Edited version of your written advice

Authorisation Number: 1012668037572

Ruling

Subject: Employment termination payment

Question

Will a termination payment received by the Taxpayer be 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

Yes

This ruling applies for the following periods:

The year ending 30 June 2014

The year ending 30 June 2015

The scheme commences on:

1 July 2013

Relevant facts and circumstances

The Employer is a business that provides a machine and driver to a client on a contractual basis.

The Taxpayer is a director and sole employee of the Employer.

The Taxpayer was employed at the Employer for a number of years up to the relevant income year.

During the relevant income year, the client terminated its contract with the Employer.

During the relevant income year we received the following reasons for the decision to close the business:

• After the contract was terminated with the client, the Employer actively sort work through connections they had within the industry. This was conducted by a series of phone calls advising other fellow associates in the industry that work was needed and that the Employer could start immediately.

• The type and size of the machine used means only commercial work can be performed.

• As such some work was sourced but at poor rates and very spasmodic. After two months of trying to source work in a poor commercial environment, it was decided to close the business and sell the equipment.

The Taxpayer in their capacity as director of the Employer made the decision to terminate their own employment.

The Taxpayer was paid a wage and all relevant entitlements under the Fair Work National Employment Standards (NES).

In the case, the Taxpayer is entitled to a number of weeks' salary if receiving a redundancy payment under the Fair Work NES.

A payment will be made to the Taxpayer within a year of the termination of employment.

The Taxpayer is not entitled to any payments had they resigned voluntarily.

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 Subparagraph 82-130(1)(a)(i)

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

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 Section 82-135

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

Income Tax Assessment Act 1997 Section 83-170

Income Tax Assessment Act 1997 Subsection 83-170(1)

Income Tax Assessment Act 1997 Subsection 83-170(2)

Income Tax Assessment Act 1997 Subsection 83-170(3)

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 Paragraph 83-175(2)(a)

Income Tax Assessment Act 1997 Subparagraph 83-175(2)(a)(i)

Income Tax Assessment Act 1997 Subparagraph  83-175(2)(a)(ii)

Income Tax Assessment Act 1997 Paragraph 83-175(2)(b)

Income Tax Assessment Act 1997 Paragraph 83-175(2)(c)

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

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

Income Tax Assessment Act 1997 Subsection 955-1(1)

Reasons for decision

Summary

The termination payment received by the Taxpayer is a tax-free part of a genuine redundancy payment for the purposes of section 83-170 of the ITAA 1997.

The payment to be made to the Taxpayer does not exceed this tax-free amount. Consequently, the total of the payment to be received is not assessable income and is not exempt income.

Detailed reasoning

Employment termination payments

By virtue of subsection 995-1(1) of ITAA 1997, employment termination payments are defined in subsection 82-130(1) of the ITAA 1997, which states that 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 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 employee termination payment (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 employment termination payment.

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 employment termination payment, 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 in their capacity as the director of the Employer has determined that the business can no longer continue after the loss of its contract the client during the relevant income year and all other avenues for business have been exhausted. Hence the decision was made during the relevant income year to terminate the employment of the Taxpayer.

As a result of the termination, the Employer will make a payment based on the Fair Work NES to the Taxpayer. 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 their employment with the Employer.

Payment is received no later than 12 months after termination

A payment will be made to the Taxpayer within a year of the termination of employment. Therefore this condition will be 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.

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.

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.

Each of these requirements will be considered in turn below.

Payment must be received in consequence of an employee's termination

For the reasons above, it is considered that, in this case, the payment was received by the Taxpayer in consequence of the termination of their employment.

Termination must involve the employee being dismissed from employment

The term 'dismissal' is not defined in the ITAA 1997 therefore, consistent with basic principles of statutory interpretation, its 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.

In this case, the Taxpayer is a dual capacity employee. Because a dual capacity employee can terminate their own employment or actively participate in or influence an act or decision to terminate their own employment, careful consideration of all the facts and circumstances is required to determine whether a dual capacity employee has not consented to their termination (paragraph 82, TR 2009/2).

