Edited version of your written advice

Authorisation Number: 1013029113014

Date of advice: 6 June 2016

Ruling

Subject: PAYG Withholding obligation

Question 1

Is an amount paid by the entity to a former employee under a Deed of Settlement and Release an employment termination payment as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the entity obliged to withhold tax from the payment forming part of the settlement sum pursuant to section 12-85 of the Taxation Administration Act 1953 (TAA 1953)?

Answer

No

Question 3

Is the entity obliged to withhold tax from the payment forming part of the settlement sum pursuant to section 12-35 of Schedule 1 of the Taxation Administration Act 1953?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

A former employee commenced employment with the entity in 19XX.

The employee ceased employment with the entity in Australia about July 20XX to work overseas for a different related entity.

The employee's employer during their time overseas was a different entity.

The overseas employer was not an Australian resident company. The entity guaranteed the obligations of the overseas employer and the payment of all entitlements due to the employee, including for the period of their employment overseas.

The overseas employer and the employee entered into an employment contract in 20XX.

The employment contract was amended in 20XX. The amended employment deed states:

Provided that prior to the Expiry Date:

the Employee has not given notice of the termination of their employment;

the Employee has not terminated their employment; and

the Employer has not terminated the Employee's employment

the Employee will remain eligible to receive the Special Bonus subject to the satisfaction of the hurdles set out in the excel spreadsheet attached to this Deed.

The Employee's employment with the overseas employer was terminated in 20XX and they returned to Australia in 20XX.

In  20XX, the employee issued a letter of demand to the entity regarding an entitlement to special bonus and short term incentive bonus payments.

The entity did not accept that the employee was entitled to special bonus or the short term incentive bonus on the grounds that the employee did not meet the conditions for the payment of the same.

The issue of bonus payments could not be resolved between the parties and in 20XX, the employee commenced legal proceedings.

The entity rejected the employee's claims and the parties eventually agreed to settle all claims without admission of liability.

A Settlement and Release Deed (the Settlement Deed) between the employee and the entity was made.

The Settlement Deed states:

Settlement Sum

The entity will procure the payment of the gross amount less taxation deductions as required by law (Settlement Sum), which will comprise of:

a gross payment in respect of the Special Bonus to be paid in the following manner:

an amount to be held in trust by the entity pending the ATO Private Ruling: and

an amount to be paid to the employee; and

an amount will be paid to the employee's Solicitor in respect of legal costs incurred by the employee since the commencement of the Proceedings…

d) The employee acknowledges that the payment under this deed of the Settlement Sum is paid in full and final satisfaction of all 'Claims' (including but not limited to, the Employment Benefits) and is made without admission of liability by the Released Parties.

The Settlement Deed also states:

The employee:

unconditionally releases the Released Parties from all Claims the employee has now or may have had in the future if the parties had not executed this deed.

The term 'Claims' is defined as all actions, claims, demands, suits, proceedings, liabilities, sums of money, damages and costs arising, whether directly or indirectly from:

• the Employment;

• the Termination;

• the Employment Deed;

• the Proceedings;

• the termination of the Employment Deed;

• the Employment Benefits;

• any act or omission of the Company or the Group during the Employment; or

• a combination of any of the above.

'Termination' is defined as 'all circumstances relating to or connected with the termination of Employment, including negotiations relating to the terms and conditions upon which that event would occur'.

'Proceedings' is defined as proceedings commenced by the employee.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 82-135

Taxation Administration Act 1953 section 12-1

Taxation Administration Act 1953 section 12-35

Taxation Administration Act 1953 section 12-85

Reasons for decision

Questions 1 and 2

Employment termination payment

Subsection 82-130(1) of the ITAA 1997 states that a payment is an employment termination payment (ETP) if:

(a) it is received by you:

in consequence of the termination of your employment; or

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 treat a payment as an ETP, all the conditions in subsection 82-130(1) of the ITAA 1997 must be satisfied. Failure to satisfy any one of the conditions under subsection 82-130(1) will result in the payment not being treated as an ETP.

Payment received in 'consequence of' the termination

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 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).

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.

As further stated by the Commissioner in paragraph 6 of TR 2003/13:

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.

In the current case, the employee's employment with the entity was terminated. The employee was dissatisfied with the amounts paid to them on the termination and consequently, the employee commenced legal proceedings in respect of their entitlement to those amounts.

The entity rejected the employee's claims and the parties agreed to settle all claims without admission of liability for the settlement sum.

