Edited version of your written advice

Authorisation Number: 1012698336548

Ruling

Subject: Genuine redundancy

Question

Will any part of the payment received on termination of employment under a deed of release be a tax-free part of a genuine redundancy payment under section 83-170 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2013.

The scheme commenced on:

1 July 2012.

Relevant facts and circumstances

Your client is an Australian resident.

Your client is under 60 years old.

From the 19XX-YY income year your client was employed by a company (the Australian Company) which was a wholly-owned subsidiary of a multi-national group of companies (the Foreign Group) whose head office was located overseas.

Your client initially held the role of a Sales Director.

Your client in subsequent years came to a hold a role as a Director and was a dual capacity employee from the relevant income year upon becoming a Managing Director.

During the subsequent income year your client was notified of the Foreign Group's decision to wind up the Australian Company.

Prior to the termination of your client's employment with the Australian Company, a member from the board of directors of the Foreign Group verbally advised that there may be an opportunity for your client to perform work for some companies within the Foreign Group.

X contracts (agreements) were produced with an effective date during the 20XX income year. These agreements are referred to later.

In a Deed of Release (the Deed) it stated your client's employment in the capacity of Managing Director of the Australian Company would be terminated on the basis of redundancy, effective during the 20XX income year.

The Deed refers to Employment having commenced during the 1998-99 income year and Termination during the 2012-13 income year.

In the Deed it also states the consideration provided for in the Deed is in full and final satisfaction of all claims of any kind the Executive has or may have had against the Group arising out of, in connection with or in relation to, the Employment and the Termination.

A payment advice provided to your client shows a total termination payment was made comprising of a Golden handshake, accrued annual leave and accrued long service leave.

You advised that had your client's employment with the Australian Company been voluntarily terminated, they would only have been entitled to a payout of their unused leave entitlements.

At the time the Deed was executed it was intended that the liquidators would:

• take possession of the Australian Company's accounts; and

• for a set period, take over the management of the Australian Company. This included the collection of outstanding debt and arranging payments for outstanding creditors.

It was then intended that the Australian Company would commence voluntary liquidation during the 20XX income year.

The Deed stated your client would maintain the role as Director in order to provide assistance to the liquidators in the finalisation of the abovementioned affairs.

You state the Australian Company did not commence liquidation on the date intended, but instead commenced liquidation during the 20YY income year.

You have advised that the assistance your client has provided the liquidator as Director has been limited to:

• making payments from the Australian Company's bank account at the direction of the liquidators; and

• executing company documents when required as requested by the liquidators and the Foreign Group.

Your client has provided estimates of the time it takes to perform the duties and states there is no remuneration as it was agreed between the relevant parties that the assistance provided was not sufficient to require remuneration.

In relation to the three agreements executed by your client were:

• Agency agreement one

• Agency agreement two; and

• Consulting agreement.

The two agency agreements listed above are identical apart from the name of the contracting agency. As such, they will be referred to as the Agency Agreements.

Copies of the Agency Agreements outlining the terms and conditions have been provided.

You have advised that the Agency Agreements include no specific directions as to how your client is to perform the work or how many hours your client spends in performing the work.

A copy of the Consultancy Agreement outlining the terms and conditions has been provided.

You have advised that in relation to Consultancy agreement:

• your client has full control over the methods used to prepare the marketing report and the amount of time spent preparing the report; and

• the agreement expired during the 20YY income year and was not renewed by the contracting company.

In relation to both the Consultancy Agreement and the Agency Agreements you have stated:

• your client has a right to subcontract or engage employees to fulfil their obligations under the contracts.

• the agreements are non-exclusive and your client is able to provide services to any other business. On dd/mm/yyyy your client executed an Agency Agreement with a business not connected with the Foreign Group.

• your client provides all the tools and equipment required to perform his duties.

• your client has no entitlement to any common employment benefits such as annual leave and long service leave.

Tax of $E was withheld from the total payment of $D as the Australian Company, on the advice of their accountants, did not treat the termination payment as a genuine redundancy payment. The accountants were of the belief that the agreements constituted arrangements at the time of dismissal, between the Australian Company and your client, to employ your client following the dismissal.

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 Section 83-10.

Income Tax Assessment Act 1997 Section 83-15.

