Draft Taxation Ruling

TR 2008/D6

Income tax: genuine redundancy payments

• TR 2009/2.
  TR 2009/2EC .

may be released

Preamble

What this Ruling is about

1. This Ruling outlines the requirements to be satisfied before any payment made to a person whose employment is terminated qualifies for treatment as a genuine redundancy payment under section 83-175 of the Income Tax Assessment Act 1997 (ITAA 1997).^[1] Genuine redundancy payments are tax-free up to a limit worked out under section 83-170.

2. The Ruling also discusses the interaction between the tax treatment of genuine redundancy payments and the tax treatment of other termination payments provided for by Divisions 82 and 83.

3. This Ruling does not deal with early retirement scheme payments, the treatment of which is provided for in section 83-180.^[2]

4. Section 27F and other provisions in the Income Tax Assessment Act 1936 (ITAA 1936) that dealt with the treatment of bona fide redundancy payments were rewritten in section 83-175 and other provisions in Part 2-40 of the ITAA 1997. Unless specifically noted, the Commissioner considers the treatment of genuine redundancy payments under the ITAA 1997 to be identical to the treatment of bona fide redundancy payments under the ITAA 1936. This Ruling may therefore be relied upon to this extent when applying the relevant ITAA 1936 provisions.

Ruling

Genuine redundancy payments and Part 2-40

5. The matter of what is a genuine redundancy payment is defined by section 83-175. The section identifies:

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the conditions that must be satisfied for at least a part of a payment to be treated as a genuine redundancy payment;

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how to work out what amount of the payment is a genuine redundancy payment; and

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what payments are excluded from being a genuine redundancy payment.

6. Section 83-175 is located within Part 2-40. Part 2-40 seeks to deal cohesively with all payments made in consequence of the termination of a person's employment. The treatment of genuine redundancy payments must therefore be determined in this context.

7. Given this, and in particular the tax treatment afforded genuine redundancy payments,^[3] the Commissioner's view is that a genuine redundancy payment must be made in consequence of termination of employment. Accordingly, genuine redundancy payments are payments made in consequence of a particular type of termination from employment (dismissal) that is attributable to a particular reason (redundancy).

8. There are various circumstances in which an employee may be dismissed due to redundancy. Such circumstances range across a spectrum of employees, from senior executives to entry level salary and wage workers, and across a multiplicity of possible relationships between the employer and the employee. The concepts employed in the provisions cover all of these variations.

9. In particular, the relationship between an employer and an employee may or may not be at arm's length. 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.^[4]

The basic requirement for a genuine redundancy payment

10. Under subsection 83-175(1), a genuine redundancy payment is one 'received by an employee who is dismissed from employment because the employee's position is genuinely redundant'.

11. There are four necessary components within this basic genuine redundancy requirement:

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The payment being tested must be received in consequence of a termination .

•

That termination must involve an employee being dismissed from employment .

•

That dismissal must be caused by the redundancy of the employee's position.

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The redundancy payment must be made genuinely because of a redundancy.

12. The satisfaction of the basic genuine redundancy requirement establishes the essential character of the payment. However, there are further conditions that must also be satisfied before a payment can be treated as a genuine redundancy payment.^[5]

Component 1: Payment 'in consequence of' termination

13. As discussed above,^[6] the Commissioner considers that any payment being tested against the basic genuine redundancy requirement must be made 'in consequence of' the employee's termination before it can be a genuine redundancy payment. Taxation Ruling TR 2003/13^[7] sets out the Commissioner's views on when a payment is made 'in consequence of' termination of employment.

14. It follows that any payment that meets the basic redundancy requirement in subsection 83-175(1) will satisfy the 'in consequence of' condition for employment termination payments provided for under paragraph 82-130(1)(a).

15. Some other payments, such as unused annual leave and unused long service leave, may also be made in consequence of termination. Any such payments that receive a more specific tax treatment are excluded from being genuine redundancy payments by subsection 83-175(4).^[8]

Component 2: 'Dismissal' from employment

16. Subject to the exception recognised in the next paragraph, the loss of a particular position with an employer is not a dismissal for the purposes of subsection 83-175(1) unless all employment with the employer is severed. The 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.