In view of the above, the payment represents a portion of the amount paid to the employee to settle all claims brought by them against their former employer, following the termination of their employment.

While the payment to be made to the employee follows as a result or effect of the settlement of the legal proceedings - the proceedings were commenced by the employee as a result or effect of the termination of their employment. That is, there was a sequence of related events following the termination of employment which ultimately led to the payment.

Therefore, it is our view that the payment to be paid to the employee by the entity is to be received by the employee in consequence of the termination of their employment.

We do not accept that the above mentioned payment is in the nature of a special bonus to be paid to the employee. Rather, we take the view that, in this case, special bonus is simply a label for, or a description of, the payment for the purposes of the settlement deed which was entered into to reach a settlement and prevent any further litigation between the parties.

Finally, a payment may be made in consequence of a number of circumstances and it is not necessary that the termination of the employment be the dominant cause of the payment so long as the payment follows as an effect or result of the termination.'

Based on the above, the condition in paragraph 82-130(1)(a) of the ITAA 1997 is met in this case.

Payment received within 12 months of termination

In this case, the termination of the employee's employment with the entity occurred in 20XX and the payment has not been received by the employee to date.

As is now more than three years after the termination, the condition in paragraph 82-130(1)(b) of the ITAA 1997 is not met.

However, subsection 82-130(4) of the ITAA 1997, as far as relevant, provides that paragraph 82-130(1)(b) of the ITAA 1997 does not apply if a person is covered by a determination under subsection 82-130(5) or (7) of the ITAA 1997.

In accordance with subsection 82-130(5) of the ITAA 1997, the Commissioner may determine (in writing) that paragraph 82-130(1)(b) of the ITAA 1997 does not apply if the Commissioner considers that the time between the employment termination and the payment is reasonable having regard to the following:

(a) the circumstances of the employment termination, including any dispute in relation to the termination;

(b) the circumstances of the payment;

(c) the circumstances of the person making the payment;

(d) any other relevant circumstances.

In accordance with subsection 82-130(7) of the ITAA 1997, the Commissioner has issued a legislative instrument SPR 2007-1 - Employment Termination Payments (12 month rule) (SPR 2007-1) which extends the definition of employment termination payment to include certain payments that are received more than 12 months after the termination of a person's employment if the delay in the payment was due to the commencement of legal action concerning either or both:

the person's entitlement to the payment;

the amount of the person's entitlement.

The legal action must have commenced within 12 months of the termination of a person's employment. Legal action is intended to cover any Court, Tribunal and other proceedings of a judicial or quasi-judicial nature which may result in the payment of an amount in consequence of the termination of a person's employment.

In this case, the Commissioner has not issued a determination under subsection 82-130(5) of the ITAA 1997. In addition, SPR 2007-1 does not apply because the employee's termination occurred on or about 20XX and the legal action was commenced by the employee in 20XX, which is more than 12 months after the termination. Consequently, the condition in paragraph 82-130(1)(b) of the ITAA 1997 has not been met in this case.

As stated above, a payment will be an employment termination payment only if all the conditions of subsection 82-130(1) of the ITAA 1997 have been met. As one of the conditions under subsection 82-130(1) of the ITAA 1997 has not been met, the payment, to be made by the entity to the employee, is not an ETP as defined in subsection 82-130(1) of the ITAA 1997.

Question 3

Part 2-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) relates to the PAYG withholding system.

Division 12 of Schedule 1 to the TAA 1953 relates to payments from which amounts must be withheld.

Section 12-35 of Schedule 1 to the TAA 1953 provides that an entity must withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee (whether of that or another entity).

In this case, the payment that forms part of the settlement sum is in respect of the special bonus. As this amount is considered to be a bonus payment, an entity must withhold an amount from the payment.

Section 12-1 of Schedule 1 of the TAA 1953 provides a number of exceptions to withholding. An entity need not withhold an amount under Subdivision 12-B, Subdivision 12-C or section 12-120 or 12-190 from a payment if the whole of the payment is not assessable income and is not exempt income of the entity receiving the payment.

You have argued that foreign salary and wages derived by a non-resident are not assessable income and would be subject to the exception.

The income is assessed in the period in which it was received. The settlement sum comprising the bonus payment was paid in the 20XX financial year.

The employee is considered to be an Australian resident in the 20XX financial year and as such, no exception applies under section 12-1 (1A) of Schedule 1 of TAA 1953.

Therefore the entity is required to withhold tax from the payment forming part of the settlement sum pursuant to section 12-35 of Schedule 1 of the Taxation Administration Act 1953.