Edited version of your private ruling

Authorisation Number: 1012530067786

Ruling

Subject: Accrued leave transfer payment

Question 1

Is the cost of an accrued leave transfer credited to an overseas subsidiary for accumulated employee entitlements tax deductible under section 8-1 of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following periods:

1 January 2012 - 31 December 2012

The scheme commences on:

1 January 2012

Relevant facts and circumstances

· An employee of a company relocated overseas and became an employee of a wholly-owned subsidiary company in 2012.

· The employee's employment with the company was suspended for the duration of their secondment overseas. However, the employee was still considered to be an employee of the company.

· The employee's accrued leave employee entitlements included annual leave and long service leave was transferred from the company to the subsidiary.

· The transfer payment was recognised by way of a journal entry which removed the liability from the company's balance sheet and credited the subsidiary's debtor's account.

· The subsidiary purchased goods from the company and the amount of the leave transfer was credited against the purchase price of those goods.

· Invoices have been provided verifying the sale of goods from the company to the subsidiary.

· The journal ledger entry has been provided verifying the crediting of the amount of annual leave entitlements against the invoices owing to the company.

· The employee terminated employment with the company and the subsidiary company in 2013. All termination payments were made by the subsidiary.

· The employee's entitlement to long service leave and annual leave is governed by the Long Service Leave Act 1955 and Fair Work Act 2009. Under these Acts, an employer must make provisions for long service leave and annual leave. In situations where an employee's employment is terminated, the employee is entitled to a payment in respect of their accrued leave.

· The Long Service Leave Act 1995 and Fair Work Act 2009 discuss situations in which an employee's service is transferred between employers. In certain situations where employers are associated with each other, an employee's service is considered to be continuous. Therefore, an employee whose employment is terminated with one employer and employment commenced with another employer will not be entitled to a payment of accrued leave but rather the employee is deemed to have transferred from the service of one employer to the service of another employer.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 26-10

Reasons for decision

In order for an expense to be deductible the provisions in section 8-1 of the ITAA 1997 must be satisfied:

8-1(1) You can deduct from your assessable income any loss or outgoing to the extent that:

a. It is incurred in gaining or producing your assessable income; or

b. It is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Note: Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income.

8-1(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

a. It is a loss or outgoing of capital, or of a capital nature; or

b. It is a loss or outgoing of a private or domestic nature; or

c. It is incurred in relation to gaining or producing exempt income; or

d. A provision of this Act prevents you from deducting it.

An expense is deductible under this section, if it falls under one of the positive limbs in subsection 8-1(1) of the ITAA 1997. However, subsection 8-1(2) of the ITAA 1997 will preclude deductibility if the expenditure that has been incurred if it falls under one of the negative limbs listed in that section.

In order for the company to carry on its business it must fulfil its obligations to its employees as contained with then Long Service Leave Act 1955 and the Fair Work Act 2009. In this case, the company is required to make provisions for an employee's annual leave and long service leave.

Accordingly, it is accepted that there is a nexus between the business activities being carried on by the employer and the employer's obligation to provide for worker entitlements, such that payment of the employee entitlements is incidental and relevant to the production of the assessable income of the business.

Under section 8-1 of the ITAA 1997 you cannot claim a deduction for an expense which is capital, private or domestic in nature. Whether a payment is revenue or capital in nature depends on the character of the payment made. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124; 90 ATC 4413; (1990) 21 ATR 1 the High Court stated at CLR 138, ATR 7; ATC 4420:

To determine whether a recipient is of an income or a capital nature, various factors may be relevant. Sometimes, the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence, sometimes, by the character of a right or thing disposed of in exchange for the receipt, sometimes by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business.

In this case, the payment of the accrued leave entitlements to the subsidiary is not considered to be capital in nature. The accrued leave entitlements are comprised of expenditure to meet the company's legal obligations to its employee. The obligation is directly connected to the income earning capacity of the business and is part of the immediate ordinary flow of business expenditure. In addition there was no enduring benefit to the company and the payment was also not domestic or private in nature. Accordingly, the payment is revenue in nature.

Subsection 26-10(1) of the ITAA 1997 states that you cannot deduct a loss or outgoing for long service leave, annual leave, sick leave or other leave, except:

a) An amount paid in the income year to the individual whom the leave related (or, if that individual has died, to that individuals dependent or legal professional representative): or

b) An accrued leave transfer payment that is made in the income year.

 In this case, the company transferred its employee's accrued leave to its subsidiary and is therefore seeking a deduction under paragraph b) above that an accrued leave transfer payment was made in the income year.

Subsection 26-10(2) provides that an 'accrued leave transfer payment' is a payment that an entity makes:

(a) in respect of an individuals leave (some or all of which accrued while the entity was required to make payments in respect of the individuals leave, or leave the individual might take); and

(b) when the entity is no longer required (or is about to stop being required) to make payments in respect of such leave; and

(c) to another entity when the other entity has begun (or is about to begin) to be required to make payments in respect of such leave; and

(d) under (or for the purposes of facilitating the provisions of) an Australian law, or an award, order, determination or industrial agreement under an Australian law.

It does not matter whether the leave accrues to the individual as an employee or for some other reason.

(a) Payment made in respect of an individuals leave

In order to be an accrued leave transfer payment, a 'payment' must be made in respect of an individuals leave. In this case, the former employee's accrued leave was transferred to the company's subsidiary. The payment was recognised through crediting the purchase price of goods that the company sold to the subsidiary. No money was exchanged between the company and the subsidiary.

