Edited version of your private ruling

Authorisation Number: 1012616749614

Ruling

Subject: Employment termination payments

Question 1

Is any part of an amount received by the Taxpayer in accordance with the terms of a Deed of Release a tax-free part of a genuine redundancy payment for the purposes of section 83-170 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the amount received by the Taxpayer a capital payment for, or in respect of, a legally enforceable contract in restraint of trade for the purposes of section 83-135 of the ITAA 1997?

Answer

No

This ruling applies for the following period:

Income year ended 30 June 2012

The scheme commences on:

During the income year ended 30 June 2012

Relevant facts and circumstances

The Taxpayer was employed by the Employer.

Several years later, the Taxpayer resigned from their employment with the Employer

Consequently, as a result of an agreement between the Taxpayer and the Employer, the Employer, without any admission of liability, agreed to pay the Taxpayer a lump sum amount.

The agreement between the Taxpayer and the Employer was formalised in a Deed of Release (the Deed) made between the Taxpayer and the Employer.

Included in the Deed are the following clauses:

• Without any admission of liability, the Employer has agreed to pay the specified amount (less any applicable taxes withheld by the Employer) to the Employee to finalise all matters arising out of or related to the Employment, on terms set out in this Deed; and

• The Employee acknowledges that the payment is in full and final settlement of all claims and entitlements which the Employee has, may have had, or but for this Deed may in the future have, against the Employer arising out of the Employment.

Less than 12 months later, in accordance with the terms of the Deed, the Taxpayer received a lump sum payment from the Employer. The payment was treated by the Employer as an employment termination payment (ETP).

The Taxpayer contends that the payment was made with the intention that it would be a genuine redundancy payment.

The Taxpayer also contends that the payment was made as "a capital payment for, or in respect of, a legally enforceable contract in restraint of trade so far as the payment is reasonable having regard to the nature and extent of the restraint".

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 Section 82-135

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

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

Income Tax Assessment Act 1997 Section 83-175

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

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

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

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

Income Tax Assessment Act 1997 Section 955-1

Reasons for decision

Summary

The amount received by the Taxpayer is not a genuine redundancy payment. Therefore, no part of the payment is tax-free for the purposes of section 83-170 of the ITAA 1997.

The amount received by the Taxpayer is not a capital payment for, or in respect of, a legally enforceable contract in restraint of trade for the purposes of section 83-135 of the ITAA 1997.

The amount received by the Taxpayer is an ETP and is taxed accordingly.

Employment termination payments

By virtue of subsection 995-1(1) of ITAA 1997, ETPs are defined in subsection 82-130(1) of the ITAA 1997, which states that a payment is an ETP 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 that termination (but see subsection (4)); and

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

To determine if a payment is an ETP, all the conditions in subsection 82-130(1) of the ITAA 1997 must be satisfied. Failure to satisfy any of the conditions under subsection 82-130(1) will result in the payment not being considered an ETP.

Furthermore, any termination payments received more than 12 months after the termination will be taxed as ordinary income at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule.

Paid as a 'consequence of' the termination of your employment

For a payment to be treated as an ETP, the first condition that must be met is that the payment is made in 'consequence of' the termination of employment of the taxpayer.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Taking into account the courts decisions on the meaning of the 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 (TR 2003/13).

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.

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 this case, the Taxpayer resigned from employment, thereby terminating their employment with the Employer, and as a result of the termination, the Employer made the payment to the Taxpayer in full and final settlement of all claims and entitlements which the Taxpayer had, or may have in the future, against the Employer. In other words, but for the termination, the payment would not have been made to the Taxpayer. Therefore, it is considered that the payment was made to the Taxpayer in consequence of the termination of her employment with the Employer.

Payment is received no later than 12 months after termination

In this case, the Taxpayer received the relevant payment less than 12 months after the Taxpayer's termination. Therefore, this condition is satisfied.

Payment is not a payment mentioned under section 82-135 of the ITAA 1997

Based on the information provided, the only payments listed in section 82-135 of the ITAA 1997 which may be relevant in this case and thus require consideration are:

• the part of a genuine redundancy or an early retirement scheme payment worked out under section 83-170 of the ITAA 1997, and

• a capital payment for, or in respect of, a legally enforceable contract in restraint of trade.

Genuine redundancy payments

In accordance with subsection 83-175(1) of the ITAA 1997, a genuine redundancy payment is so much of a payment that:

• is received by an employee who is dismissed from employment because the employee's position is genuinely redundant; and

• exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of their employment at the time of the dismissal.

