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Ruling

Subject: Employment termination payment

Question:

Will the payment (the Bonus) made on termination of employment qualify as an employment termination payment?

Answer:

Yes, to the extent that the Bonus excludes the tax-free part of a genuine redundancy payment.

This ruling applies for the following period:

Year ending 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You commenced employment with your Employer (the Employer) in the 2007-08 income year.

During the 2011-12 income year the Employer informed you in a letter that:

(a) the Employer had entered into discussions for the potential sale of an asset with an interested entity (the Purchaser);

(b) redundancies could result as a consequence of the sale process;

(c) should a sale agreement be reached, the Purchaser could require the Employer to provide operational support in connection with the asset for a period of time after the sale; and

(d) in view of the uncertainty around the sale process, the Employer had decided to implement a Plan (the Plan) which included a Bonus (the Bonus).

In relation to the Bonus it was stated in the letter:

(a) if an agreement was signed for sale of the asset to the Purchaser and various conditions were satisfied you would be eligible to receive the Bonus;

(b) the Bonus, which is in addition to your normal salary, would be paid in accordance with set formula;

(c) the Bonus would be paid upon the date of your termination of employment (a date which was predetermined by the Employer); and

(d) if the agreement did not eventuate the Bonus would not be paid and you would remain an employee of the Employer; and

(e) if you terminated your employment prior to the termination date you would not receive the Bonus.

In the letter it was also stated that the Bonus is additional to any other amounts you would receive upon redundancy.

A copy of your enterprise bargaining agreement (EBA) has been provided. In relation to termination of employment it mainly relates to the periods of notice each party is required to give the other in cases of termination.

In the 2012-13 income year the Employer confirmed in a letter:

(a) your employment would be terminated on the termination date as a result of the sale;

(b) the Purchaser provided written confirmation that your position is no longer required and that your role will cease to exist; and

(c) the Employer has no other suitable roles for you and accordingly your employment with the Employer will terminate the termination date.

In the letter your entitlements were detailed and this included details of the severance payment you would receive and the Bonus amount. Further, the letter showed that the payments would be paid to you shortly after the termination date.

You state that there is no agreement between you and the Employer or the Employer and another employer to re-employ you;

You are less than 50 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 82-130(1)(a)

Income Tax Assessment Act 1997 Section 82-130(1)(b)

Income Tax Assessment Act 1997 Section 82-130(1)(c)

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Paragraph 82-135(e)

Income Tax Assessment Act 1997 Subsection 83-170

Income Tax Assessment Act 1997 Subsection 83-175(1)

Income Tax Assessment Act 1997 Subsection 83-175(2)

Income Tax Assessment Act 1997 Paragraph 83-175(2)(a)

Income Tax Assessment Act 1997 Paragraph 83-175(2)(b)

Income Tax Assessment Act 1997 Paragraph 83-175(2)(c)

Income Tax Assessment Act 1997 Subsection 83-175(3).

Income Tax Assessment Act 1997 Subsection 83-175(4)

Reasons for decision

Summary

The severance and bonus payments to be made on the termination of your employment are considered to be genuine redundancy payments.

The portion of the combined payments in excess of the tax-free amount is the taxable component of an employment termination payment and is to be included in your assessable income for the 2012-13 income year.

Detailed reasoning

Employment termination payment

A payment made to an employee is an employment termination payment if the payment satisfies all the requirements in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997) and is not specifically excluded under section 82-135.

Subsection 82-130(1) of the ITAA 1997 states:

A payment is an employment termination payment if:

(a) it is received by you:

(i) in consequence of the termination of your employment; or

(ii) after another person's death, in consequence of the termination of the other person's 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.

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

· payment for unused annual leave or unused long service leave;

· the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

· reasonable capital payments for personal injury.

In consequence of the termination of your employment

The phrase in consequence of is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Whilst the courts have divergent views on the meaning of this phrase, the Commissioner's view on the meaning and application of the in consequence of test are set out in Taxation Ruling TR 2003/13 Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase in consequence of.

While TR 2003/13 considered the meaning of the phrase 'in consequence of' in the context of the eligible termination payments, TR 2003/13 can still be relied upon as both the former provision under the Income Tax Assessment Act 1936 and the current provision under the ITAA 1997 both use the term 'in consequence of' in the same manner. It should be noted that the eligible termination payments ceased to exist from 1 July 2007 and were replaced by employment termination payments.

