Employment Termination Payments (BP 16) Finance in Practice, Taxation Unit, General Tax

Transcription

1 Employment Termination Payments (BP 16) Finance in Practice, Taxation Unit, General Tax Custodian/Review Officer: Principal Finance Officer, General Tax Version no: 2 Applicable To: QH staff Approval Date: 22/03/2011 Effective Date: 22/03/2011 Next Review Date: 11/03/2012 Authority: Approving Officer Director, Tax Unit Signature Supersedes: 1 Key Words: tax, pay as you go, PAYG, employment termination payment, life benefit, transitional, directed Accreditation References: 1 Purpose The purpose of this Procedure is to provide information relating to the taxation of employment termination payments, from an employer s perspective. That is, the Business Procedure is intended to advise on PAYG withholding requirements, if any, surrounding the termination payments. 2 Supporting Documents References PAYG Withholding Schedule 27 Superannuation and Termination Payments PAYG Withholding Schedule 32 Tax table for employment termination payments Taxation Administration Act 1953, Schedule 1, Sections 12-1, Taxation Administration Regulations 1976 Superannuation Industry (Supervision) Regulations 1994 Income Tax (Transitional Provisions) Act 1997 PAYG Withholding Schedule 32 Employment Termination Payments TR 2002/21 Pay As You Go (PAYG) Withholding from salary, wages, commissions, bonuses or allowances paid to office holders TR 2005/16 Income tax: Pay As You Go - withholding from payments to employees 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 3 Consultation Key stakeholders (position and business area) who reviewed this version are: Director, Taxation Unit Principal Finance Officer, General Tax Version No.2; Effective From: 22/03/2011 Page 1 of 14

2 Contents Introduction Definitions Components of an employment termination payment Exclusions Life benefit termination payment Death benefit termination payment Transitional termination payments Directed termination payments PAYG withholdings Employer obligations Employee s obligations In Consequence Of...12 Abbreviations...13 Useful Links...14 Calculators...14 Version Control Version No Date Author/Reviewer Version No Date Author/Reviewer 1 10/12/2008 Peter Curtis 2 11/03/2011 Peter Curtis Version No.2; Effective From: 22/03/2011 Page 2 of 14

3 Introduction Abbreviations used in this Procedure are listed at the end of the document. Prior to 1 July 2007, payments made in consequence of the termination of the employment were called Eligible Termination Payments. These included superannuation payments and employer payments under the same legislation. As from 1 July 2007, the income tax law now deals with the two sets of payment separately. Payments made during the life of the payee are now known as employment termination payments, to distinguish them from the superannuation lump sum payments. For convenience, the acronym ETP will be used for eligible termination payment and employment termination payment. Oftentimes it may be difficult to determine whether a payment is ordinary income and therefore subject to withholding under TAA53 s.12-35, or an ETP subject to withholding under TAA53 s.12-85, or neither of these! S takes into consideration the tax offset available under ITAA97 s (life benefit termination payments) or under ITTPA s.82-10a (transitional termination payments). This document will look at the nature of the ETP and, through the case law, circumstances when the payment is, or is not, an ETP, bearing in mind that the legislation has been amended since the relevant cases have been decided. The transition provisions will also be addressed. 1. Definitions The references to days below are to calendar days, not business or work days. "Days to retirement" means the number of days from the day on which the person stopped being capable of being gainfully employed to his or her last retirement day. Death benefit termination payment means an ETP made after the death of the former employee. Employment days means the total number of days of employment to which the ETP relates and is used in the formula of apportionment to calculate the pre-july1983 segment (if any) and the invalidity segment (if any). ETP Cap means the threshold up to which the ETP will be taxed at concessional rates, and above which the excess ETP will be taxed at the top marginal rate plus medicare levy. For financial year it is $145,000 1 ( : $140,000). It was initially set by ITAA97 s , and is indexed annually. Gainfully employed means employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment (ITAA97 s.995-1(1)). 1 Key Superannuation Rates & Thresholds, ATO public document #60489 Version No.2; Effective From: 22/03/2011 Page 3 of 14