In addition to the above, subsection 83-175(2) of the ITAA 1997 states that a genuine redundancy payment must meet the following conditions:

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

(i) the day he or she turned 65; or

(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 that age or complete the period of service (as applicable);

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

However, subsection 83-175(3) of the ITAA 1997 provides that 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 of the payment or at a later time.

Meaning of genuine redundancy

The requirements to be satisfied before any payment made to a person whose employment is terminated qualifies for treatment as a genuine redundancy payment under section 83-175 of the ITAA 1997 are discussed in Taxation Ruling TR 2009/2 (TR 2009/2).

With regard to the first requirement set out in subsection 83-175(1) of the ITAA 1997, the Commissioner considers that there are four necessary components within this requirement:

• the payment must be received in consequence of an employee's termination;

• the termination must involve the employee being dismissed from employment;

• dismissal must be caused by the redundancy of the employee's position; and

• the redundancy payment must be made genuinely because of a redundancy.

As stated previously, it is considered that, in this case, the payment was received by the Taxpayer in consequence of the Taxpayer's termination of employment.

The terms 'dismissal' and 'redundancy' are not defined in the ITAA 1997 therefore, consistent with basic principles of statutory interpretation, their meaning must be determined according to the ordinary meaning of the words, having regard to the context in which they appear.

Accordingly, the Commissioner's view, as stated in Taxation Ruling TR 2009/2, is that dismissal means a decision to terminate employment at the employer's initiative without the consent of the employee. This stands in contrast to employment that is terminated at the initiative of the employee, for example in the case of resignation.

A position is redundant when the functions, duties and responsibilities formerly attached to the position are determined by the employer to be superfluous to the current needs and purposes of the organisation. A dismissal is not caused by redundancy where personal acts or default are the cause for termination for example, unsatisfactory performance or behaviour (paragraph 25, TR 2009/2).

Contrived cases of redundancy will not meet the conditions in section 83-175 of the ITAA 1997. The fact that an employer and employee have an understanding that a payment on termination is caused by redundancy, or that the employer treats the payment as a redundancy payment for tax purposes, does not of itself establish genuine redundancy (paragraph 32, TR 2009/2).

Applying the above to the Taxpayer's circumstances, it is considered that the payment received by the Taxpayer in consequence of the termination of the Taxpayer's employment is not a genuine redundancy payment. This view is based on the following:

• The Taxpayer's resigned from their employment with the Employer voluntarily, that is, the employment was terminated at the Taxpayer's initiative and not at the initiative of the Employer;

• There is nothing to indicate that the Taxpayer's employment was terminated because their position was no longer needed having regard to the current needs and purposes of the Employer; and

• The fact that the Taxpayer and/or the Employer had an understanding that the termination was caused by genuine redundancy does not, of itself, establish a case of a genuine redundancy.

Consequently the payment received by the Taxpayer is not a genuine redundancy payment for the purposes of section 83-175 of the ITAA 1997.

Restraint of trade payments

In accordance with paragraph 82-135(j) of the ITAA 1997, a payment is not an ETP if it is:

(j) a capital payment for, or in respect of, a legally enforceable contract in restraint of trade by you so far as the payment is reasonable having regard to the nature and extent of the restraint;

It is contended, that the Taxpayer's 'career has been dramatically impacted by this employment and the resulting outcome' and, as such, there is no doubt the payment created a restraint of trade. However, on close examination of the Deed, there is nothing in the terms of the Deed to support that contention.

In accordance with the terms of the Deed, the payment was made to the Taxpayer in consideration for full and final settlement of all claims and entitlements which the Taxpayer had, or may have had, or may in future have against the Employer and arising from the employment.

It has been held that where the question is the characterisation, for income tax purpose, of a payment made under a Deed, the nature of the payment is determined by reference to the terms of the Deed and the facts surrounding the payment. In other words, the Deed is the principal determinant as to reason for and the nature of the payment.

In this case, there is nothing in the Deed that indicates that the payment was made because of genuine redundancy of the Taxpayer or that it was a capital payment for, or in respect of, a legally enforceable contract in restraint of trade. Consequently, it is our view that the payment is not a genuine redundancy payment or a restraint of trade payment.

Therefore, the payment received by the Taxpayer from the Employer is an ETP and is taxed accordingly.