The set-off of liabilities is discussed in TNT Skypak International (Aust) Pty Ltd v FC of T 88 ATC 4279 (Skypak). In that case, the applicant purchased a company and the vendor reduced the purchase price of the business by the amount of accrued leave entitlements. The Commissioner argued that this was a set-off of cross debts and therefore the vendor had made a payment equal to the accrued leave entitlements to the applicant and was assessable income. The Federal Court found there was no set-off of cross debts. The only debt was the debt owed under the purchase agreement by the taxpayer. Taxation Ruling IT 2557 Income Tax: Assessability or deductibility of an amount in respect of accrued leave entitlement taken into account in the purchase price of a business further discusses the Federal Courts decision in Skypak and states:

Overturning the AAT decision in Case U9, 87 ATC 138, Gummow J held that the amount was not assessable under the statutory provision, accepting the taxpayer's argument that no amount was 'received'. His Honour rejected the Commissioner's argument that the 'amount' in question may be 'received' for the purposes of the section by a set-off of liabilities, ie that while no sum on account of holiday pay was paid to the taxpayer there was nevertheless a set-off within the computation of which that sum was included. The Commissioner's argument failed because there was no cross-debts between the taxpayer and Ipec, so there could be no set-off.

In light of the above, it is important to determine whether there was a set-off of cross debts between the company and the subsidiary. In the case of Skypak there was no set-off of cross debts because no debt, besides the purchase of the company, existed.

In Skypak at ATC 4288, reference was made to Re Harmony and Montague Tin and Cooper Mining Co (Spargo's case)(1873) 8 Ch App 407 which established the principle that the set-off of obligations is the same as the making of a cash payment. In his judgement Mallish LJ stated:

Nothing is clearer than that if parties account with each other, and sums are stated to be due on one side, and sums to an equal amount due on the other side on that account, and those accounts are settled by both parties, it is exactly the same thing as if the sums due on both sides had been paid. Indeed, it is a general rule of law, that in every case where a transaction resolves itself into paying money by A. to B., and then handing it back again by B. to A., if the parties meet together and agree to set one demand against the other, they need not go through the form and ceremony of handing the money backwards and forwards.

Under subsection 26-10(2) of the ITAA 1997, an accrued leave transfer payment, must involve a 'payment' of the employee's leave entitlements. In this case, the company has calculated the amount of leave that is owed to its former employee. Therefore, it is this amount that the company must pay to the subsidiary company.

The company sold goods to its subsidiary, as evidenced by the invoices provided. Therefore, the subsidiary company owed amounts to the company in the relevant income year.

Consequently, there are two debts that exist. As evidenced by the journal entry the two amounts owing to the companies are set-off against each other. Therefore, the set-off of cross debts as discussed in Spargo's case and Skypak is apparent in this situation.

It is considered that the company made a 'payment' to the subsidiary.

(b) When the entity is no longer required to make payments in respect of leave

The employee's employment with the company was suspended when they commenced employment with the subsidiary company. As a result of the suspension of employment the company was no longer required to make payments in respect of accrued leave entitlements.

(c) The other entity is required to make payments in respect of leave

The company's employee commenced employment with the subsidiary company and accrued leave entitlements were transferred to that entity.

As an employee of the subsidiary, the subsidiary was required to make payments in respect of annual leave and long service leave as per the employee's employment contract.

On the termination of employment with the subsidiary, all termination payments were made by the subsidiary.

Therefore, the subsidiary was required to make payments in respect of the leave.

(d) under an Australian law, or an award, order, determination or industrial agreement under an Australian law

The payment of accrued leave to the subsidiary must be made under (or for the purposes of facilitating the provisions of) an Australian law, or an award, order, determination or industrial agreement under an Australian law.

Paragraph 26-10(2)(d) of the ITAA 1997 intends to cover situations in industries where it is an industrial practice for employees to regularly transfer between employers and for payments to be made by the transferring employer to the new employer in respect of accrued leave entitlements under the terms of an industrial agreement or award or based upon a decision by employers to make such payments as a matter of commercial reality. This is made clear from the Explanatory Memorandum to the Taxation Laws Amendment Bill 1993 which inserted the old law, section 51(3)(a) of the Income Tax Assessment Act 1936 (now 26-10 of the ITAA 1997). This ensures the payment will be deductible to the employer who makes the payment and assessable to the employer who receives the payment.

Both the Long Service Leave Act 1995 and Fair Work Act 2009, provide that a payment must be made to a terminating employee in respect of long service leave and annual leave. The Acts both discuss transfers of employment between associated companies and provide that continuity of service will not be broken if the employee terminates employment with one employer and commences employment with the another employer.

However, the two Acts referred to above, do not provide that a payment must be made from the original employer to the employee's new employer on the transfer of employment.

In consideration of the above, it is not apparent the payment of accrued leave from the company to the subsidiary was made under an Australian law, or an award, order, determination or industrial agreement under an Australian law or to facilitate such a provision. Further it is not apparent that it is a common industrial practice for employees in this situation to transfer between employers. This particular situation appears to be isolated to the company's employee being seconded to the subsidiary.

In addition, there was no transfer of employment, from the company to the subsidiary. Payment of accrued leave transfer payments are made when an employee's employment is terminated and employment commenced with a second employer. In this case, employment with the company was suspended while the employee commenced employment with the subsidiary. Therefore, there are insufficient grounds to support a reason that the company must pay an amount of accrued leave to the subsidiary because its employee was seconded to the subsidiary.

Therefore the payment is not an accrued leave transfer payment.