Edited version of private advice

Authorisation Number: 1051859761780

Date of advice: 7 July 2021

Ruling

Subject: Assessable income - remuneration - bonus payments

Question 1: Are the Payments assessable under either section 6-5 or 15-2 of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year they are received?

Answer: Yes.

Question 2: Is there a discount capital gain under Division 115 of the ITAA 1997?

Answer: No.

This ruling applies for the following periods

Income year ending 30 June 20XX

Income year ending 30 June 20XX

Income year ending 30 June 20XX.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

You received a letter of offer of employment from Company A which included the following information:

•                The position is a salaried position

•                Your position was in a management role on a part-time basis

•                Your remuneration totalled $XX,XXX (gross) per annum inclusive of superannuation entitlements

•                You were eligible to receive several bonuses subject to conditions being met, in relation to Company A's sale proceeds from specified activities:

You entered a Contract of Employment (the Contract).

You did not receive any bonuses as outlined in the Contract and you entered into negotiations with Company A in relation to your bonuses.

You and Company A entered into a Deed of Variation of Employment Contract (the Deed) which provided for the deleting of the relevant clause in the Contract relating to your bonuses and for you to receive a payment in several years in relation to the agreed total amount of your accrued bonuses, being collectively referred to as the Payments.

You continued to be employed by Company A after you entered into the Deed.

Company A have indicated that they will be reporting the amounts included in the Payments as provided in the Deed in your payslip, and that they will withhold tax on those amounts.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 15-2

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Question 1:

There is an order to be followed when considering the potential application of remuneration related provisions to payments made to an employee.

The order for situations such as that being considered in the ruling are as follows:

•                Ordinary income (section 6-5 of the ITAA 1997)

•                Other remuneration benefits (section 15-2 of the ITAA 1997)

•                Capital gains tax (Parts 3-1 and 3-3 of the ITAA 1997).

We have considered the following when determining the assessability of the payments you will receive under the Deed.

Ordinary and statutory income

The provision of labour is the principal means of deriving income and it is at the centre of the notion of income according to ordinary concepts. A payment received by an individual in their capacity as an employee or otherwise in connection with employment activities constitutes ordinary income.

Salary and wages, including sick pay, holiday pay, back pay and long service leave, are the main forms of employment income and are assessable as ordinary income under section 6-5 of the ITAA 1997. Such payments are made to an employee under an employment contract as remuneration for services.

An incentive bonus generally comes within the meaning of ordinary income. An incentive bonus is an additional reward payment derived in the capacity as an employee as a financial incentive to remain in employment (Dean & Anor v. Federal Commissioner of Taxation (1997) 78 FCR 140; (1997) 37 ATR 52; 97 ATC 4762).

The remuneration strategy for a key individual within an organisation often contains special elements such as bonuses to reflect that key individual's effect on the organisation. The form that these special elements take can also affect the organisation. Such bonuses can also be situational and be paid at times when special rewards or incentives are considered appropriate.

Amounts that are not ordinary income but are included in your assessable income by another provision are called statutory income under section 6-10 of the ITAA 1997.

The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997 and included in this list is section 15-2 of the ITAA 1997.

Bonuses paid to employees are assessable under section 6-5 of the ITAA 1997 and would also come within section 15-2 of the ITAA 1997 which specifically taxes allowances, gratuities, compensations, benefits, bonuses and premiums provide to a taxpayer in respect of, or in relation directly or indirectly to, any employment, or services rendered by the taxpayer (unless already assessable under section 6-5).

In Sent v FC of T 2011 AATA 198, a Share Issue Deed providing for the issue of shares in the employer to the taxpayer or his nominee was executed. A payment to the executive share trust by the employer was ultimately used to buy the shares. The Administrative Appeals Tribunal (AAT) held that the taxpayer who agreed to give up his accrued bonus entitlements in return for a payment to an executive share trust in which he held an interest had derived assessable income. The AAT held that the accrued bonus payments would have been assessable income if received by the taxpayer. The fact that a payment was instead made to a trust in respect of these accrued bonuses did not change this outcome.

On appeal, the Federal Court in Sent v FC of T [2012] FCA 382 agreed that the payment to the trust was assessable as it was a reward for the taxpayer ' s services. The Federal Court however, disagreed with the AAT's finding that to the extent that the payment made to the trust was in respect of cancelled bonus entitlements that might accrue in the future, it was not assessable. The court viewed that the AAT was wrong to hold that the payment of monies in advance of services being rendered raised the presumption that if the services were not provided that the amount would be repaid. Although the future bonus entitlements were contingent on certain factors, these entitlements were cancelled and eventually replaced with a payment for which there was no contingencies.

