The Tax Office recently released an important tax ruling – TR 2009/2 – that outlines the conditions for a payment to qualify for concessional tax treatment as a “genuine redundancy payment” under the tax law.
They are important because part of a genuine redundancy payment is tax-free – for 2008-09, the tax-free amount is $7,350 + ($3,676 x number of years of employment to which the payment relates). So, for an employee with 10 years’ service, the tax-free amount could be $44,110.
Tax and redundancy payments is, like all things tax, complicated. It’s beyond the scope of this article to go into the full details here, but I hope the following outline is helpful.
The Tax Commissioner considers that a genuine redundancy payment under the tax law must be made “in consequence of” a particular type of termination from employment (dismissal) that is attributable to a particular reason (redundancy).
The Tax Office considers that a close examination and evaluation of the particular circumstances of each employment relationship and how this impacts on the dealings between the parties will influence whether, and to what extent, a payment made on termination is a genuine redundancy payment. Such circumstances range across a spectrum of possible relationships between the employer and the employee (in particular, whether the relationship between the employer and the employee is at arm’s length).
The tax law specifically states that a genuine redundancy payment is one “received by an employee who is dismissed from employment because the employee’s position is genuinely redundant”. The Ruling says the four necessary components to qualify as a genuine redundancy payment are:
1. The payment must be received “in consequence of” an employee’s termination.
2. That termination must involve the employee being dismissed from employment.
3. That dismissal must be caused by the redundancy of the employee’s position.
4. The redundancy payment must be made genuinely because of a redundancy.
The Tax Commissioner’s view is that a genuine redundancy payment can only arise where there is no suitable job available for the employee with the employer, meaning that he or she must therefore be dismissed. All employment with the employer must be severed. This is subject to an exception for a person holding an office with the employer at the same time as having a common law employment relationship.
The Ruling notes that it is only if the employer considers there is no available job for which the employee is suited, and that he or she must therefore be dismissed, that the question of redundancy arises.
The Tax Office says a ‘dismissal’ 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 (eg. resignation). Determining whether an employee has consented (either express or implied) to their termination requires an assessment of the facts and circumstances of each case.
The Commissioner considers that a dismissal can still occur even where an employee has indicated they would be interested in having their employment terminated, provided that the final decision to terminate employment remains solely with the employer. Such a case may arise where expressions of interest in receiving a redundancy package are sought from employees as part of a structured process undertaken by the employer as a means of promoting industrial harmony. An employee is also still considered to be dismissed where, following notification of termination, the employee negotiates with the employer or nominates to end their employment at an earlier time.
The Ruling states that the dismissal must be caused by redundancy of the employee’s position, and not for some other reason, and that redundancy must be the prevailing or most influential reason for the dismissal if there is more than one contributing cause.
Further, 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. However, a dismissal is not caused by redundancy where personal acts or default are the prevailing or most influential cause for the termination (eg. where a person is dismissed due to unsatisfactory performance or behaviour).
Where an employer dismisses an employee after a reorganisation of duties, functions and responsibilities, a more careful analysis is required. The Tax Commissioner says a restructure of an organisation does not necessarily import redundancy where employees are dismissed following the reallocation or restructure. In these circumstances, it is necessary to consider what impact the restructure had on the duties, functions and responsibilities formerly fulfilled by the dismissed employee.
The Tax Office warns that contrived cases of redundancy will not meet the conditions for redundancy. Importantly, the Ruling states that the fact that an employer and employee have an understanding that a payment on termination is caused by redundancy or that the employer treats the payment as a redundancy payment for tax purposes does not of itself establish genuine redundancy.
The Ruling indicates further conditions for a genuine redundancy payment include:
• the dismissed employee is not older than specified age limits (ie. an employee must be less than 65 years old at the time of dismissal);
• the termination is not at the end of a fixed period of employment (subject to certain exceptions for rolling fixed-term contracts);
• the actual 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.
The Ruling also deals with the tax treatment of genuine redundancy payments, including the division of termination payments on redundancy into relevant elements for tax purposes – and particularly the ascertainment of the genuine redundancy component that is tax-free.
Genuine redundancy payments are tax-free up to a limit (indexed annually). This tax-free amount is worked out according to a Base Amount ($7,350 for 2008-09) plus a Service Amount ($3,676 for 2008-09) for each whole year of service.
Any amount of a genuine redundancy payment in excess of the tax-free amount is generally taxed as an employment termination payment, even where the amount is received more than 12 months after the termination. Any voluntary termination element of a redundancy payment is taxed as an employment termination payment if paid within 12 months of termination.
Where each of the conditions for a genuine redundancy payment is satisfied, the Ruling says the tax treatment of the payment is determined via the following steps:
1. Identify and exclude any amounts that are not genuine redundancy payments (eg. unused annual leave and long service leave payments) which are subject to more specific tax treatment.
2. Determine the extent to which remaining amounts may be genuine redundancy payments.
3. Work out the extent to which any genuine redundancy payment is tax-free.
4. The remaining amounts may be assessable as a genuine redundancy payment in excess of the tax-free amount or as a voluntary termination element.
Because of the concessional tax treatment afforded to genuine redundancy payments, it is important to ensure that such payments are in fact genuine. Reference to this tax ruling, plus advice from your accountant or adviser, is important. The temptation might be to simply make the payment, call it a redundancy, and then forget it. But the tax laws are quite specific here and any future Tax Office audit might produce some unpleasant results – both for the employer and the former employee.
Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.
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