Edited version of your written advice

Authorisation Number: 1012980247067

Date of advice: 11 March 2016

Ruling

Subject: Employment termination payment.

Question

Is any part of the proposed payment your client will receive after the termination of their employment, considered to be a genuine redundancy payment in accordance with section 83-175 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

Your client commenced employment with the former employer as an ongoing employee in the 19XX-XX income year.

In early 20XX, your client entered into an agreement (the Agreement) with the former employer whereby your client's appointment as Director of a particular area was confirmed.

Your client's appointment was for a fixed period of five years.

Your client's former employer restructured its organisational structure in the relevant income year, effectively disestablishing your client's former position and allocating those functions to other areas.

Your client's employment with the former employer terminated one year before the end of the fixed contract of employment, with the former employer agreeing to pay your client the remaining period of the fixed contract of employment.

Your client's proposed separation payment on termination will comprise the following components:

• annual leave;

• leave loading;

• long service leave; and

• payout of remaining period of contract.

None of the above proposed payments to be received by your client will be for payment in lieu of superannuation benefits.

At the time of the termination there was no arrangement between your client and the former employer, or between the former employer and another person, to employ your client after termination.

Your client was less than 65 years old at the time of termination.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Subsection 83-10(2)

Income Tax Assessment Act 1997 Paragraph 83-15(a)

Income Tax Assessment Act 1997 Subsection 83-80(1)

Income Tax Assessment Act 1997 Subsection 83-85(1)

Income Tax Assessment Act 1997 Section 83-170

Income Tax Assessment Act 1997 Section 83-175

All references are to the ITAA 1997 unless otherwise indicated.

Reasons for decision

Summary

A portion of the proposed payment is a genuine redundancy payment.

The tax-free part of the genuine redundancy payment is calculated in accordance with subsection 83-170(3).

The remaining amount is an employment termination payment and treated as assessable income in the relevant income year.

The unused annual leave and leave loading amount and unused long service leave amount are not employment termination payments. These amounts are included in your client's assessable income in the relevant income year and subject to marginal rates of tax. However, as these amounts were made in connection with a genuine redundancy, your client is entitled to a tax offset on these amounts.

Detailed reasoning

Employment termination payment

A payment is an employment termination payment if it satisfies all the requirements in section 82-130 and is not specifically excluded under section 82-135.

Subsection 82-130(1) 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.

Section 82-135 provides that certain payments are not employer termination payments. Relevantly, these include (among others):

• unused annual leave or long service leave payments; and

• the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

Proposed separation payment

Taxation Ruling TR 2003/13 Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of' (TR 2003/13) states, at paragraphs 5 and 6, that:

5. ...the Commissioner considers that 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.

6. The phrase requires 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.

While TR 2003/13 contains references to repealed provisions, some of which may have been rewritten, the ruling still has effect.

Your client's employment was terminated one year before the end of the fixed contract of employment and as a result, a proposed payment is to be paid by your client's former employer to your client.

There is a clear causal connection between the termination of your client's employment and the proposed payment of this amount. The payment follows as an effect or result of the termination of your client's employment. In other words, but for the termination of your client's employment this payment would not have been made to your client.

Therefore, the proposed payment is made in consequence of the termination of your client's employment as defined in subparagraph 82-130(1)(a)(i).

Further, if this amount is paid to your client within 12 months of their termination paragraph 82-130(1)(b) will also be satisfied.

However, it is important to note, that the proposed payments for unused annual leave, leave loading and long service leave are specifically excluded from being employment termination payments under section 82-135. Consequently, the amounts representing unused annual leave, leave loading and unused long service leave are not employment termination payments and are taxed in accordance with Subdivision 83-A and Subdivision 83-B respectively.

Further, the tax-free part of a genuine redundancy payment is also excluded from being an employment termination payment under section 82-135.

Genuine redundancy payment

Under subsection 83-175(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. 

In Taxation Ruling 2009/2 Income tax: genuine redundancy payments (TR 2009/2), the Commissioner has outlined 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.