Income Tax Assessment Act 1997 Section 83-80.

Income Tax Assessment Act 1997 Section 83-85.

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 Section 995-1.

Reasons for decision

Summary

The golden handshake payment of $A your client received is a genuine redundancy payment. Of this amount, $X is non-assessable non-exempt income as it represents the tax-free part of a genuine redundancy payment.

The amount of your genuine redundancy payment in excess of your tax-free amount, being $Y, is taxed as an employment termination payment.

Detailed reasoning

Genuine redundancy payment

A payment made to an employee is a genuine redundancy payment (GRP) if it satisfies all the conditions set out in section 83-175 of the Income Tax Assessment Act 1997 (ITAA 1997).  This section 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 and 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 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)).

Subsection 82-135 of the ITAA 1997 includes (among others):

_ superannuation benefits;

_ the payment of a pension or annuity; and

_ unused annual leave (paragraph 82-135(c)) or long service leave payments (paragraph 82-135(d)).

In view of the above, the payment your client received for unused long service leave cannot be a GRP pursuant to subsection 82-135(4) of the ITAA 1997. The taxation treatment of this payment will be discussed in due course.

Whether the 'golden handshake' payment of $A your client received constitutes a GRP will be addressed below.

In order to satisfy the definition of a GRP in subsection 83-175(1) of the ITAA 1997, there needs to be a dismissal from employment, the position must be redundant and the payment received must exceed the amount that would have been received had there been a voluntary resignation.

According to the facts your client's role as a Managing Director was made redundant following the decision to wind up the Australian Company. The Australian Company ceased trading shortly after the effective date of the Deed of Release (the Deed).

As the Australian Company ceased trading with the intention to liquidate, it is clear your client's role as Managing Director was made redundant.

However, as your client was a dual employee and still holds the role of Director, it needs to be considered whether a dismissal took place for general redundancy purposes.

The Deed stated your client would maintain the role as Director in order to provide assistance to the liquidator in the finalisation of the Australian Company's affairs. This would ordinarily imply that a 'dismissal' has not actually taken place. However, according to the facts your client merely assists the liquidator and does not receive any remuneration as the relevant parties agreed that the assistance provided was not sufficient to require remuneration.

Further, the Deed represents a full and final satisfaction of all claims your client has against the Group arising from the employment and termination.

Therefore, despite your client still holding the position of Director while the Australian Company is being liquidated, the requirement of 'dismissal' is satisfied for the purposes of the definition as the Deed represents a finalisation of all affairs for which remuneration is provided.

As your client would only have been entitled to a payout relating to unused leave entitlements upon voluntary termination, the golden handshake exceeds what your client could reasonably have expected to receive.

Based on the above, the golden handshake payment of $A satisfies the definition of a GRP under subsection 83-175(1) of the ITAA 1997.

However, subsection 83-175(2) of the ITAA 1997 requires a number of other conditions to be satisfied; the most contentious being the condition under paragraph 83-175(2)(c) of the ITAA 1997. As such, this condition will be analysed in isolation below.

No stipulated arrangement to employ

In order to satisfy the criteria of a GRP under paragraph 83-175(2)(c) of the ITAA 1997 there must not have been an arrangement between your client and the employer, or the employer and another entity, at the time of the dismissal to employ your client following the dismissal.

Taxation Ruling TR 2009/2, titled Income Tax: genuine redundancy payments, which outlines the Commissioner's view of the requirements for a payment to qualify as a GRP under section 83-175 of the ITAA 1997, discusses what constitutes an 'arrangement to employ'. In particular:

52. The Commissioner considers that the phrase 'arrangement... to employ' in paragraph 83-175(2)(c) refers to common law employment only. This condition does not contemplate a situation where there is an arrangement to engage the former employee as an independent contractor.

Accordingly, it must be determined whether your client was an independent contractor or an employee for the purposes of the three contracts (Agreements) he entered into with the subsidiaries of the Foreign Group.

Common law employee

A common law employee is employed under a contract of service as opposed to an independent contractor who is employed under a contract for services.

Whether a person is considered a common law employee is determined by examining the terms and circumstances of the contract, referring to the key indicators expressed in the relevant case law and examining a number of factors within the context of the relationship between the parties. No one indicator of itself is determinative and therefore the totality of the relationship is considered.