4 Invalidity segment means the notional future service component of an amount paid on termination of employment. The invalidity must be confirmed by at least two legally qualified medical practitioners. See Section 2 below for a full description. Last retirement day means if an individual's employment or office would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be), or in any other case - the day on which he or she would turn age 65 (ITAA97 s.995-1(1)). Life benefit termination payment means an employment termination payment made during the lifetime of the former employee. Pre-July 1983 segment means the portion of the ETP applicable to the period of service from the date of commencement to 30 June It therefore only has any relevance if the commencement date is earlier than 30 June Preservation age is defined in the Superannuation Industry (Supervision) Regulations 1994 in terms of birthdates. The preservation age is the age until which the preserved benefits and the restricted non-preserved benefits have to be retained in the superannuation fund. It is the earliest age at which retirees can access their superannuation benefits generally, on retirement. The ages are: Date of Birth Preservation Age Before 1 July July June July June July June July June After 30 June Taxable component means the amount remaining after deducting the tax free component from the ETP. Tax free component means the collective amount of either or both of the Pre-July 1983 segment and the invalidity component, on which income tax is not payable. Version No.2; Effective From: 22/03/2011 Page 4 of 14

5 2. Components of an employment termination payment Taxable Component The taxable component is the amount remaining (if any) after deducting the tax-free component from the ETP. Consequently, the tax free component needs to be determined firstly. Tax Free Component Invalidity Segment A component of an ETP can be an invalidity segment only if the following conditions have been satisfied: 1. The payee must have stopped being gainfully employed, because of ill-health 2. The employment must have ceased before the employee s last retirement day 3. Two legally qualified medical practitioners must have certified that due to ill-health it is unlikely that the employee can ever be gainfully employed in the capacity for which he or she is reasonably qualified, considering his or her education, experience or training. The days to retirement have to be determined, firstly. This is the number of days that the employee would have had to have worked, had he or she been able to continue working, as at the date of termination, until the last retirement day would have transpired, including the day of the last retirement day. The items needed in order to calculate the segment (=[IS]) are: 1. Total amount of the ETP (=[E]) 2. Days to retirement (=[R]) 3. Employment days (=[S]) The amount of the segment is then calculated using the following formula: [IS] = [E] x [R] / ( [S] + [R] ) This amount is tax free; it may be paid without any withholding. Pre July 1983 Segment This is calculated after deducting the Invalidity Segment from the total ETP (=[C]). Then the following two items are needed: 1. The number of days of employment to which the payment refers and which occurred before 1 July 1983 (=[A]) 2. The total number of days of employment to which the payment refers (=[B]). The segment is then calculated using the formula [C] x [A] / [B]. This amount is tax free; it may be paid without any withholding. Version No.2; Effective From: 22/03/2011 Page 5 of 14

6 3. Exclusions The following payments are not employment termination payments. These are excluded by s of ITAA97. A superannuation benefit A pension An annuity payment An unused annual leave payment An unused long service leave payment The tax free part of a genuine redundancy payment The tax free part of an early retirement scheme payment A capital payment in respect of personal injury so far as (to the extent to which) the payment is reasonable having regard to the nature of the personal injury and its likely effect on the employee s capacity to derive income from personal exertion (eg. Employment) There are various reasons behind these exclusions. By having been excluded, the payment may be given more concessional tax treatment. Some are non-assessable, such as the capital payment. The excluded items cannot be transitional termination payments and therefore cannot be rolled over. The excluded items also do not count towards the ETP cap. The superannuation benefit payments are specifically covered elsewhere in the legislation. Others among the excluded are fully assessable when received, as ordinary income, such as the pensions and annuity payments. 4. Life benefit termination payment These are employment termination payments paid during the lifetime of the former employee. From 1 July 2007, any invalidity or pre-july 1983 amounts in a life benefit employment termination payment will be tax-free. The tax on any remaining, taxable component will depend on the payee s age, as shown in the following table. Payee s age relative to the preservation age Under preservation age on the last day of the income year in which the payment is made. Preservation age or over on the last day of the income year in which the payment is made. Tax on taxable component from 1 July 2007 Up to ETP Cap taxed at a maximum rate of 30% plus Medicare levy. Amount over ETP Cap taxed at top marginal tax rate plus Medicare levy. Up to ETP Cap taxed at a maximum rate of 15% plus Medicare levy. Amount over ETP Cap taxed at top marginal tax rate plus Medicare levy. Of course, there is a big BUT to these concessions. That is: the termination payment cannot be rolled over into superannuation. The sole exception is a transitional ETP. See Page 8 for details of these payments. Version No.2; Effective From: 22/03/2011 Page 6 of 14