The Commissioner considers that there are four necessary components within this termination requirement:

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

• That termination must involve the 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.

Component 1: Payment 'in consequence of' an employee's termination.

As stated above, it is considered that the proposed payment will be received in consequence of the termination of your client's employment. Therefore, the first component of subsection 83-175(1) has been satisfied.

Component 2: Dismissed from employment.

At paragraph 18 of TR 2009/2, the Commissioner states:

Dismissal is a particular mode of employment termination. It requires 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.

On the basis of the facts as presented in your case, it is evident that your client did not resign but was, in fact, dismissed from their employment at the initiative of their former employer.

Therefore, the second component of subsection 83-175(1) has been satisfied.

Component 3: Dismissal caused by the redundancy

It is the Commissioner's view, as stated at paragraph 25 of TR 2009/2, that:

25. An employee's position is redundant when an employer determines that it is superfluous to the employer's needs and the employer does not want the position to be occupied by anyone. Accordingly, it is fundamentally the employer's decision that a position is redundant. On occasion the decision may be unavoidable due to the circumstances surrounding the employer's operations.

Based on the information provided, it is evident that the former employer made the ultimate decision that your client's position was redundant and that was the prevailing reason your client was dismissed from their employment.

Information available confirms that your client's role as Director of a particular area, was disestablished and the relevant services will be delivered by another unit.

The third requirement of a genuine redundancy has therefore been satisfied.

Component 4: 'genuinely' redundant.

The need for an employee's position to be genuinely redundant means that contrived cases of redundancy will not meet the conditions in section 83-175.

In your client's case, there is nothing to indicate that the redundancy is not genuine. Therefore, the fourth component of a genuine redundancy has been satisfied.

Further conditions for a genuine redundancy payment

Before a payment that meets the basic redundancy requirement in subsection 83-175(1) qualifies as a genuine redundancy payment, all other conditions in subsections 83-175(2) and (3) must be met. These conditions include:

• the payment must be made before a person turns 65 or an earlier mandatory age;

• the termination was not at the end of a fixed period of employment;

• the actual amount that was paid is not greater than the amount that could reasonably be expected to be paid had the parties been dealing at arm's length;

• the amount that was paid was in excess of what a person would have been entitled to receive if they had voluntarily resigned;

• there was no arrangement for re-employment with the employer or a related party after the termination date; and

• the payment was not in lieu of superannuation benefits.

On the basis of the information provided, it is considered that all the conditions of subsections 83-175(2) and 83-175(3) are also satisfied.

As it is accepted that your client's employment was terminated because their position was genuinely redundant, part of the condition under subsection 83-175(1) has been met. However, subsection 83-175(1) also requires that for a payment to be a genuine redundancy payment, it should exceed the amount that an employee would receive on voluntary termination of employment. That is, only that part of the payment that exceeds the amount that could reasonably be expected to be received by your client had they voluntarily terminated their employment at the time of termination is treated as a genuine redundancy payment.

As noted earlier, the payments for unused leave entitlements are taxed under Subdivision 83A and Subdivision 83B. The balance is a genuine redundancy payment as your client would not have received it had they voluntarily terminated employment.

Taxation of a genuine redundancy payment

Subsection 83-170(2) 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 not assessable income and is not exempt income. Any amount in excess of the tax-free amount is taxed as an employment termination payment.

As per subsection 83-170(3), the formula for working out the tax-free amount is:

Base amount + (Service amount × Years of service)

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

For the 2015-16 income year:

Base amount means $9,780; and

Service amount means $4,891.

Taxation treatment of unused annual leave and long service leave

Unused annual leave and unused long service leave payments are to be included in your client's assessable income for the relevant income year (subsection 83-10(2) and subsection 83-80(1)).

However, as it has been determined that your client's former position is genuinely redundant, your client is entitled to a tax offset which ensures that the rate of tax on these payments does not exceed 32% (including Medicare levy) (paragraph 83-15(a) and subsection 83-85(1)).