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.

In paragraph 6 of TR 2003/13, the Commissioner recognises that:

The phrase requires 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.

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.

Therefore, if the payment follows as an effect or a result from the termination of employment, the payment will be made in consequence of the termination of employment.

There is also a broader view of the meaning of in consequence of the termination of employment. Paragraph 29 of TR 2003/13 provides that a payment will be in consequence of the termination of employment if the termination is either a cause of the payment or an antecedent event.

Furthermore, in Case No M 101/1976 (1977) 77 ATC 475; (1977) 22 CTBR (NS) 41 the No. 2 Board of Review considered whether a production completion bonus was made in consequence of termination of employment. The facts of the case were that on the day he was retrenched, the taxpayer received a production completion bonus of $2,750 from his employer. In a letter to the Deputy Commissioner, the taxpayer's former employer explained that the bonus payment was designed as an incentive to keep the employee on a particular project until he was no longer needed. Payment of the bonus was conditional on the employee remaining on the job until retrenched. The taxpayer gave evidence that had he resigned at any time before the retrenchment date he would have received no part of the bonus.

The No. 2 Board of Review held that the payment constituted an allowance or compensation paid in a lump sum in consequence of the termination of the taxpayer's employment within the meaning of former paragraph 26(d) of the ITAA 1936 (the precursor to the ETP provisions). The decision of majority of the Full High Court in Reseck applied.

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.

The circumstances of the present case are almost identical to those circumstances in Case No M 101/1976 (1977) 77 ATC 475; (1977) 22 CTBR (NS) 41 considered by the No 2 Board of Review.

In your case, the Employer, as part of a sales process, implemented a Plan (the Plan) to retain its employees during the sale and for a period after the sale process was completed.

The Employer stated that as part of the Plan a bonus (the Bonus) would be paid to employees who agreed to continue with their employment until a date determined by the Employer (the 'termination date') or earlier upon their role with the Employer becoming redundant.

Further the Employer stated that if:

(i) an agreement was not signed for the sale; or

(ii) conditions precedent to the sale were not satisfied; or

(iii) the asset was not transferred prior to a specific date;

the Bonus would not be paid and the employee contract would continue on its existing terms in support of the Employer's continued ownership of the vessel.

In your case, you accepted the Employer's offer to participate in the Plan and, in a redundancy letter (the letter) the Employer informed you that your employment will be terminated on the termination date.

The letter also states in addition to your salary and other outstanding entitlements the severance and Bonus payments you will receive.

It is clear from the facts that the Bonus, and the severance pay, will be made to you shortly after the termination of your employment with the Employer and as result of the termination of employment.

In view of the facts provided it is considered that the payments, the severance pay and Bonus, will be made 'in consequence of' your termination of employment' as there is a direct causal connection between the termination of employment and the making of the payments.

The termination of employment and the payments are all intertwined and connected. If not for the termination of employment on the termination date the payments would not be made. Further, as shown in the case of the Bonus, the Employer advocated the implementation of the Plan as a result of the sale process and the prospect that redundancies may be unavoidable.

It is considered that there is sufficient nexus between the making of the payments and the termination of employment to say that the payments will be made in consequence of your termination of employment.

In view of the above, subparagraph 82-130(1)(a)(i) of the ITAA 1997 will be satisfied.

Payment received no later than 12 months after termination

In addition to meeting the other conditions for a payment to be an employment termination payment, paragraph 82-130(1)(b) of the ITAA 1997 specifies 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'.

As shown in the facts, the Employer has stated that your employment will be terminated on the termination date and the payment will be made shortly after..

Accordingly, as the payment will be made within 12 months of the termination of your employment, the requirement in paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied.

A payment mentioned in section 82-135 of the ITAA 1997

As previously mentioned, section 82-135 of the ITAA 1997 excludes certain payments from being employment termination payments, These payments include:

· a payment for unused annual leave

· a payment for unused long service leave

· capital payments for personal injury

· the tax-free amount of a genuine redundancy payment.

In your case, the facts provided show that the issue of whether any part of the Bonus, and also the severance payment, is a genuine redundancy payment requires consideration.