Superannuation Guarantee Ruling SGR 2005/1 identifies the major indicators to determine a common law employment relationship to be:

• Control.

• Integration.

• Results.

• Delegation.

• Risk.

• Provision of tools and equipment and payment of business expenses.

Control

Paragraph 33 of SGR 2005/1 states that a common law employee is told not only what work is to be done, but how and where it is to be done and refers to the following statement made by Justice Dixon of the Full High Court in Humberstone v. Northern Timber Mills (1949) 79 CLR 389; (1949) 23 ALJ 584; [1950] VLR 44; [1949] ALR 985:

The question is not whether in practice the work was in fact done subject to a direction and control exercised by an actual supervision or whether an actual supervision was possible but whether ultimate authority over the man in the performance of his work resided in the employer so that he was subject to the latter's order and directions. …

According to the Consultancy Agreement, your client was required to produce a report at least quarterly or any other time specified by the other party. The contract does not specify as to how your client was to perform the work or the hours required to perform the work. Therefore, it is reasonable to conclude that while your client was told what to do, the contract did not bind your client to 'how' or 'where' the work was to be completed. This indicates your client possessed sufficient control to warrant the Consultancy Agreement to be that of an independent contractor.

Your client's obligations under the Agency Agreements were to promote, market and solicit orders of the company's products to existing and potential customers. These included submitting orders, negotiating, executing and implementing sales of products, settle complaints and other sales support activities for the purpose of new and existing projects. Your client was also required to supply the company with reports regarding the above as and when required.

In completing these activities, a term (the Term) in the Agency Agreements stipulated your client was required to strictly conform to any and all instructions given from time to time by the company.

The Term would suggest the contract bound your client not only by the 'what' but potentially also the 'how' and 'where'. This would suggest your client could not exercise the level of control expected in a contract for service. However despite the contract specifying the 'what' and 'how', according to paragraph 35 of SGR 2005/1 this does not necessarily imply an employment relationship as a high degree of direction and control is not uncommon in contracts for services.

Based on the above it is unclear whether your client could exercise the level of control required to be considered an independent contractor. However, it is also unclear whether your client's control was restricted enough to warrant the status of an employee.

Accordingly, a definitive conclusion with regards to the 'control' criteria for the Agency Agreements cannot be made.

Integration

Paragraph 39 of SGR 2005/1 distinguishes between an employee and an independent contractor by identifying the difference between a person serving their employer within their employer's business and a person who is carrying on a trade or business of their own.

There is little evidence in the Consultancy Agreement to suggest your client was integrated into the contracting party's business. The contract was non-exclusive, your client did not work full time, and your client had independence in terms of how the work was to be produced. Based on this your client would not be considered an integral part of the business.

Whilst not determinative, it is important to consider the intentions of both parties. The contract explicitly acknowledges your client as an independent contractor stating that neither your client nor your client's agents shall be considered as having the status of an employee.

Further, the Consultancy Agreement expired during the 20YY income year and was not renewed. This suggests that the substance of the contract accurately reflects the form of the contract. That is, it was not a contract of service disguised as a contract for service.

Based on the above it would appear more likely that your client was operating a business as a consultant, rather than serving the contracting company within their business. This would suggest the Consultancy Agreement was a contract for service and therefore that of an independent contractor.

Similarly, the Agency Agreements acknowledge your client as a non-exclusive independent contractor. What is noteworthy about the Agency Agreements is that they state that any stationary or advertising used by your client was to reflect your client as an independent contractor. This indicates that under the Agency Agreements, your client was never held out to customers as an employee of the company but rather as carrying a business.

Based on the above analysis of the 'integration' criteria, it would appear the Agency Agreements are contracts for services.

Results

A strong indicator that a person is a contractor is where the nature of the contract is for the worker to produce a given result.

Paragraph 42 of SGR 2005/1 quotes Justice Sheller of the NSW Court of Appeals in World Book (Aust) Pty Ltd v. Federal Commissioner of Taxation (1992) 27 NSWLR 377; (1992) 46 IR 1; (1992) 108 ALR 510; (1992) 23 ATR 412; (1992) 92 ATC 4327 (World Book) as follows:

Undertaking the production for a given result has been considered to be a mark, if not the mark, of an independent contractor.