7 5. Death benefit termination payment A death benefit termination payment is an employment termination payment received by a person after the death of the former employee causes the termination of the employment. The treatment of the taxable component of death benefit employment termination payments depends on whether the payment is made to a dependant or non-dependant and how much is paid. Payment to a dependant From 1 July 2007, the taxable component of a death benefit employment termination payment paid to a dependant of the deceased is tax-free, to the extent of the recipient s cap on concessionally taxed employment termination payments. The remainder of the said taxable component (if any) will be taxed at the top marginal tax rate plus Medicare levy. Payment to a non-dependant From 1 July 2007, the taxable component of a death benefit employment termination payment paid to a non-dependant that is within the recipient s cap on concessionally taxed employment termination payments will be taxed at a maximum rate of 30% plus Medicare levy. The remainder of the taxable component (if any) will be taxed at the top marginal tax rate plus Medicare levy. The table below sets out the tax treatment for death benefit employment termination payments. Recipient Tax on taxable component from 1 July 2007 Dependant Amount within the recipient s ETP Cap is tax-free. Amount over the recipient s ETP Cap taxed at recipient s top marginal tax rate plus Medicare levy. Non-dependant Amount within the recipient s ETP Cap taxed at a maximum rate of 30% plus Medicare levy. Amount over the recipient s ETP Cap taxed at recipient s top marginal tax rate plus Medicare levy. Cap on death benefit employment termination payments The cap places a limit on the amount of death benefit employment termination payments payable for the same employment termination that are taxed concessionally. The death benefit employment termination payments cap operates independently of the life benefit employment termination payments cap. That is, any death benefit employment termination payments received by the former employee s estate do not count towards the life benefit employment termination payments cap. Similarly, any life benefit employment termination payments that the former employee receives during his or her lifetime do not count towards the death benefit employment termination payments cap. Version No.2; Effective From: 22/03/2011 Page 7 of 14

8 6. Transitional termination payments A transitional termination payment is an employment termination payment which is eligible for the concessions not otherwise available to a normal ETP. The concessions are lower rates of tax (through the use of break points), and the ability to roll the payment over into a superannuation fund or a superannuation annuity. They are specifically covered in the ITTPA, Division 82. In order to qualify as a transitional termination payment, the payment must be: A life termination payment Received on or after 1 July 2007 and before 1 July 2012 Received under an entitlement provided under contract, law, instrument, or agreement within the meaning of the Workplace Relations Act 1996 as in force just before 10 May In addition, the contract, law, or agreement must have specified the amount of the payment, or a way to work out a specific amount. This includes specifying a method or a formula or by a person choosing between forms of payment. Transitional payments still have the invalidity segment and the pre-july 1983 segment, which are tax free. Tax offsets (rebates) are available to limit the rates of tax to those shown in the table below. The ETP caps do still apply, with a twist. ITTPA s.82-10b prescribes a lower cap amount, that being the ETP cap amount, which it follows each year with the indexation. The lower cap amount is reduced by the amounts that have previously used the concession available to amounts under the lower cap amount. The lower cap amount is also reduced if the total of the taxable components of all directed termination payments in the income year in which the recipient reached preservation age or later and the taxable components of all payments received before preservation age exceed the difference between the upper cap and lower cap amount. ITTPA s.82-10d prescribes an upper cap amount. This has been set at $1m initially, and is not indexed annually. The upper cap amount is reduced by the amount of all previous taxable transitional termination payments and the taxable component of all directed termination payments. (ITTPA s.82-10d(2) states that the cap is reduced by ETP amounts included in your assessable income.) Both of them need to be tracked because they affect the withholding rates. The entitlement as at 9 May 2006 is a critical point. If it cannot be established, then the ETP will merely be a life termination payment, and the transitional concessions will not be available. ITTPA s.82-10(1)(b) states that the entitlement is provided for under [a written contract, a law of the Commonwealth, a State, a Territory or another country, an instrument under such a law or a Version No.2; Effective From: 22/03/2011 Page 8 of 14

