Edited version of your private ruling

Authorisation Number: 1012484841518

Ruling

Subject: Employment termination payment - transfer payment and retention bonus

Issue 1

Question:

Will the transfer payment made to employees who transfer their employment to another employer, as a result of the outsourcing of certain business functions to the other employer, be an employment termination and subject to Pay-As-You-Go (PAYG) withholding tax instalments?

Answer:

Yes

Issue 2

Questions

1. Will the payment, described as a 'retention bonus', paid to a key staff member at termination of employment on completion of an agreed term be an employment termination payment and subject to PAYG withholding tax instalments?

2. If the 'retention bonus' is a employment termination payment, will any part of the payment be the tax-free part of a genuine redundancy?

Answers:

1. Yes

2. No

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

Issue 1

1. The employer announced plans to outsource a particular business unit (the Unit) in their organisation.

2. The key principle for the change is that the employer is seeking to be more efficient. As a result of being unable to introduce efficiencies in this department, the employer decided to outsource the function to a private operator.

3. The employer has entered into a service contract with a private sector entity (the service contractor) for a specified period with an option to extend for a further number of years for the provision of certain services. The contract will commence from 1 July 20XX.

4. All permanent employees of the employer who choose, as a result of the transfer of the Unit to the service contractor, will:

(a) terminate their employment with the employer; and

(b) accept employment with the service contractor.

5. It is not compulsory for the employer employees to accept employment with the service contractor.

6. Employees of the employer who:

(a) are not offered a position with the service contractor; or

(b) do not accept a position with the service contractor; or

(c) do not accept an offer of voluntary redundancy;

will be managed by the employer under the provisions of the enterprise agreement that applies to them immediately prior to the commencement date, which is the date on which the service contractor starts operating the Unit service.

7. The service contractor will not make any transferring employees compulsorily redundant for a specified number of years from the date of transfer, but may do so afterwards consistent with the consultation provisions of the relevant enterprise agreements.

8. The service contractor must recognise past service with the employer (and any prior service currently recognised by the employer) for all purposes including, but not limited to, for the purposes of any enterprise agreement, the Fair Work Act 2009 and any law regulating the employment of any transferring employees.

9. Transferring employees who accept the offer and commence employment with the service contractor will receive the transfer payment. That is, the transfer payment will be made no later than the first full pay after which the service contractor commences operation of the Unit in place of the employer.

10. The transfer payment will be made by the employer, not the service contractor.

11. The transfer payment is an amount in addition to any other benefits or statutory leave entitlement transferring employees will receive on termination of their employment with the employer.

12. The transfer payment is not the same type of payment as a redundancy payment and will not reduce or set off any severance moneys payable to a transferring employee who is subsequently made redundant by the service contractor.

13. The transfer payment provided to the transferring employee will be determined based on length of continuous employment with the employer.

Issue 2

14. The employer has offered one key staff member a 'retention bonus'.

15. In a letter from the employer to the key staff member it is stated that:

· the employer has assigned the key staff member to a managerial position in a project role;

· the key staff member will be entitled to payment of their current remuneration rate plus the outcome of the relevant remuneration review;

· the completion date of this project and the key staff member's intended date of exit is at the end of the subsequent income year;

· the key staff member will exit the organisation at the conclusion of the project. The employer will provide several months' notice of the project completion date;

· the key staff member will receive a retention bonus of a specified percentage of the key staff member's total remuneration package if the key staff member completes the full term of engagement and meets certain key performance indicators.

16. The key staff member receiving the retention bonus is not transferring to the service contractor and, as such, will not be receiving the transfer payment.

17. The retention bonus will be paid by the employer along with the redundancy payment on termination of the key staff member's employment. The key staff member's redundancy payment is a specified number of weeks per year of service.

18. You advised that redeployment is not an option available to the key staff member. The key staff member will be leaving the employer on completion of the project.

Relevant legislative provisions

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 Paragraph 82-130(1)(b).

Income tax Assessment Act 1997 Subsection 82-130(2).

Income tax Assessment Act 1997 Subsection 82-130(4).

Income tax Assessment Act 1997 Sub-paragraph 82-130(4)(a).

Income tax Assessment Act 1997 Subsection 82-130(5).

Income tax Assessment Act 1997 Subsection 82-130(7).

Income tax Assessment Act 1997 Subsection 82-130(2).

Income tax Assessment Act 1997 Section 82-140.

Income tax Assessment Act 1997 Section 82-145.

Income tax Assessment Act 1997 Section 82-175.

Income tax Assessment Act 1997 Section 995-1.