Genuine redundancy payment

To determine if any part of the severance and Bonus payments (the Payment) you will receive from the Employer constitutes a genuine redundancy payment (GRP), all the conditions in section 83-175 of the ITAA 1997 will need to be satisfied.

Where a payment is made to an employee after 30 June 2007, a GRP is defined in subsection 83-175(1) of the ITAA 1997 as:

· so much of a payment received by an employee who is dismissed from employment because the employee's position is genuinely redundant as exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of the dismissal.

Subsection 83-175(2) of the ITAA 1997 states that for a payment to qualify as a GRP all of the following conditions must be met:

(a) the employee is dismissed before the earlier of the following:

(i) the day he or she turned 65;

(ii) if the employee's employment would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be);

(b) if the dismissal was not at arm's length - the payment does not exceed the amount that could reasonably be expected to be made if the dismissal were at arm's length;

(c) at the time of the dismissal, there was no arrangement between the employee and the employer, or between the employer and another person, to employ the employee after the dismissal.

In addition, subsection 83-175(3) of the ITAA 1997 provides that a GRP does not include any part of a payment that was received by the employee in lieu of superannuation benefits to which the employee may have become entitled at the time of the payment or at a later time. In addition, subsection 83-175(4) provides that a payment is not a GRP if it is a payment mentioned in section 82-135.

The Commissioner has issued Taxation Ruling TR 2009/2 which outlines the Commissioner's view of the requirements to be satisfied for a payment to qualify as a genuine redundancy payment under section 83-175 of the ITAA 1997.

It is proposed to examine each of these provisions.

The requirement under subsection 83-175(1) of the ITAA 1997

The first requirement which is specified in subsection 83-175(1) of the ITAA 1997 has four criteria:

· the payment is in consequence of the employee's termination of employment;

· the payment is received by an employee who is dismissed from employment;

· the employee is dismissed because the employee's position is genuinely redundant; and

· the payment exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of the dismissal.

Payment in consequence of termination

The issue of whether the Payment you will receive in the 2012-13 income year is in consequence of the termination of your employment was discussed above. It was determined that the Payment will be made in consequence of your termination of employment. Therefore the criterion that the payment must be received in consequence of a termination is met.

Dismissal from employment

Dismissal from employment usually means that the termination of employment is involuntary on the part of the employee concerned and is instigated by the employer.

From the facts provided, it is evident that your termination of employment will be the result of a dismissal which was instigated by the Employer. Further, the dismissal is not the result of any misbehaviour on your part but arises from a negotiations entered into by the Employer to divest itself of an asset, that is, a vessel.

Therefore, the termination of your employment is clearly a dismissal for the purposes of subsection 83-175(1) of the ITAA 1997.

Genuine redundancy

Having established that the Payment will be in consequence of termination of employment, and there will be a dismissal from employment for the purposes of subsection 83-175(1) of the ITAA 1997, the next criterion that needs to be considered is whether you were dismissed because your position is genuinely redundant.

Redundancy is a situation where the dismissal of an employee is not caused by any consideration peculiar to the employee. Redundancy does not extend to a situation where an employee is dismissed for personal or disciplinary reasons or because the employee was inefficient, but rather because an employer no longer requires employees to carry out work of a particular kind or to carry out work of a particular kind at the same location.

At paragraph 27 of TR2009/2 the following comment is made:

… if an employer decides after downsizing or some other structural reorganisation to terminate an employee, the former position of the employee is redundant as long as the downsizing or reorganisation is the prevailing or most influential cause of the termination.

In your case the facts show that your dismissal will not be for any reasons such as inefficiency or misbehaviour but due to the Employer reorganising its operations which involves the sale of a an asset. As a result of the sale the Employer no longer requires that your role which was attached to the asset.

Further, as evidenced in the redundancy letter, the Employer stated that your role would cease to exist and hence you would be made redundant. Further, the Employer also stated that there were no other suitable roles for you with the Employer.

In view of the above it is evident that your employment will be due to a genuine redundancy and the Payment is made as a result of the genuine redundancy.

Accordingly, it is considered that this third criterion under subsection 83-175(1) of the ITAA 1997 will be satisfied.

The payment exceeds what you would have received in consequence of the voluntary termination of your employment at the time of your dismissal.