9 workplace agreement within the meaning of the Workplace Relations Act 1996] as in force just before 10 May If the contract, law, instrument, or agreement came into effect on or after 10 May 2006, the ETP cannot be paid as a transitional ETP. If a contract or agreement that pre-existed before 10 May 2006, and is extended (see below) beyond 9 May 2006, the entitlement will endure, and the ETP may qualify, in the absence of any other impediment. If a pre-existing (before 10 May 2006) contract or agreement is re-written, replaced, superseded, or executed afresh in any other manner on or after 10 May 2006, then the entitlement contemplated in the ITTPA has not endured, and the ETP cannot be paid under the transitional arrangements of the ITTPA. An example is the Queensland Health enterprise bargaining agreement EB6 Administrative Stream Employees (Queensland Health) Certified Agreement 2006, which was signed on 28 November 2006, that is, after 9 May It would seem therefore to rule out transitionary concessions. However, it does not contain any provisions for calculating the termination pay amount. It is then necessary to look at other industrial instruments of relevance. The Queensland Public Service Award - State 2003, handed down on 25 March 2003, effective 16 June 2003 predates the transitionary requirements, and contains a clause setting out the basis for a calculation of a termination payment specifically, pay in lieu of notice. In the absence of any other such instrument, or a similar provision within that same instrument, only a termination payment comprising pay in lieu of notice would meet the transitionary provisions. It is necessary to assess the various elements in the termination payment and their foundation by reference to relevant documents, to ascertain whether or not they are transitional termination payments. It is also necessary to separately pay the ETPs if some part is transitionary, and the others are not, because the whole payment would not qualify as a single payment. Version No.2; Effective From: 22/03/2011 Page 9 of 14

10 7. Directed termination payments Queensland Health Procedure: Employment Termination Payments A directed termination payment is a component of a transitional termination payment. It is made at the discretion of the employee, and it must be made to a complying superannuation fund, or to the purchase of a superannuation annuity. Advice from QSuper has been obtained and it confirms that the direction does not have favour QSuper. The direction can favour any complying superannuation fund 2. The employer must provide a pre-payment statement to the employee. That statement sets out the amount and the components (taxable and tax-free) of the ETP (which can only be a life termination payment). The employee must return the statement within 30 days if he or she wants any part of the ETP to become a directed payment. If the statement is not returned within the time frame, the employer must treat the whole of the transitional termination payment as if there was no directed termination payment. The direction from the employee can be for any proportion of the various components if more than one. What remain out of those components after the directed amounts are deducted then are paid to the employee as a transitional termination payment. The components thereof are the original components less the directed components. The directed termination payments are not taxed in the employee s hands. However, ITAA97 s renders the taxable component taxable in the hands of the entity receiving the directed termination payment. The employee (or other payee as the case may be) may have to pay tax on subsequent payments out of the fund or the annuity provider. 8. PAYG withholdings The applicable law is TAA53 s Superannuation lump sums and employment termination payments An entity must withhold an amount from any of the following payments it makes to an individual: (a) a superannuation lump sum; (b) an employment termination payment. For exceptions, see section 12-1 The only exception is an amount that is exempt income in the payee s hands. In TAA53 s.12-1, it says that the whole of the payment has to be exempt (emphasis added). However, in its publication NAT , the ATO states that you must withhold an amount from the taxable component according to Table A on page 3. Do not withhold from the tax-free component of the ETP. The legislation would seem to require withholding to occur from the whole payment if there is a taxable component and a tax-free component in a single payment. The instruction in Schedule 32 will be adopted, since it is has the authority of a public ruling. By and large, the amount to be withheld from the ETP depends on the type, the age of the payee, and the taxable component. 2 from Employer Services, QSuper, 10/12/ Schedule 32 Tax table for employment termination payments, NAT 70980, May 2008, page 2 Version No.2; Effective From: 22/03/2011 Page 10 of 14

