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Ruling

Subject:

Employment termination payment - transitional termination payment

Question 1:

Is any part of the payment considered to be a transitional termination payment as defined in section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A)?

Answer:

Yes.

Question 2:

Is the payment made directly to a complying superannuation fund a directed termination payment under section 82-10F of the IT(TP)A?

Answer:

Yes.

Question 3:

Can a further amount be paid into the complying superannuation fund as a directed termination payment?

Answer:

No.

This ruling applies for the following periods

Year ending 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

Over 35 years ago, your client commenced employment with an employer (the employer).

Effective from the third quarter of the 2005-06 income year, your client was appointed to a position in an Employment Deed (2005 Deed).

The 2005 Deed was for a fixed period of a specified number of months, with your client's employment to be terminated in the first quarter of the 2008-09 income year.

On termination of employment due to retirement your client was entitled to a specified payment. At a specific clause of the 2005 Deed it refers to the specified payment.

In another clause of the 2005 Deed it provides a method of calculating the specified payment and states that the employer will pay (unless this agreement is terminated beforehand) the employee an amount equal to a specified percentage of the total fixed remuneration where the employee's employment with the employer ceases at the end of the maximum term of this agreement.

Your client's total fixed remuneration as at the commencement date of the 2005 Deed has been provided.

In the fourth quarter of the 2006-07 income year, a deed variation (2007 Deed) was entered into to extend the terms of the 2005 Deed by a specified number of months and for your client's employment to cease in the first quarter of the 2009-10 income year.

The method for calculating the amount of the specified payment did not change. A specific clause of the 2007 Deed was deleted and replaced however it stated that the employer will pay (unless this agreement is terminated beforehand) the employee an amount equal to a specified percentage of the total fixed remuneration where the employee's employment with the employer ceases at the end of the maximum term of this agreement.

In the third quarter of the 2008-09 income year, a further deed variation (2009 Deed) was entered into to extend the terms of the 2007 Deed by a specified number of months and for your client's employment to cease in the fourth quarter of the 2010-11 income year.

The method for calculating the amount of the specified payment did not change. A specific clause of the 2009 Deed was deleted and replaced however it stated that the employer will pay the employee an amount equal to a specified percentage of the total fixed remuneration when the employee's employment with the employer ceases in the fourth quarter of the 2010-11 income year or such earlier date of termination of employment.

In the fourth quarter of the 2010-11 income year, your client retired and ceased employment at the conclusion of 2009 Deed.

Although the 2005 Deed was subsequently modified in some minor respects to extend the terminating date, the method for calculating the amount of the specified payment under the terms of the 2005 Deed that came into effect in the third quarter of the 2005-06 income year, have not been subsequently amended in any way under the 2007 Deed or 2009 Deed.

In the fourth quarter of the 2010-11 income year, the employer was advised to direct part of the taxable component of the specified payment to a complying superannuation fund (the Fund). A pre-payment statement was requested to be issued to your client to advise the amounts of the taxable and non-taxable components. In addition the employer was requested to make the total tax free component and the remaining taxable component to your client's bank account, with all payments being made by close of business in the fourth quarter of the 2010-11 income year.

At the conclusion of the 2009 Deed, your client was entitled to receive a specified payment on termination of employment.

The employer did not issue a pre-payment statement to your client.

The employer made a PAYG payment summary - employment termination payment for the year ending 30 June 2011 to your client which shows a taxable component and a tax free component of with an amount of tax withheld.

In the fourth quarter of the 2010-11 income year, the employer made a payment to the Fund.

Your client is under the age of 65 years.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 295-190(1).

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 Subsection 82-10(3).

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

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

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

Summary

The taxable component of the payment made under the Deed to your client in the 2010-11 income year is a transitional employment termination payment.

The payment made by the employer on your client's behalf to a complying superannuation fund will be treated as a directed termination payment.

The remaining amount was made to your client's bank account therefore cannot be directed to a complying superannuation fund and is included as assessable income in your client's income tax return for the 2010-11 income year.

Detailed reasoning

Payments made in consequence of the termination of a taxpayer's employment are known as employment termination payments.

Employment termination payments cannot be rolled over into a complying superannuation fund, unless the payment qualifies as a transitional termination payment under section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A).

Transitional termination payment

Under subsection 82-10(1) of the IT(TP)A, a life benefit termination payment received between 1 July 2007 and 30 June 2012 is a transitional termination payment in the following circumstances:

(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.

The terms contract, law and agreement all connote circumstances that are binding on the employer. The circumstances as they exist just before 10 May 2006, must be such that the employer is obliged by force of a contract, law or agreement to pay a specific amount or to pay an amount according to the specifications of a method or a formula. As explained at paragraph 4.67 of the Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006, a person must be entitled as at 9 May 2006, to a payment on termination of employment.

The Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Act 2007 which introduced section 82-10 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)]

The first issue for consideration is whether the payment to be made to an employee satisfies the requirement of being an entitlement under a written contract.

Essentially, in order for the entitlement to be provided for under a particular employment agreement as in force just before 10 May 2006 an employee must have been entitled to receive a payment under the agreement just before 10 May 2006. Further, the agreement must still be in place when the payment is made, and the employee must still be entitled to that payment at the time of their termination.

This means that if, for instance, the employee is employed under a different agreement at the time of termination, or if the provision relating to the payment has been amended between 9 May 2006 and the time of termination, the payment will not meet this requirement of a transitional termination payment.

However, subsection 82-10(3) of the IT(TP)A states that the payment will be a transitional termination payment to the extent the contract, law, instrument or agreement specifies an amount of the payment, or a method or formula by which a specific amount of the payment can be determined.

In this case, your client was employed under an employment deed (2005 Deed) which was entered into prior to 10 May 2006.

Under the terms of the 2005 Deed your client was entitled to receive a specified payment on the termination of employment. At a specific clause of the Deed it provides a method of calculating the specified payment to be made to your client at the end of the maximum term of the agreement or beforehand if the agreement is terminated.

The 2005 Deed was applicable from the third quarter of the 2005-06 income year. Therefore, your client's specified payment entitlement which was provided for under the 2005 Deed was in place before 10 May 2006.

It is noted that the 2005 Deed was subsequently modified in some minor respects and the terminating date extended under the 2007 and 2009 Deeds. However, the method for calculating the amount of the specified payment under the terms of the 2005 Deed that came into effect in the third quarter of the 2005-06 income year has not been subsequently amended in any way under the 2007 Deed or 2009 Deed.

Although your client's termination payment was calculated in accordance with the 2009 Deed, this deed calculated the payment using the same methodology as the 2005 Deed which was in place prior to 10 May 2006.

The specified payment made in the 2010-11 income year for your client is calculated under the same condition and method of calculating the employee's entitlement on retirement as terms under the 2005 Deed which was in place just before 10 May 2006. As such, your client's employment contract allows for the payment to be determined by the pre May 2006 contract.

Hence, as the payment is being made under a deed as in force just before 10 May 2006, the payment is considered to be a transitional termination payment.

Consequently, all the requirements under section 82-10 of the IT(TP)A have been satisfied. The amount in excess of the tax free amount to be made to your client under the terms of the 2009 Deed will be a transitional employment termination payment in 2010-11 income year as defined in section 82-10.

Transitional employment termination payments may be:

· rolled-over (in full or in part) to a superannuation fund, ADF or RSA; or

· used (in full or in part) to buy a superannuation income stream before 1 July 2012.

Directed termination payments

Section 82-10F of the IT(TP)A states:

A transitional termination payment (or part of such a payment) is a directed termination payment if:

· the individual chooses, in accordance with this section, to direct the payment (or part of the payment) to be made; and

· the payment (or part of the payment) is made on the individual's behalf as directed.

Choice to make payment

An individual may choose, within 30 days after a pre-payment statement about a transitional termination payment is given to the individual under section 82-10E, to direct the payer to use all or part of the payment to make a payment on behalf of the individual:

(a) to a complying plan; or

(b) to purchase a superannuation annuity.

To make a choice, the individual must:

(a) make it in an approved form; and

(b) give the completed form to the payer.

The payer must, immediately after receiving a completed form under subsection (3):

(a) give the entity (or entities) to which the payment is directed written notice of the amount that is to be paid, and of the tax free component of the amount; and

(b) comply with the direction (or directions) in the form.

Personal contributions and roll-over amounts included in assessable income of an entity are set out in the table under subsection 295-190(1) of the Income Tax Assessment Act 1997. Item 3 of the table shows the taxable component of a directed termination payment (within the meaning of section 82-10F of the IT(TP)A) is assessable income of a complying superannuation fund, a complying approved deposit fund and a retirement savings account provider.

Therefore, in this case the directed termination payment of the taxable component is to be included in the income year in which it is received by the superannuation provider as assessable income of the fund in the 2010-11 income year.

Consequently, the fund, rather than your client, will pay the relevant tax at the fund's tax rate (generally 15%) arising on the payment, rather than at your client's marginal tax rate.

When lodging your client's income tax return for the 2010-11 income year, you will need to refer to this ruling.

As the remaining taxable component of the payment was made to your client's bank account in the 2010-11 income year no further amounts can be directed to a complying superannuation fund. This amount is to be included as assessable income in your client's income tax return for the 2010-11 income year.