Edited version of your private ruling

Authorisation Number: 1012445250040

Ruling

Subject: Employment termination payments - tax free component

Question

Has the tax free component in respect of a payment of unused sick leave paid on the termination of employment been calculated correctly?.

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

During the income year ended 30 June 2012

Relevant facts and circumstances

In the early 1970s you commenced employment with your former employer (the Employer).

At the time you commenced employment with the Employer, a Workplace Agreement (the Agreement) provided for a payment of accrued sick leave on termination of employment.

In the early 1990s the State Award replaced the Agreement with the effect that accrued sick leave was no longer payable on termination of employment.

The number of sick days you held immediately before dd/mm/199X was 999 days.

Your sick leave balance never dropped below 999 days.

In the recent year you retired from your employment with the Employer.

Subsequently, the Employer paid you an amount in respect of the accrued sick leave. The amount comprised of a tax free component and a taxable component.

The payment for unused sick leave was made in accordance with the State Award (the Relevant Award) and calculated using your salary as at the time of termination.

A Clause of the Relevant Award provides that:

(a) Sick leave shall accumulate from year to year so that any balance of leave not taken in one year may be taken in subsequent year or years.

(b) Where an employee had an entitlement under awards rescinded and replaced by the Relevant Award for the payment of unused sick leave and where such entitlement existed at a month in 1993, such entitlement to payment of untaken sick leave shall be paid in accordance with another Act (the Act).

A Clause of the Act provides that the maximum number of days of accumulated sick leave that may be cashed-in after the month in 1993 (whether by resignation, retirement, death or otherwise) is the lesser of:

(a) The number of days of accumulated sick leave, as at the date of termination of employment, that the employee could cash-in in accordance with the relevant provisions in force on that date; and

(b) The number of days of accumulated sick leave, as the month in 1993 that the employee could have cashed-in if their employment had been terminated immediately before that date and all the conditions for the payment had been satisfied.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-125

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 82-140

Income Tax Assessment Act 1997 Section 82-150

Income Tax Assessment Act 1997 Subsection 82-150(1)

Income Tax Assessment Act 1997 Section 82-155

Income Tax Assessment Act 1997 Subsection 82-155(2)

Income Tax Assessment Act 1936 Subsection 27A(1)

Income Tax Assessment Act 1936 Section 27AA

Reasons for decision

Summary

The total number of days of employment to which the payment for unused sick leave paid on the termination of your employment relates is equal to the number of days in the period between the commencement date and the termination of employment. Therefore, the tax free component of the payment has been calculated correctly.

Detailed reasoning

With certain exemptions, an employment termination payment (ETP) is a payment made in consequence of the termination of a person's employment that is received no more than 12 months after the termination (although the 12 restriction does not apply in some circumstances).

An ETP may comprise of a tax free component and a taxable component. The tax free component is so much of the payment that consists of:

(a) the invalidity segment; and

(b) the pre-July 83 segment of the payment. (section 82-140 of the Income Assessment Act 1997)

In accordance with subsection 80-150(1) of the ITAA 1997, an employment termination payment contains an 'invalidity segment' if:

· the payment was made to a person because they can no longer work because of physical or mental ill-health;

· the person stopped working before they reached their 'last retirement day'; and

· two legally qualified medical practitioners have certified that it is unlikely the person can ever work again in a role for which they are qualified by virtue of training, experience or education.

An ETP contains a pre-July 1983 segment if any of the employment to which the payment relates occurred before 1 July 1983. It is calculated as follows: (ubsection 82-155(2) of the ITAA 1997).

Step 1.  Subtract the *invalidity segment (if any) from the *employment termination payment.

Step 2.  Multiply the amount at step 1 by the fraction: Number of days of employment to which the payment relates that occurred before 1 July 1983 Total number of days of employment to which the payment relates

The Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Act 2007 that enacted subsection 82-155(1) of the ITAA 1997 states:

4.29 The pre-July 1983 segment is calculated as the portion of the payment that represents the individual's service period prior to 1 July 1983. The methodology for calculating this is currently set out in the ITAA 1936. The formula to be inserted into the ITAA 1997 effectively mirrors the existing calculation by apportioning the benefit based on the number of days of service prior to 1 July 1983 divided by the total number of days in the service period.

In accordance with the former section 27AA of the Income Tax Assessment Act 1936 (ITAA 1936), the pre-July 83 component of an ETP was the lesser of the following amounts:

(i) the amount calculated using the formula:

(ETP - C - IC - NQ - EC - CGT)

×

Pre-July 83  Total period

where: …

Pre-July 83 is the number of whole days (if any) in the eligible service period that occurred before 1 July 1983; and

Total period is the number of whole days in the eligible service period; …

As far as relevant, 'eligible service period' (ESP) is defined in the former subsection 27A(1) of the ITAA 1936 as:

a) where the relevant eligible termination payment is an eligible termination payment by virtue of paragraph (a) or (aa) of the definition of eligible termination payment - the period, or the aggregate of the periods, of the employment to which the relevant eligible termination payment relates; or …

A detailed interpretation of the definition of ESP in subsection 27A(1) of the ITAA 1936 is set out in the Income Tax Ruling IT 2168 which, at paragraph 4, states:

4. Where an eligible termination payment (ETP) is made in consequence of the termination of a person's employment, the eligible service period is the period, or the aggregate of the periods, of the employment to which the ETP relates. Whether an ETP "relates" to particular employment is a question of fact in each individual case. It is to be taken that the eligible service period is the person's total period of most recent continuous service with the employer making the payment (or contributing to the superannuation fund making the payment) and any related employer or employers (including any employer entity taken over by the employer or related employer or any entity in a sequence of takeovers ending with the takeover by the employer or related employer) unless there is evidence that shows that the payment was made in recognition of a different period of employment.

At paragraph 6, IT 2168 refers to the calculation of an ETP made in respect of unused sick leave entitlements and states:

… the whole of an employment period would be counted where, as happens, the value of sick leave accrued during the final year of the employment is excluded from the calculation of an ETP made in respect of unused sick leave entitlements.

In your case, although you lost your entitlement to payment of accrued sick leave under an agreement which was rescinded in a month in 1993, you continued to accumulate sick leave from year to year until your termination. At termination of your employment, in accordance with the Relevant Award, you were paid an amount which was equivalent to 999 days calculated with reference to your salary at the time of termination.

You were paid this amount because it would have been lesser than the amount calculated with reference to the number of days of accumulated sick leave, as at the time of termination of employment, that you could have cashed-in in accordance with the existing provisions as in force on that date.

Effectively, the value of sick leave that you accumulated from the month in 1993 to the date of termination was excluded from the calculation of the ETP made in respect of your unused sick leave entitlements. As such, the whole of the employment period with the employer is counted rather than the period between your start date and then month in 1993 only.

Based on the above, the tax free component of the payment made in respect of the accumulated sick leave entitlement has been calculated correctly.