Edited version of your written advice

Authorisation Number: 1051200875057

Date of advice: 22 March 2017

Ruling

Subject: Employment termination payments

Question

Is any part of the payment that a person (the Taxpayer) received on the termination of their employment a genuine redundancy payment under section 83-175 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

Income year ended 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

The Taxpayer commenced employment with an entity (the Employer).

The Taxpayer's employment was terminated by the Employer as the role was no longer required due to operational requirements.

The Taxpayer was employed by the Employer under a fixed term Employment Contract (the Agreement). The termination date of the contract had not occurred when the Taxpayer was made redundant.

The Taxpayer has been employed by the Employer under a series of fixed term contracts.

Had the Taxpayer voluntarily terminated the Agreement, they would not have received the early end of contract payment.

The Employer advised that the payment was calculated according to industry standards. The Employer did not provide any information as to which industry standards were used in calculating the final payment.

The Taxpayer was issued with a PAYG payment summary employment termination payment. The payment summary has been issued at code 'O'

The Taxpayer is less than 65 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 82-130.

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, subsection 83-170(2).

Income Tax Assessment Act 1997, subsection 83-170(3).

Income Tax Assessment Act 1997, section 83-175

Reasons for decision

Summary

An amount consisting of the payment in lieu of notice and the early end of contract payment, is a genuine redundancy payment (GRP) as defined in section 83-175 of the (ITAA 1997). Only part of this amount is not assessable and is not exempt income. That is, it is tax free and does not need to be included in the Taxpayer's income tax return.

The remainder of the GRP is taxed as an employment termination payment (ETP). It is to be included in the Taxpayer's assessable income.

The payment consisting of the payment for annual and the payment for annual leave loading is not a GRP as this payment is excluded from definition of an ETP by section 82-135 of the ITAA 1997. It is to be included in the Taxpayer's assessable income.

Detailed reasoning

A payment made to an employee is a GRP if it satisfies all the criteria in section 83-175 of the ITAA 1997.

In accordance with subsection 83-175(1) of the ITAA 1997, a GRP 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 their employment at the time of dismissal.

The Commissioner of Taxation has issued Taxation Ruling TR 2009/2 Income tax: genuine redundancy payments (TR 2009/2), which outlines the requirements to be satisfied before any payment made to a person whose employment is terminated qualifies for treatment as a GRP under section 83-175 of the ITAA 1997.

In discussing what constitutes a GRP in accordance with subsection 83-175(1) of the ITAA 1997, paragraph 11 of TR 2009/2 states:

There are four necessary components within this requirement:

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

● That termination must involve an 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.

Payment 'in consequence of' 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. Whilst the courts have divergent views on the meaning of this 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 contains references to repealed provisions, some of which may have been rewritten, the ruling still has effect 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:

5. ... 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 instance, the Taxpayer's employment was terminated by the Employer due to the redundancy of the Taxpayer's position. The result of the termination was a lump sum payment. Therefore, the payment was received by the Taxpayer in consequence of the termination of their employment.

Dismissal' and 'redundancy'

The Commissioner's view, as stated in paragraphs 18 and 25 of TR 2009/2 is that:

18. 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 the employment that is terminated at the initiative of the employee…

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.

In this instance it is clear that the Taxpayer did not voluntarily resign from their employment. Rather, their employment was terminated by the Employer because the position that the Taxpayer occupied was no longer needed and the Employer did not want the position to be occupied by anyone else.

However, while it is accepted that the Taxpayer was dismissed from employment because their position was genuinely redundant, subsection 83-175(1) of the ITAA 1997 also requires that the payment received in consequence of redundancy exceeds the amount that the Taxpayer would have received had they voluntarily resigned from employment.

Paragraph 82-130(1)(c) of the ITAA 1997 specifically excludes payments of unused annual leave (including payments for unused leave loading) from being employment termination payments.

However, based on the information provided, an amount consisting of the payment in lieu of notice and the early end of contract pay is greater than the amount that the Taxpayer would have received if they had terminated their employment voluntarily at that time. That is, the payment exceeds the amount that the Taxpayer could have reasonably expected to receive in consequence of an alternate mode of employment termination.

Further conditions for a genuine redundancy payment

In addition to the basic requirement for a genuine redundancy payment found in subsection 83-175(1) of the ITAA 1997, the further conditions for genuine redundancy payment treatment in subsections 83-175(2) and (3) of the ITAA 1997 require that:

● the employee is dismissed before the earlier of 65 or a specified age;

● the termination is not at the end of a fixed period of employment;

● the amount paid is not greater than the amount that could reasonably be expected had the parties been dealing at arm's length, (in the event that the employer and employee are in fact not dealing at arm's length in relation to the dismissal);

● there is no arrangement entered into between the employer and the employee or the employer and another entity to employ the dismissed employee after the termination; and

● the payment is not in lieu of superannuation benefits.

In this instance, an amount is considered to be a GRP because:

● at the time of the termination the Taxpayer was less than 65 years of age;

● the Taxpayer's employment was not at the end of a fixed period;

● it is accepted that the dealings between the Taxpayer and the Employer were at arm's length;

● there was no agreement to employ the Taxpayer after the termination; and

● the payment was not in lieu of superannuation benefits.

Tax-free treatment of GRPs

Subsection 83-170(2) of the ITAA 1997 provides that so much of the GRP that does not exceed the amount worked out using the formula prescribed in subsection 83-170(3) of the ITAA 1997 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. The formula for working out the tax free amount is:

Base amount + (Service amount x Years of service)

For the 2015-16 income year:

Base amount means $9,780;

Service amount means $4,891; and

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

Accordingly, the tax-free part of the GRP received by the Taxpayer in the 2015-16 income year is:

$9,780 + ($4,891 x year of service) = an amount.

In the 2015-16 income year, a portion of the total GRP of is below the tax-free amount.

The remaining amount is an ETP to be included in the Taxpayer's assessable income for the 2015-16 income year.

This remaining amount is referred to as the taxable component of the ETP. As this amount was paid in relation to a GRP, it is subject to the ETP cap.

The ETP cap for the 2015-16 income years is $195,000. As the taxable component of the remaining amount is below the ETP cap, it is taxed at a minimum rate of 32% (including Medicare levy).

Taxation consequences of unused annual leave paid in connected with a GRP

Paragraph 83-10(a) of the ITAA 1997 provides that a payment that a person received in consequence of the termination of their employment is an unused annual leave payment if it is for annual leave that a person has not used.

Subparagraph 83-15(a)(i) of the ITAA 1997 provides that a person is entitled to a tax offset to ensure that the rate of tax on an unused annual leave payment does not exceed 30% to the extent that the payment was made in connection with a genuine redundancy payment.

The payment for unused annual leave and annual leave loading was paid in connection with a genuine redundancy payment. Therefore the Taxpayer is entitled to a tax offset to ensure that the rate of payment on this amount does not exceed 30%.