Paragraph 43 of SGR 2005/1 goes on to state:

The 'production of a given result' means the performance of a service by a person who is free to employ their own means (such as third party labour, plant and equipment) to achieve the contractually specified outcome. Satisfactory completion of the specified service is the 'result' for which the parties have bargained. The consideration is often a fixed sum on completion of the particular job as opposed to an amount paid by reference to hours worked. If remuneration is payable when, and only when, the contractual conditions have been fulfilled the remuneration is usually made for producing a given result.

The Consultancy Agreement requires your client to produce a periodic report. This represents a contractually specified outcome your client must deliver and therefore a 'result' for which the parties have bargained for. While the report in itself could be considered a 'result' there are other factors that suggest the contract is one to produce a given result.

Firstly, there is evidence in the Consultancy Agreement that demonstrates your client could also to produce the report through subcontractors. This is confirmed in the Agreement whereby reference is made to your client's agents. Further, nowhere in the contract does it state your client has to personally perform the tasks.

Secondly, with regards to remuneration, the contract specified a fixed annual fee to be paid to your client on a periodic basis. Whilst not necessarily paid on completion of the report, it is a pre-negotiated fee and is not paid with reference to hours worked.

The above would suggest the Consultancy Agreement is a contract to produce a result which makes it more likely that your client holds the status of an independent contractor rather than an employee.

The Agency Agreements require your client to perform various tasks involving the promotion and sale of the companies' products. Whilst your client is not producing a tangible product, for example, a report as seen in the Consultancy Agreement, your client is remunerated on a commission basis.

In this case, as the commission is calculated with reference to total sales, the total periodic sales figure could be considered a 'result'. Further, if the companies fail to receive full payment in respect of any purchase order submitted by a customer your client was responsible for, no commission would be payable. This suggests your client is only remuneration upon completion of the specified service for which the parties have bargained.

Further, nowhere in the Agency Agreements is it specified that your client was required to personally perform the work.

The above indicates the Agency Agreements are contracts to produce a result which again suggests your client holds the status of an independent contractor rather than an employee under these contracts.

Delegation

Paragraph 48 of SGR 2005/1 states that if a person is contractually required to personally perform the work, this is an indication that the person is an employee. If an employee has unlimited power to delegate the work to others (with or without approval or consent of the principal), this is a strong indication that the person is being engaged as an independent contractor.

As discussed previously, neither the Consultancy Agreement nor the Agency Agreements require your client to personally perform the contracted services. You have stated that all agreements allow your client to delegate work by subcontracting. This has been confirmed in the Consultancy Agreement as previously discussed.

As your client is able to delegate work under both the Consultancy Agreement and the Agency Agreements, it provides a strong indication that your client is being engaged as an independent contractor in these contracts.

Risk

Paragraph 51 of SGR 2005/1 states that where a worker bears little or no risk of the costs arising out of injury or defect in carrying out their work, they are more likely to be an employee. An independent contractor often carries their own insurance and indemnity policies.

The Consultancy Agreement provides no indication with regards to the risk borne by your client.

In regards to the Agency Agreements, it can be argued that your client bears the commercial risk for the services provided under these contracts. This is because the companies are not obliged to pay commission where they fail to receive full payment in respect of sales negotiated by your client.

The Agency Agreements provide no indication of any insurance or indemnity policies your client was required to obtain.

Based on the above it would appear that your client bares some risk with respect to the Agency Agreements, but otherwise the risk indicator remains unclear.

Provision of tools/equipment and payment of business expenses

Paragraph 52 of SGR 2005/1 states that the provision of assets, equipment and tools by an individual and the incurring of expenses and other overheads is an indicator that the individual is an independent contractor.

Paragraph 57 of SGR 2005/1 goes on to state that an employee, unlike a contractor, is often reimbursed for expenses incurred in the course of employment.

There is no mention in either the Consultancy Agreement or the Agency Agreements as to which party is responsible for the provision of tools and equipment. However, you have stated your client provides all the tools and equipment required to perform the duties under all the contracts. This would indicate your client is engaged as an independent contractor.