17. The exception to this general principle is the case of a person holding an office with the employer at the same time as having a common law employment relationship with the same employer. In this case dismissal from either the office or common law employment involves a dismissal from employment for the purposes of subsection 83-175(1). An example is a person who is both a director of the employer company and a common law employee of the company who is terminated from one of these two capacities.^[9]

18. Dismissal is a particular mode of termination. It requires a termination of employment at the initiative of the employer without the consent of the employee. This stands in contrast to employment that is terminated at the initiative of the employee, for example in the case of resignation or retirement.

19. Consent in this context refers to the employee choosing to agree to or approve the act or decision to terminate employment in circumstances where the employee has the capacity to make such a choice. Determining whether an employee has consented to their termination requires an assessment of the facts and circumstances of each case. Consent may be either expressly stated by the employee or implied by their behaviour or conduct.

20. A dismissal can still occur even where an employee has indicated that 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 are sought from employees in receiving a redundancy package as part of a structured process undertaken by the employer as a means of promoting industrial harmony.

21. Cases of constructive dismissal are also a dismissal for the purposes of subsection 83-175(1). Constructive dismissal occurs where the actions or behaviour of the employer in relation to the employment relationship effectively curtail the element of consent on the employee's behalf. The simplest case of constructive dismissal is where an employee is asked to resign under threat (explicit or implicit) of dismissal. Another example is where the employee resigns after the employer offers work in an alternative position which is inappropriate given the employee's particular circumstances (for example, their skills or experience). While in form this is a termination at the employee's initiative, it is recognised as a dismissal in fact.

Component 3: Dismissal caused by 'redundancy'

22. As noted above, dismissal is a particular mode of employment termination. Section 83-175 further requires that the dismissal be caused by redundancy of the employee's position, and not for some other reason. In other words, redundancy must be the reason for termination by way of dismissal.

23. As is the case in determining if there is a dismissal, the reason for a dismissal is to be established in light of the facts and circumstances of each case. The redundancy of the relevant position must be the prevailing or most influential reason for the dismissal if there is more than one contributing cause.

24. 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. On occasion the decision may be unavoidable due to the circumstances of the employer's operations.

25. In some circumstances, an employer may reallocate the duties and functions attached to a particular position to another position within the employer's organisational structure. In such cases, the former position is redundant. However, if the employee who had been working in that position is still employed by the employer following the reallocation of duties and functions, there will not be a dismissal.^[10]

26. On the other hand, if an employer decides after a structural reorganisation to terminate an employee, the former position of the employee is effectively redundant as long as the reorganisation is the prevailing or most influential cause of the termination.

27. A dismissal is not caused by redundancy where personal acts or default are the prevailing or most influential cause for the termination. For example, a person may be dismissed due to unsatisfactory performance or behaviour.

28. In some cases, an employer may decide to reorganise or restructure their organisation at the same time as identifying underperformance of particular members of staff or areas within the existing organisational structure. In the event that employees are dismissed in these circumstances, careful consideration will need to be given to what was the prevailing or most influential cause of dismissal.

29. In circumstances where an employee resigns after being offered alternative employment with an employer following an organisational restructure, it will be necessary to assess whether the termination of employment amounts to a constructive dismissal.^[11]

Component 4: 'Genuine' redundancy

30. Contrived cases of redundancy will not meet the conditions in section 83-175. Whether a redundancy is 'genuine' is determined on an objective basis.

31. 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.

Further conditions for a genuine redundancy payment

32. Beyond the basic genuine redundancy requirement just discussed,^[12] the further conditions for genuine redundancy payment treatment require that:

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the dismissed employee is not older than specified age limits;

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

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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;

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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

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the payment is not in lieu of superannuation benefits.

Age-based limits

33. An employee must be less than 65 years old at the time of dismissal for a redundancy payment to qualify as a genuine redundancy payment.

34. However, if the employment of a particular employee would have otherwise terminated at a younger age than 65, the employee must be dismissed before that time to give rise to a genuine redundancy payment. This younger age becomes the employee's age-based limit in these circumstances.