Income tax Assessment Act 1997 Section 82-155.

Taxation Administration Act 1953 Section 12-85.

Reasons for decision

Summary

The transfer payments to be received by eligible employees because of the termination of their employment with the employer and accept employment with the service contractor are employment termination payments.

The retention bonus to be made to a key staff member is considered an employment termination payment. No part of the payment will be exempt from tax as a genuine redundancy payment. The retention bonus is to be paid for the completion of the project on the agreed terms and meeting the key performance indictors; not because the key staff member's employment is to be made redundant.

Detailed reasoning

1. Employment termination payment

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 Income Tax Assessment Act 1997 (ITAA 1997)).

Section 995-1 of 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:

(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.

Therefore, it can be seen that a number of conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

To determine if the transfer payments are 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 TSP not being considered an employment termination payment.

Payment is made in consequence of the termination of employment

The first condition to be met is that the payment is received by the person in consequence of the termination of their employment.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the words have been interpreted by the courts in several cases. The Commissioner has also issued Taxation Ruling TR 2003/13 which discusses the meaning of the phrase.

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.

Also in paragraph 5 of TR 2003/13 the Commissioner notes that the Courts have considered the meaning of the words in consequence of in several cases.

Of note are the decisions made by the Full Bench of the High Court in Reseck v. Federal Commissioner of Taxation¹ (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation² (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 my opinion necessary that the termination of the services should be the dominant cause of the payment.

While Justice Jacobs, in the same case, 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. In doing so the Full Federal Court emphasised that a payment may be in consequence of the termination of employment even though the termination is not the dominant cause of the payment.

In particular, 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

Suffice to say, the view of both Courts was 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 phrase in consequence of and the decisions in Reseck and McIntosh were considered more recently by the Federal Court in Le Grand v Federal Commissioner of Taxation³ (Le Grand), where 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 applicants 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.

Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was expressed 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 noted in both paragraphs 6 and 28 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'.

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 for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135.

In the present case, the relevant facts in respect of outsourcing of their particular business unit (the Unit) indicate that eligible employees of the employer will be able to elect whether to remain employed with employer or to transfer their employment to the appointed service contractor of the employer.

Employees who take up positions with the service contractor will cease employment with the employer.

The transfer payment is only payable on the condition that eligible employees have had their employment terminated with the employer and accept the offer and commence employment with the service contractor. The payment of the transfer payment follows as an effect or result of the termination and the payment would not have been made to the eligible employees but for the termination of their employment with the employer.

In view of the above, the payment of the transfer payment is made in consequence of the termination of employment and is therefore an employment termination payment under section 82-130 of the ITAA 1997.

The payment is made no later than 12 months after the termination of employment

The second requirement under section 82-130 of ITAA 1997 is that the payment be made within12 months of the termination of employment. Payments made outside 12 months will be taxed as ordinary income at marginal tax rates.

In the current case, the employer advised that the transfer payments will be made within 12 months of termination of employment.

Accordingly, the requirement under paragraph 82-130(1)(b) of ITAA 1997 will be satisfied.

The payment is not a payment specifically excluded under section 82-135

The third condition for the payment to meet the criteria, as an employment termination payment is stated under paragraph 82-130(1)(c) of the ITAA 1997, is that the payment must not be specifically excluded under section 82-135.

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

· superannuation benefits;

· payment for unused annual leave or unused long service leave (and any other similar leave);

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

· reasonable capital payments for personal injury.

On the basis of the information provided by the applicant, it is considered that the payments are not payments that are specifically excluded under section 82-135 of the ITAA 1997. Therefore the condition under paragraph 82-130(1)(c) has been met.

As the payments made or to be made to the eligible employees satisfy all the conditions under subsection 82-130(1) of the ITAA 1997, the payments are employment termination payments for the purposes of section 82-130.

It should be noted that an employment termination payment cannot be rolled over into a complying superannuation fund.

2. Retention bonus

In relation to this issue it is necessary to determine whether the payment described as a 'retention bonus' paid to a key staff member at termination of employment on completion of an agreed term will be an employment termination payment.

As previously mentioned, the question of whether a payment is made in consequence of the termination of employment will be determined by the relevant facts and circumstance of each case.

In this case, the key staff member's employment agreement with the employer, the key staff member will be entitled to receive the retention bonus if the following conditions are met:

(a) completion of the full term of engagement on a specific date;

(b) the key staff member's will exit the organisation at the conclusion of the project and the intended date of exit; and

(c) meet the key performance indicators (KPI) set out by the employer under the agreed terms.