The Consultancy Agreement provides an avenue for your client to be reimbursed for out of pocket expenses, other than travelling and lodging expenses which have already been factored into the annual fee. However, your client cannot pay for such expenses without consent from the company.

Further you have stated that despite the reimbursement provision in the contract, there was an agreement between your client and the company that there would be no claims for reimbursement for any expenses under the agreement.

Based on the above, this indicator remains unclear for the Consultancy Agreement.

The Agency Agreements state that other than the commission payable to your client, the company has no obligation to pay any other compensation, costs or expenses to your client. This is consistent with independent contractor engagements.

Other indicators

Other indicators of whether an employment relationship exists have been variously stated and have been added to from time to time. These include the right to suspend or dismiss the person engaged, the right to exclusive services of the person engaged, compulsory uniforms, provision of benefits such as annual, sick and long service leave and the provisions of other benefits prescribed under an award for employees.

As stated previously, both the Consultancy Agreement and the Agency Agreements are non-exclusive and therefore your client is free to engage in work with other contracting parties. Further, you have stated that your client has executed an Agency Agreement with a business not connected with the Foreign group.

Neither the Consultancy Agreement nor the Agency Agreements provide for employee benefits such as sick leave or annual leave.

Based on these other indicators it would appear your client was engaged as an independent contractor.

Through the analysis of various indicators, SGR 2005/1 identifies when an individual is considered an employee under subsection 12(1) of the SGAA. In this case, the indicators of control, integration, results contract, delegation, risk and the provision of tools/equipment and payment of business expenses have been considered.

In relation to the Consultancy Agreement, the risk and reimbursement indicators produced an unclear result. However, the other indicators of control, integration, results, delegation, provision of tools and employee benefits did not establish a common law employee relationship between the parties. Based on this we can conclude your client was engaged as an independent contractor under the Consultancy Agreement.

The control and risk indicators produced unclear results with respect to the Agency Agreements. However, all the remaining indicators were clear in not finding a common law employee relationship between the parties. As such we have determined that your client was engaged as an independent contractor under the Agency Agreements.

Based on the above, the condition under paragraph 83-175(2)(a) of the ITAA 1997 has been satisfied.

The remaining conditions under subsection 83-175(2) of the ITAA 1997 are satisfied as:

• your client is less than 65 years of age; and

• according to the payment advice, no amount was received by you in lieu of superannuation.

In view of the above, $X of your client's total redundancy payment of $A is non-assessable, non-exempt income under subsection 83-170(2) of the ITAA 1997. Therefore, it is not required to be included in your client's income tax return for the 2012-13 income year.

Tax-free amount of a genuine redundancy payment

Subsection 83-170(2) of the ITAA 1997 provides that so much of the genuine redundancy payment that does not exceed the amount worked out using the formula prescribed in subsection 83-170(3) is non-assessable, non-exempt income. Any amount in excess of the tax-free amount is taxed as an employment termination payment. The formula for working out the tax-free amount is:

Base amount + (Service amount × Years of service)

For the 2012-13 income year:

Base amount is $8,806;

Service amount is $4,404; and

Years of service is the number of whole years in the period, or sum of periods, of employment to which the payment relates.

Employment termination payment

As stated previously, any amount in excess of the tax-free amount is an employment termination payment. Thus, the amount of your client's GRP in excess of the tax-free amount is $Y will be taxed as an employment termination payment (ETP).

As the ETP is made in connection with genuine redundancy and your client had reached their preservation age of 55 by the end of the relevant income year, the applicable tax rate is 16.5% including Medicare levy.

Further issues for you to consider

Taxation treatment of unused annual leave and unused long service payments

Unused annual leave would ordinarily be included in assessable income under section 83-10 of the ITAA 1997 and subject to marginal rates of tax. However, if a payment of unused annual leave is made in connection with a genuine redundancy payment, section 83-15 allows a tax offset to ensure that the rate of tax on this amount does not exceed 30% plus Medicare levy.

Similarly, unused long service leave would ordinarily be included in assessable income under section 83-80 of the ITAA 1997. However, if this payment is made in connection with a genuine redundancy payment, section 83-85 allows a tax offset to ensure that the rate of tax on this amount does not exceed 30% plus Medicare levy.