The Full Federal Court agreed in Sent v FC of T (No 2) [2012] FCAFC 187 (Sent case) and held that the entitlement to the shares was free and clear of any contingency as to services provided and was not subject to any 'claw back' condition. The character of such a benefit in the form of shares was income because it was as much a reward for services rendered as it was a payment of the bonus entitlements.

Taxation Ruling TR 2010/6 Income tax, Pay As You Go Withholding and fringe benefits tax: tax consequences on the issue, holding and redemption of bonus units as part of an employee benefits trust arrangement considers the taxation implications for employees where bonus units are issues to employees as part of an employee benefits trust arrangement and:

•                whether, and in what circumstances, a payment received by an employee as a result of redemption of their bonus units constitutes a payment of salary or wages to the employee for the purposes of section 6-5 of the ITAA 1997 or compensation, benefits or bonuses for the purposes of section 15-2 of the ITAA 1997;

•                whether the issue of bonus units to an employee is in respect of employment or services rendered by the employee and constitutes a payment of salary or wages to the employee for the purposes of section 6-5 of the ITAA 1997 or compensation, benefits or bonuses for the purposes of section 15-2 of the ITAA 1997.

Paragraphs 12 and 13 of TR 2010/6 state:

12. When the employee redeems the bonus units and receives a payment from the trustee, the payment received by the employee is considered to be a derivation of salary or wages or bonus income, and therefore of ordinary income, for the purposes of section 6-5 or 'allowances and other things provided in respect of employment or services' for the purposes of section 15-2.

13. The payment received by the employee on redemption of the bonus units has the character of salary or wages or bonus income because the payment is made to the employee as a reward for services provided by the employee to the employer.

Capital payments

In practical terms, section 15-2 of the ITAA 1997 will generally only apply to receipts that are of a capital nature as section 6-5 of the ITAA 1997 would apply in preference to revenue receipts.

Payments of a capital nature will be assessable under section 15-2 of the ITAA 1997 if there is a relationship between the payment and the taxpayer's employment.

Application to your circumstances

You commenced employment with Company A and in accordance with the Contract were entitled to receive bonuses. However, you did not receive the accrued bonuses which resulted in you entering into the Deed to vary the Contract, being the Deed.

Under the Deed your accrued bonuses were replaced by an absolute entitlement for you to be paid an agreed amount, with a specified amount to be paid over several years. Additionally, the clause in the Contract relating to your original bonuses was deleted.

Any bonuses you would have received under the Contract would have been a reward for your services to your employer and would have been assessable income to you. While Company A was obligated to pay you the original bonus incentives, the fact that your bonuses are being paid in a different/substitute form will not alter the character of the receipt of the bonuses in your hands.

The bonus payments have changed under the Deed and for the reasons expressed in the Sent case, the Payments under the Deed due to the variation of the Contract are payments related to your employment and are rewards for your service to Company A. The Payments will also retain the same character as the bonus incentives that you should have received under the Contract and have not been converted to being capital in nature.

In accordance with the principles contained in the Sent case and TR 2010/6, the Payments are assessable under either section 6-5 or 15-2 of the ITAA 1997 and will be assessable in the income years in which they are received.

As we have determined that the Payments are assessable income under either section 6-5 or 15-2 of the ITAA 1997, there is no need to discuss any further whether the Payments are capital in nature.

Question 2:

Discount capital gains

You make a capital gain or loss as a result of a capital gains tax (CGT) event happening to a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property under subsection 108-5(1) of the ITAA 1997.

CGT events include:

•                CGT event C2, which occurs when a CGT asset is cancelled, redeemed, released, discharged, satisfied, abandoned, surrendered, or forfeited under section 104-25 of the ITAA 1997; and

•                CGT event D1 which occurs when you create a contractual right or other legal or equitable right in another entity under section 104-35 of the ITAA 1997.

A gross capital gain amount can be reduced by the 50% CGT discount if the conditions contained in Division 115 of the ITAA 1997 are met.

Section 118-20 of the ITAA 1997 exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains to prevent double taxation of those amounts.

Application to your circumstances

When you entered into the Deed, you received a right to receive the Payments over several years. Your employer created the contractual right in you to receive the Payments if certain conditions were met. You did not create the contractual right and therefore CGT event D1 does not occur to you.

You did not have a capital gain arising from a CGT event upon entering the Deed. Whilst a CGT event C2 will occur when the Payments are made to you under the Deed, the capital proceeds in relation to each payment will be reduced to nil due to the amount being otherwise included in your assessable income.

As per the Sent case, the original character of the bonus payments to you under the Contract was income, and that character will be maintained when the Payments are made under the Deed. Therefore, as the Payments will be totally assessable under either section 6-5 or 15-2 of the ITAA 1997 you will not make a capital gain to which the 50% CGT discount can be applied.