Edited version of your private ruling

Authorisation Number: 1012453067071

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Ruling

Subject: Transitional termination payment

1. Is the Retention Bonus Payment a transitional termination payment?

2. Is the Change of Control Payment made on the termination of employment of your client a transitional termination payment?

Answer

1. No.

2. No.

This ruling applies for the following period:

2011-12 income year

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Your client was employed by Company A in an executive position of Company B from 2003 to 2009.

In a letter from Company A to your client, your client received an offer of employment from Company A for an executive position in Company B from 2003 to 2007. The terms and conditions of your client's employment were contained in the Offer of Employment letter.

A paragraph of the offer of employment letter advised the payment to be received on termination of employment.

A letter from Company A to your client extended your client's employment until 2009 under the same terms and conditions of your client's employment contained in the original Offer of Employment letter. Provision for severance payments remained by reference to the same remuneration.

During the 2008-09 income year, Company E took over your client's employment contract. In an employment contract dated during the 2008-09 income year between Company E and your client advised that your client's employment will commence during the 2008-09 income year and continue until the 2013-14 income year.

Your client's employment contract with Company E provided for the transfer of your client's annual leave and long service leave entitlements from Company A to Company E, with reference to a commencement date several years ago.

Company A and your client also entered into a Deed of Release during the 2008-09 income year which provided for the continuation of leave entitlements and the transfer of liability for these entitlements being transferred from Company A to Company E.

The 2009 Deed also makes provision for a special payment to your client on a change of control of Company A. If a change in control of Company A occurs during the period of the employment by Company E or Company A ceases to Control or jointly-Control Company E during the same period, and your client's employment with Company E is terminated, Company A shall pay to the Executive a change of control payment less any applicable tax.

During the 2010-11 income year Company A made an offer to your client for a Retention Bonus Payment by letter. Your client was advised that Company C has received an indicative, non-binding and conditional proposal from Company D to acquire Company C at a price in cash per share (the "Proposed Transaction"). In order to secure your client's ongoing commitment with their joint venture company, Company E, the Board of Company C is prepared to offer your client a Retention Bonus Payment (the "Bonus") payable during the 2011-12 income year subject to the following conditions being met:

· The Proposed Transaction is accepted by the Board of Company C and is approved by the shareholders of Company C, and

· The Proposed Transaction is successfully closed prior to the 2011-12 income year and,

· Your client satisfies all of the indictors detailed and,

· Your client's employment has not been terminated for cause, including but not limited to serious misconduct, prior the 2011-12 income year; and

· Your client has not resigned with the resignation to take effect prior to the 2011-12 income year.

In the event the transaction concludes later than the 2011-12 income year, the payment will be made upon closing of the transaction.

Following the acquisition of Company C by Company D during the 2011-12 income year, Company D informed your client of their intention to terminate your client's employment and pay a termination payment. This resulted in the payment of the special Payment as provided by the Deed of Release.

Your client terminated employment with Company A during the 2011-12 income year.

A PAYG Payment Summary - individual non-business stated that your client received a gross payment from Company A in the 2011-12 income year with tax withheld.

A Pay Advice from Company A stated that the gross payment that was paid during the 2011-12 income year was comprised of a 'Bonus-Retention' Payment and a change in control special payment.

Your client is over 55 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 82-130

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

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

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

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

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

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

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Section 995-1

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 Paragraph 82-10(1)(a)

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

Income Tax (Transitional Provisions) Act 1997 Paragraph

Income Tax (Transitional Provisions) Act 1997

Reasons for decision

Summary of decision

The Retention Bonus Payment made to your client during the 2011-12 income year is not an employment termination payment. As the payment is not an employment termination payment it does not meet the requirements to be a transitional termination payment. The Retention Bonus Payment is assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997.

The change of control payment made to your client during the 2011-12 income year is an employment termination payment. However the payment does not meet the requirements to be a transitional termination payment as the payment was made under a Deed of Release which was not in force before 10 May 2006.

Detailed reasoning

Retention bonus payment

Employment termination payment

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that:

employment termination payment has the meaning given by section 82-130 of the ITAA 1997.

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

A payment is an employment termination payment if:

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

(a) it is received no later than 12 months after that termination (but see subsection (4)); and

(b) it is not a payment mentioned in section 82-135.

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

To determine if the Retention Bonus Payment your client received from the employer is an employment termination payment all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

Failure to satisfy any of the conditions will result in the payment not being considered an employment termination payment.

Paid as a consequence of the termination of employment

It should be noted that the phrase 'in consequence of the termination of your employment' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

In light of these decisions, the Commissioner discusses the meaning of the phrase in Taxation Ruling TR 2003/13 titled Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of' (TR 2003/13).

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.

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).

In Reseck Justice Gibbs stated:

Within the ordinary meaning of the words, a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination... It is not in my opinion necessary that the termination of the services should be the dominant cause of the payment...