The last criterion that needs to be considered is whether the payment exceeds the amount that you could reasonably be expected to receive in consequence of the voluntary termination of your employment will be treated as a GRP.

It your case it is considered that both the severance payment and Bonus are in excess of what you would have received had you voluntarily terminated employment as:

(i) the enterprise bargaining agreement under which you are employed does not make any reference to amounts or calculation of amounts you would be entitled upon voluntary termination of employment; and

(ii) the Employer's letter mad in the 2011-12 income year specifically states that the Bonus is a payment you will receive in addition to any other payments.:

In view of the above, it is considered that the Payment (the severance payment and Bonus) are in excess of what you would receive had you voluntarily terminated employment.

Conclusion in relation to subsection 83-175(1) of the ITAA 1997

It is considered that all the criteria stipulated in subsection 83-175(1) of the ITAA 1997 will be satisfied.

Consequently it is considered that the total payment (representing the severance and Bonus payments) constitutes a GRP within the meaning of subsection 83-175(1) of the ITAA 1997. However, a GRP must also satisfy the conditions in subsections 83-175(2) to 83-175(4).

The requirements under paragraphs 83-175(2)(a) and (b) of the ITAA 1997

As already noted previously, paragraph 83-175(2)(a) of the ITAA 1997 prescribes that the employee must be dismissed before the earlier of:

· the day he or she turned 65; or

· if the employee's employment would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as applicable).

It is accepted that there was no date prior to your 65^th birthday on which you were required to terminate employment, and that you were not required to terminate employment before you were dismissed on the effective date. Also given that you were under 65 years of age at the time of your dismissal, you have satisfied the requirements of paragraph 83-175(2)(a) of the ITAA 1997.

Additionally, it is accepted that all dealings between yourself and the employer were at arm's length. Therefore it follows that you have also satisfied the requirement under paragraph 83-175(2)(b) of the ITAA 1997.

The requirement under paragraph 83-175(2)(c) of the ITAA 1997

Also as noted previously, paragraph 83-175(2)(c) of the ITAA 1997 requires that at the time of the dismissal, there was no arrangement between the employee and the employer, or between the employer and another person, to employ the employee after the dismissal.

In the present case, there will be no re-employment by your Employer nor is there evidence of any re-employment arrangement with another entity, so it is accepted that you have satisfied the requirement under paragraph 83-175(2)(c) of the ITAA 1997 in this case.

The requirements under subsections 83-175(3) and 83-175(4) of the ITAA 1997

Subsection 83-175(3) of the ITAA 1997 provides that a GRP does not include any part of a payment that is received in lieu of superannuation benefits. No part of the payment to be made to you is in lieu of superannuation benefits. Therefore it is accepted that the requirement under subsection 83-175(3) is satisfied.

Also as noted previously, subsection 83-175(4) of the ITAA 1997 provides that a payment is not a GRP if it is a payment mentioned in section 82-135 (other than a GRP or early retirement scheme payment).

Section 82-135 of the ITAA 1997 includes payments such as pensions, foreign termination payments, unused annual leave and unused long service leave.

An examination of the payment to be made to you shows that the requirement in subsection 83-175(4) of the ITAA 1997 has been satisfied.

A GRP under sections 83-170 and 83-175 of the ITAA 1997

You have satisfied all the criteria set out in section 83-175 of the ITAA 1997 and consequently it is considered that the total amount constitutes a GRP for the purposes of section 83-170.

Tax-free treatment of a GRP

Subsection 83-170(2) of the ITAA 1997 provides that so much of the GRP that does not exceed the amount worked out using the formula prescribed in subsection 83-170(3) is not assessable income and is not exempt income. Any amount in excess of the tax-free amount is taxed as an employment termination payment. The formula for working out the tax-free amount is:

Base amount + (Service amount × Years of service)

A calculation has made in relation to the above formula and the relevant amounts in your case and shows the total GRP (representing the severance and Bonus payments) exceeds the tax-free amount.

Conclusion

The tax-free amount of the GRP is not assessable income and is not exempt income under subsection 83-170(2) of the ITAA 1997.

In relation to the balance of the GRP it represents an ETP which is to be included as assessable income in your tax return for the 2012-13 income year.