11 The tax-free component does not require any tax to be withheld. Table A contained in Schedule 32 is reproduced below. Please note that it applies to the taxable components only. There is no requirement to withhold from the tax-free components of any ETP. Income component derived by the payee in the income year Life benefit ETP Transitional ETP* Death benefit ETP paid to nondependants Death benefit ETP paid to dependants Age of person at the end of the income year in which the payment is received Under preservation age Preservation age and over All ages Under preservation age Preservation age and over All ages All ages All ages Component subject to Rate of PAYG withholding withholding (including Medicare levy) Up to the ETP cap amount 31.5% Up to the ETP cap amount 16.5% Amount above the ETP cap 46.5% amount Up to the lower cap amount 31.5% Up to the lower cap amount 16.5% Amount above the lower 31.5% cap amount up to the upper cap amount Amount above the upper 46.5% cap amount Up to the ETP cap amount 31.5% Amount above the ETP cap 46.5% amount Up to the ETP cap amount Amount above the ETP cap amount Nil 46.5% * The lower cap amount and the upper cap amount are described earlier see Transitional Payments. Version No.2; Effective From: 22/03/2011 Page 11 of 14

12 9. Employer obligations Queensland Health Procedure: Employment Termination Payments There are basically three obligations imposed upon the employer. These obligations will not arise with each and every ETP. Firstly, the employer must issue a payment summary to the payee within fourteen (14) days of the payment having been made, if tax has been withheld. Secondly, if, and only if, the payment is a transitional termination payment, the employer must issue a pre-payment statement 4 to the employee. This is directed by ITTPA s.82-10e, which requires the statement to show the tax free component amount, the taxable component amount, and any other matters shown in the regulations. A search of/for the latter failed to reveal any extra requirements. The statement is intended to give the employee the option of rolling some, or all, of the payment into a superannuation fund or into a superannuation annuity. These two choices are required to be included in the statement. Thirdly, the employer must carry out the employee s direction. When there is no direction from the employee, which is a valid option, the employer has to pay the amount of the ETP to the employee, net of any PAYG withholding. The employer is able to act on this if the employee has not returned the statement within 30 days. The employer must also notify the entity or entities, to whom the employee has directed that payment be made, that payment is about to occur and the extent to which it is tax free. 10. Employee s obligations This section only applies when the payment is a transitional termination payment. It follows on from the employer s obligations outlined above. The employee may choose to direct part or all of the payment. If he or she DOES choose to direct that the payment is to go to one or other of the two choices, then he or she must make it in the approved form, and give the completed form to the employer. 11. In Consequence Of In TR 2003/13, the ATO adopts a view that is narrower than that adopted by the Courts. It should be noted that this ruling was issued after, not before, Le Grand 5 which was a Federal Court decision in 2002, adopted with approval in Forrest 6 decided by the Full Federal Court after the taxation ruling was issued. The ruling appears to be at loggerheads with Le Grand. Justice Goldberg concluded in Le Grand that The thrust of the judgments in Reseck and McIntosh is rather to the effect that a payment is made in consequence of a particular circumstance when the payment follows on from, and is an effect or result, in a causal sense, of that circumstance. 4 See NAT , Instructions and Form, issued by the ATO 5 Le Grand v FC of T 2002 ATC Forrest v FC of T 2010 ATC Version No.2; Effective From: 22/03/2011 Page 12 of 14

13 The ATO on the other hand, says intr 2003/13 the payment must follow as an effect or result of the termination. In other words, but for the termination, the payment would not have been made. It is not sufficient that the payment is simply made subsequently to the termination. The phrase but for the termination the payment would not have been made is considered to be too restrictive, in comparison with the decisions in Le Grand and Forrest. There is probably good reason for this, because narrowing the scope for categorisation a payment as an ETP means that more payments will be classed as fully assessable. In Reseck, 7 Jacobs J. reasoned a broader test, saying that in consequence of did not import causation, but rather just a following on. Abbreviations ATO: Australian Taxation Office ITAA97: Income Tax Assessment Act 1997 (Cwlth) ITAA36: Income Tax Assessment Act 1936 (Cwlth) ITTPA: Income Tax (Transitional Provisions) Act 1997 TAA53: Taxation Administration Act 1953 (Cwlth) TR: Taxation Ruling, issued by the Australian Taxation Office 7 Reseck v FC of T 75 ATC 4213 Version No.2; Effective From: 22/03/2011 Page 13 of 14

14 Useful Links (Copy the link and paste it into address panel of the web browser. These are not hyperlinks.) Directed Termination Payment Transitional Arrangements Employment Termination Payments Calculators ETP Cap 12&mnu=&mfp=&st=&cy=1 Version No.2; Effective From: 22/03/2011 Page 14 of 14