While Justice Jacobs stated:

It was submitted that the words 'in consequence of' import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a 'following on'.

In looking at the phrase 'in consequence of' the Full Federal Court in McIntosh considered the decision in Reseck. Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment.

Suffice it to say that 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.

Furthermore, in Le Grand v. Federal Commissioner of Taxation [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39 (Le Grand), the issue before the court was whether an amount received by the applicant as a result of accepting an offer of compromise in respect of claims brought by him against his former employer, in relation to the termination of his employment was in whole, or in part, an ETP. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an ETP.

Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicant's employment and the payment to warrant the finding that the payment was made 'in consequence of the termination' of the applicant's employment. I am satisfied that the payment was an effect or result of that termination in the sense that there was a sequence of events following the termination of the employment which had a relationship and connection which ultimately led to the payment. True it is that the payment was made not only to settle the applicant's claim for common law damages for breach of the employment agreement but also for statutory damages...

Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was articulated by Justice Gibbs in Reseck. Thus, for the payment to have been made in consequence of the termination of employment, the payment must follow as an effect or result of the termination of employment. As earlier stated in paragraph 6 of TR 2003/13, there must be 'a causal connection between the termination and the payment even though the termination need not be the sole or dominant cause of the payment'.

The Full Federal Court in Dibb v. Federal Commissioner of Taxation [2004] FCAFC 126; (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786, has applied the above decisions in finding that the payment received by the taxpayer under a Deed of Release to settle various causes of action against the employer following the termination of employment was an ETP.

Paragraph 31 of TR 2003/13 the Commissioner states:

It is clear from the decision in Le Grand, that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of the taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

The essence of this analysis is that if the payment follows as an effect or a result of the termination of employment, the payment will be made in consequence of the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. The termination of the payment need not be the sole or dominate cause of the payment.

The question of whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case.

From the facts of the case Company A received an indicative, non-binding and conditional proposal from Company D to acquire the shares in Company A. As a result of that proposal, your client was offered a Retention Bonus Payment to secure your client's on going commitment concerning the proposed acquisition. A letter to your client during the 2010-11 income year stated that the offer of the Retention Bonus Payment was subject to the following:

· The Proposed Transaction is accepted by the Board of Company C and is approved by the shareholders of Company C, and

· The Proposed Transaction is successfully closed prior to the 2011-12 income year and,

· Your client satisfies all of the indicators which were detailed in the offer of retention bonus letter during the 2010-11 income year and,

· Your client's employment has not been terminated for cause, including but not limited to serious misconduct, prior to 2011-12 income year; and

· Your client has not resigned with the resignation to take effect prior to the 2011-12 income year.

In this case your client terminated employment during the 2011-12 income year and was paid the Retention Bonus Payment during the 2011-12 income year. Although the Retention Bonus Payment coincided with or shortly followed the termination of your client's employment, the payment was not being made in consequence of the termination of that employment. The Retention Bonus Payment was only being paid to ensure that your client continued employment until the proposed acquisition. Also the Retention Bonus Payment will not be paid under certain circumstances such as resignation prior to a particular date, or dismissal for cause such as serious misconduct. Most importantly, once the acquisition date was reached, your client was entitled to the payment regardless of whether your client did or did not terminate their employment.

There is no causal connection between the termination and the payment. The Retention Bonus Payment was not conditional on the termination of your client's employment. It cannot be said that the Retention Bonus Payment follows on as an effect or a result of the termination of employment. Therefore the Retention Bonus Payment is not considered to be made in consequence of the termination of employment.

As the Retention Bonus Payment is not considered to be received by your client in consequence of the termination of your client's employment, the requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has not been met.

As mentioned above all the conditions under subsection 82-130(1) of the ITAA 1997 must be satisfied before a payment is considered an employment termination payment. As it has been determined that one of the conditions under subsection 82-130(1) of the ITAA 1997 have not been met, it is not necessary to discuss the other conditions of subsection 82-130(1) of the ITAA 1997. Therefore the Retention Bonus Payment is not considered to be an employment termination payment under subsection 82-130(1) of the ITAA 1997.

Transitional termination payment

Some employment termination payments made between 1 July 2007 and 30 June 2012 are subject to transitional arrangements. Payments made under these arrangements (transitional termination payments) attract tax concessions designed to broadly mirror arrangements prior to 1 July 2007, including the ability to direct these amounts into superannuation.

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

To qualify as a transitional termination payment, the payment must be a life benefit termination payment (as defined in subsection 82-130(2) of the ITAA 1997) that meets the requirements of section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A).

As it has been determined that the Retention Bonus Payment is not an employment termination payment and which therefore is not a life benefit termination payment, the payment cannot be a transitional termination payment.

The Retention Bonus Payment is considered to be ordinary salary and wages and assessable under section 6-5 of the ITAA 1997. The payment should be included as salary and wages income in your client's income tax return in the 2011-12 income year.