It can be seen from the above the retention bonus will be made to the key staff member on the termination of the key staff member's employment with the employer on the completion date of the project. In addition to the completion date, the key staff member also needs to meet the KPI to receive the retention bonus. Therefore, the retention bonus is made as 'in consequence of' the key staff member's termination of employment. As such, there is a direct causal connection between the termination of employment and the making of the retention bonus

The termination of employment and the retention bonus are all intertwined and connected. If not for the termination of employment on the intended completion date, the retention bonus will not be made. In particular, the payment of the retention bonus is conditional on the key staff member remaining in employment with the employer until the intended completion date and meeting the KPI.

It is considered that there is sufficient nexus between the making of the payment and the termination of employment to say that the payment is being made in consequence of the key staff member termination of employment.

Genuine redundancy payment

The Commissioner is now to consider will any part of the retention bonus be the tax-free part of a genuine redundancy payment.

Section 83-175 of the ITAA 1997 states:

(1) A genuine redundancy payment is 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.

(2) A genuine redundancy payment must satisfy the following conditions:

(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 dismissal.

(3) However, a genuine redundancy payment 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 the payment was received or at a later time.

Payments not covered

(4) A payment is not a genuine redundancy payment if it is a payment mentioned in section 82-135 (apart from paragraph 82-135(e)).

Taxation Ruling TR 2009/2, Income Tax: genuine redundancy payments, provides guidance on the factors to be considered in the interpretation of section 83-175 of the ITAA 1997.

In discussing what constitutes a genuine redundancy payment in accordance with subsection 83-175(1) of the ITAA 1997, paragraph 11 of TR 2009/2 states:

There are four necessary components within this requirement:

· The payment being tested must be received in consequence of an employee's termination.

· That termination must involve an employee being dismissed from employment.

· That dismissal must be caused by the redundancy of the employee's position.

· The redundancy payment must be made genuinely because of a redundancy.

It should be noted that whether the key staff member's employment is to be terminated on account of a genuine redundancy is not a matter to determine by the Commissioner. It is the ultimate decision of the employer that the dismissal must be caused by the redundancy of the key staff member's position.

Whilst the legislative provision governing genuine redundancy will determine the extent of the liability of an employee to income tax on payments received or to be received, it does not affect the liability of an employer to income tax. The only impact on an employer is in relation to the amount of tax they will be required to withhold from the payments.

In this case, the key staff member will have a separate redundancy entitlement on termination of employment with the employer, in accordance with the key staff member's employment contract.

In respect of the retention bonus, it is the Commissioner's view that the bonus arises from an agreement where the key staff member agreed to remain with the employer until the completion date of the agreed employment contract. Further, the retention bonus is contingent upon the completion of the agreed project and the key staff member's continued employment with the employer on the specific date.

The retention bonus is only payable on the condition that the key staff member fulfils the full term of employment contract and meeting the KPI. The bonus will not be made if the key staff member does not meet the KPI. The bonus is linked with the performance of the key staff member and not because of the key staff member's position being redundant. Accordingly, no part of the retention bonus will be the tax-free part of a genuine redundancy payment.

3. Taxation Treatment

An employment termination payment will be comprised of the following components:

· Tax free component - as provided in section 82-140 of the ITAA 1997, this includes an invalidity segment within the meaning of section 82-150 (if any) and/or a pre-July 83 segment within the meaning of section 82-155 (if any); and

· Taxable component - the amount remaining after deducting the tax free component calculated in accordance with section 82-140 from the total payment, as prescribed in section 82-145.

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.

4. PAYG Withholding

Section 12-85 of Schedule 1 of the Taxation Administration Act 1953 (TAA) states:

An entity must withhold an amount from any of the following payments it makes to an individual:

(a) a superannuation lump sum;

(b) an employment termination payment.

As shown above, the payment to be made to the eligible employees is an employment termination payment. Therefore, an amount must be withheld.

The amount to withhold depends on whether a Tax File Number (TFN) has been provided.

If a TFN has not been provided before the payment is made, tax must be withheld at the rate of 46.5% from the taxable component. This represents the top marginal rate plus Medicare levy.

If the payee has provided the employer with a TFN, tax must be withheld at the following rates:

For the 2012-13 and 2013-14 income years the ETP cap amount is $175,000 and $180,000 respectively.

Preservation age is the age at which retirees can access their superannuation benefits generally when they retire.

If the employee was born:

· before 1 July 1960 they can access their superannuation when they are 55.

· after 30 June 1960 their preservation age will be between 55 and 60. This is because the preservation age will gradually increase from 55 to 60 between 2015 and 2025.

¹ (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45

² (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325

³ [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39