the Commissioner with two executive employment agreements. The 1^st EEA was made in 2002. The 2^nd EEA was effective from a specified date in 2004.

There is a slight difference between the provision on mutual termination contained in the 1^st EEA and that contained in the 2^nd EEA. The respective provisions read as follows:

Under the 1^st EEA

Mutual termination

Either party may terminate this agreement by giving to the other written notice of the period set out in … the Schedule. In the case of termination by the Company, the Company may elect to pay the remuneration for that period in lieu of notice …

Under the 2^nd EEA

Mutual termination

Either party may terminate this agreement by giving written notice to the other as set out in … the Schedule. In the case of termination by the Company, the Company may elect to pay the remuneration for that period in lieu of notice. In the case of termination by the Executive, if the Executive does not give the appropriate notice, the Executive shall not be entitled to any additional payment for notice.

The Commissioner has also noted the following clause in the 2^nd EEA, which the 1^st EEA does not have:

Redundancy

In calculating the remuneration payable to the Executive on a redundancy, the greater of the applicable statutory redundancy or monies payable upon termination in lieu of notice, will be used.

The Schedule to the 1^st EEA provides for a specified number of months as the required period of notice to be given by either party in the event of termination of employment. The Schedule to the 2^nd EEA provides for a specified number of months that applies to the Employee, and another specified number of months that applies to the Company, as the required period of notice to be given by one party to the other party, in the event of termination of employment.

Apart from the Employer replacing Company A as the employing entity of the Employee some time after May 2006, there has not been any change to those terms and conditions of employment that relate to the Employee's termination entitlement and period in lieu of notice since the specified date in 2005.

Evident from the history of the changes in the relevant provisions over time is that:

o the relevant provisions had already been in place long before 10 May 2006; and

o the 2^nd EEA is the contract 'as in force just before 10 May 2006', under which the Employee's entitlement to a life benefit termination payment is provided for and which also 'specifies the amount of the payment, or a way to work out a specific amount of the payment'.

In other words, paragraph 82-10(1)(a) and subsection 82-10(3) of the ITTPA are satisfied.

According to the Employer, the circumstances which prompted the change of the employing entity:

o were in respect of an internal restructuring involving all employees employed by companies within the group to be transferred to the same employing entity to create operational efficiencies within the group; and

o did not otherwise affect the terms and conditions of employment of the Employee, who at all material times had worked for the business conducted by Company A.

The Perfrement Case

In Perfrement v. Federal Commissioner of Taxation [2011] AATA 264; (2011) 2011 ATC 10-179 (the Perfrement case), the applicant commenced employment with Mobil Oil Australia Ltd (Mobil) in November 1992. Mobil had, at that time, a redundancy policy in place. Mobil subsequently amended that policy in May 1995, July 2005 and July 2008. The effect of the last amendment was to advise Mobil's employees that their redundancy entitlement at law no longer included the option to roll over a redundancy payment into a superannuation fund.

After the applicant's employment was terminated by redundancy on 30 September 2008, Mobil made a redundancy payment to the applicant in cash despite the applicant's request to have that payment rolled over into a superannuation fund as the applicant believed that the payment qualified as a transitional termination payment (TTP).

The applicant contended that he and Mobil had not entered into a new contractual arrangement in relation to redundancy after 10 May 2006. The applicant further contended that although Mobil changed its redundancy policy from time to time, that fact alone did not change the fact that the redundancy payment was determined by reference to a formula in place prior to 10 May 2006.

The Administrative Appeals Tribunal (AAT) that heard the case held that the redundancy payment made by Mobil to the applicant was a TTP. In its decision the AAT stated that:

34 The Tribunal is of the opinion that the policy published by the employer in July 2008 was neither a new contract nor a variation of the existing contract. The redundancy policy published in July 2008 was essentially a memorandum of advice to employees as to the effect of newly introduced tax laws. It was, in essence, self-evident advice contained within a company policy document. There was, as submitted by the Respondent, no change to the method of compensation in the event of redundancy, but rather a change in the application of tax laws to those benefits.

35. The Tribunal may have reached a different conclusion had the July 2008 redundancy policy effected an alteration to the employer's method of calculating an employee's entitlement; or if it had in some way altered the essential character of the existing policy. However, this was not the effect of the July 2008 policy. It was more in the form of advice regarding changes to the law that the employer was passing on to employees.

Payment in lieu of notice is a transitional termination payment

Having considered the information provided and the Perfrement case, the Commissioner is of the view that the amount in lieu of notice, which is equivalent to a specified number of months of the Employee's salary, qualifies as a TTP under section 82-10 of the ITTPA.

Ex-gratia payment not a transitional termination payment

However, as the 2^nd EEA has only provided for payment of a specified number of months of the Employee's salary in lieu of notice where the Employee's employment is terminated by the Employer, the ex-gratia payment that will be made to the Employee as part of the Payment is not a TTP.

As the ex-gratia payment nevertheless satisfies the requirements under subsection 82 -130 (1) of the ITAA 1997, it is an employment termination payment within the meaning of that subsection.