Change of Control payment

Employment termination payment

As discussed above 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.

Paid as a consequence of the termination of employment

The phrase 'in consequence of the termination of your employment' was discussed above.

From the facts, your client was paid an amount as a Change of Control payment under a Deed of Release during the 2008-09 income year between Company A and your client. Under a clause of the Deed of Release your client will be paid a Change of Control payment if your client's employment is terminated during a Change of Control of Company C.

Based on the information provided, it is evident the Change of Control payment is paid in consequence of the termination of your client's employment with Company A. The payment is made under the Deed of Release due to your client's employment being terminated as a result of a Change of Control of the employer. The termination of employment and the payment are all intertwined and connected.

Therefore as the Change of Control Payment is considered to be received by your client in consequence of the termination of their employment, the requirement under subparagraph 82-130(1)(a) of the ITAA 1997 has been met.

The payment is received no later than 12 months after termination

The second condition is stated under paragraph 82-130(1)(b) of the ITAA 1997. The payment must be received within 12 months of the employee's termination of employment, unless the payment is covered by a determination exempting them from the 12 month rule.

As your client's employment was terminated during the 2011-12 income year, and the payment was received by your client during the 2011-12 income year, the 12 month requirement under paragraph 82-130(1)(b) of the ITAA 1997 was satisfied.

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

Section 82-135 of the ITAA 1997 specifically excludes certain payments from being employment termination payments. The payment is not excluded under section 82-135 of the ITAA 1997. Therefore the requirement under paragraph 82-130(1)(c) of the ITAA 1997 was satisfied.

As all the conditions under subsection 82-130(1) are satisfied, the Change of Control payment is an employment termination payment.

Under subsection 82-130(2) of the ITAA 1997 a life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies.

The Change of Control payment is a life benefit termination payment as the payment is an employment termination payment received by your client in consequence of the termination of your client's employment.

We will now determine whether the Change of Control Payment is a transitional termination payment.

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).

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

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.

To consider if the life benefit termination payment paid by Company A is a transitional termination payment, it becomes necessary to consider whether the payment meets the requirement of being an entitlement that is 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.

In 2009 your client entered into a new fixed term employment contract with Company E and your client also entered into a Deed of Release with Company A that provided for the Change of Control Payment on the termination of employment.

From the facts, the entitlement for the Change of Control Payment was not provided under a contract as in force just before 10 May 2006. The terms and conditions of employment contained in the original offer of employment in 2003 did not make any reference to the Change of Control Payment.

Similarly the terms of conditions of employment in the letter offering a extension of employment made no mention of a change in control payment. Your client only became eligible for the payment from the 2009 Deed of Release.

Consequently, it cannot be said that the Change of Control Payment made to your client was received because of an entitlement that is provided for under a written contract or agreement as in force just before 10 May 2006 as required under subsection 82-10(1) of the IT(TP)A to be a transitional termination payment.

Therefore, although, the Change of Control Payment is an entitlement made in consequence of the termination of your client's employment and is an employment termination payment, it does not qualify for further concessional treatment as a transitional termination payment as it does not meet the condition in paragraph 82-10(1)(b) of the IT(TP)A in order to qualify as a transitional termination payment.

As determined above the Change of Control payment is an Life Benefit Termination Payment and taxed as follows:

Tax Treatment of a Life Benefit Termination Payment (LBTP):

An employment termination payment will comprise of the following components:

Tax free component - this includes the pre-July 83 segment (if any) and/or the invalidity segment (if any); and

Taxable component - the amount remaining after deducting the tax free component from the total payment.

The tax free component is not assessable income and is not exempt income. The taxable component is included, in full, as assessable income.

The taxable component is subject to tax, depending on the person's age when the payment is received.

Where a taxpayer is at or above their preservation age, the taxable component of the LBTP is taxed at 15% plus Medicare Levy for amounts up to the employment termination payment cap, and at 46.5% plus Medicare Levy for the amount above this cap. (the employment termination payment cap is $165,000 in the 2011-12 income year).

The taxable components of all LBTPs received in an income year, or in respect of the same termination of employment, are counted towards this cap. Any tax-free amounts are not counted towards the cap.

Your client received a LBTP during the 2011-12 income year. There is no tax free component in this payment as there is no pre-July 83 segment or invalidity segment. The entire payment of will comprise a taxable component.

Employment termination payments cannot be rolled over into a complying superannuation fund, complying approved deposit fund (ADF) or to a retirement savings account (RSA) provider.

Your client should include the employment termination payment in your client's income tax return for the 2011-12 income year.

Conclusion

The Retention Bonus Payment is not a transitional termination payment. The payment is assessable income under section 6-5 of the ITAA 1997 and should be included in your client's income tax return for the 2011-12 income year.

The change of control payment made on the termination of employment is an employment termination payment and should be included in your client's income tax return for the 2011-12 income year.