The question of consent for a dual capacity employee can be addressed by considering the following two matters (paragraph 84, TR 2009/2):

• First, did the person agree to or approve the employer's act or decision to terminate their own employment? If not, the termination is without the person's consent and is therefore a dismissal.

• Secondly, if the person did agree to or approve the employer's act or decision to terminate their own employment, were the circumstances surrounding the act or decision such that the person did not have any real or practical choice in terminating their own employment. If so, the termination is without the person's consent and is therefore a dismissal.

In this case, the Taxpayer in their capacity as director had approved the Employer's decision to terminate their own employment. The Employer had lost the contract that was the only source of its business, and it was unsuccessful in finding new work. It is considered that the circumstances surrounding the decision were such that the Taxpayer did not have any real or practical choice but to terminate their own employment. Hence, the termination is without the Taxpayer's consent and is therefore a dismissal.

Dismissal must be caused by the redundancy of the employee's position

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 (paragraph 25, TR 2009/2).

In this case, the Employer will cease to exist once it has disposed of all its assets and payed all its liabilities. Accordingly, the Taxpayer in their capacity as director has determined that the position of the Taxpayers role as a driver was no longer required. Therefore this requirement is satisfied.

The redundancy payment must be made genuinely because of a redundancy

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).

Based on the reasons above, we accept that the redundancy payment was made genuinely because of a redundancy.

Exceeds the amount that could reasonably be expected

The payment that the Taxpayer receives must exceed 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.

The Taxpayer is not entitled to any payments had they resigned voluntarily.

The payment to be made to the Taxpayer will based on the Fair Work NES.

As the amount that the Taxpayer is to receive is more than the amount that would have been reasonably expected had the Taxpayer voluntarily resigned, this requirement is satisfied.

Further conditions for a genuine redundancy payment

Further conditions must be satisfied in order for the payment to be considered a genuine redundancy payment (see subsection 83-175(2) of the ITAA 1997).

The first condition requires that the taxpayer is dismissed before the earlier of the day the taxpayer turns 65 or the day they reach a particular age or completed a particular period of service that would have terminated the taxpayer's employment

This condition is satisfied as the Taxpayer was dismissed from their role before they turned 65 years of age.

The second condition requires that if the dismissal were not at arm's length, that the payment does not exceed the amount that could be reasonably expected to be made if the dismissal were at arm's length.

This condition does not apply as the dismissal was made at arm's length.

The third condition is that at the time of 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.

This condition is satisfied as, at the time of dismissal there was no arrangement (written, verbal or implied) between the Taxpayer and the Employer or between the Employer and another person, to employ the Taxpayer after the dismissal.

Not a payment received by the employee in lieu of superannuation benefits

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.

This condition is satisfied as the payment is not received in lieu of superannuation benefits.

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

Subsection 83-175(4) of the ITAA 1997 provides that a payment is not a genuine redundancy payment if it is a payment mentioned in section 82-135 (apart from paragraph 82-135(e)). Section 82-135 of the ITAA 1997 includes (among others):

_ superannuation benefits;

_ the payment of a pension or annuity; and

_ unused annual leave or long service leave payments.

This condition is satisfied as the payment is not a payment mentioned in section 82-135 of the ITAA 1997 (apart from paragraph 82-135(e)).

Tax-free amount

Section 83-170 of the ITAA 1997 provides that so much of the genuine redundancy payment that does not exceed the amount worked out using the prescribed formula is not assessable income and is not exempt income. The formula for working out the tax-free amount is:

Base amount + (Service amount x Years of service)

For the 2014-15 income year:

Base amount means $9,514;

Service amount means $4,758; and

Years of service means the number of whole years in the period, or sum of periods, of employment to which the payment relates. It should be noted that six months, eight months or even eleven months do not count as a whole year for the purposes of this calculation.

1. The Taxpayer had completed a number of years of service at the time of the termination of their employment. Therefore, the tax-free amount determined under subsection 83-170(3) of the ITAA 1997 is:

= $9,514 + [$4,758 x completed years of service]

= $X

2. The payment to be made to the Taxpayer does not exceed this tax-free amount. Consequently, the total of the payment received is not assessable income and is not exempt income.