Not the end of a fixed term contract or a project

35. A payment made at the end of a fixed period of employment cannot normally be a genuine redundancy payment.

36. However, some rolling fixed-term contracts may, as a matter of fact, establish an ongoing employment relationship. The completion of a stipulated period of service in these circumstances does not of itself disqualify a payment made at the end of the period from being a genuine redundancy payment. It is therefore possible that a genuine redundancy payment may be paid in these types of cases.

37. In some cases, particularly involving multi-disciplinary project-based work, an employee's period of service may be determined by reference to the achievement of a particular outcome rather than a specified period of time. The employee's period of service in these circumstances concludes on the achievement of that outcome.

Arm's length amount

38. The arm's length amount requirement stipulates that the actual payment made should not exceed what could reasonably be expected if the parties had been dealing at arm's length. This condition only needs to be met if it is established that the employer and employee are not dealing at arm's length in relation to the dismissal.

39. If the relationship between the employer and employee is not at arm's length, it will not necessarily follow that any dealing between the parties is not at arm's length. Nevertheless, the relationship between the parties is a very significant factor in assessing the nature of the dealing in relation to the dismissal.

40. If the parties are not dealing at arm's length, then it must be the case that the amount paid was no more favourable to the employee than what could reasonably be expected had the parties been dealing at arm's length.

41. This condition contrasts the actual non-arm's length dealing with a hypothetical arm's length dealing. Apart from this change, all other circumstances surrounding the termination of the employment relationship are assumed to be the same.

42. If the original employment arrangement (for example, an employment contract, award or other form of industrial agreement) involves an arm's length dealing, the amount that could reasonably be expected under an arm's length termination dealing is usually the redundancy entitlement, if any, under that arrangement. Special circumstances peculiar to the employee would be required to establish a reasonable expectation of an amount greater than the entitlement under the employment arrangement.

43. Given this, it does not necessarily follow that what could reasonably be expected at arm's length is zero if there is no contractual or other entitlement to a redundancy payment under an arm's length employment arrangement. It is reasonable in some circumstances to expect ex gratia redundancy payments to be made.

44. In any case, the years of service provided by the dismissed employee and the value of their remuneration package of the time of the dismissal are particularly influential in determining what could reasonably be expected under an arm's length dealing. Ensuring that the amounts paid under any actual arm's length dealings are worked out on a comparable basis to those conducted other than at arm's length is also important in establishing that this condition is satisfied.

45. If the payment is more than the arm's length amount, then the entire payment is disqualified from being a genuine redundancy payment. Like the other tests in subsection 83-175(2), the arm's length amount requirement is a condition for a payment to be treated as a genuine redundancy payment.

No stipulated arrangement to employ

46. An arrangement to employ an employee after his or her termination prevents a dismissal giving rise to a genuine redundancy payment if that arrangement is entered into between either:

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the employer and the dismissed employee; or

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the employer and another entity.

47. In the second of these two cases, the other entity would commonly be the new employer, although this need not necessarily be the case. For instance, there could be an arrangement between a subsidiary company, the employer, and a holding company, the other entity, to employ the terminating employee in another subsidiary company within the group.

Payments not in lieu of superannuation benefits

48. Under subsection 83-175(3), a payment is not a genuine redundancy payment to the extent that it is made in place of superannuation benefits due at the time or in the future.

49. Superannuation benefits, as defined, are generally made by reason of a person's entitlement under a superannuation fund, a similar superannuation plan or superannuation-related legislation.^[13] Superannuation benefits are also specifically excluded from being genuine redundancy payments under subsection 83-175(4). Therefore, a payment that is excluded under subsection 83-175(3) would have to be made by an entity other than in respect of a person's superannuation entitlement (for example, by the employer) which seeks to take the place of such an entitlement.

Tax treatment of genuine redundancy payments

Division of termination payments on redundancy into elements for tax purposes

50. If the basic genuine redundancy requirement and the other necessary conditions are satisfied, the following steps are taken to work out the tax treatment of the payments that are consequently made:

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Any amounts that are subject to a more specific tax treatment than employment termination payments or genuine redundancy payments are identified and excluded. A full list of such payments is set out in the paragraphs of section 82-135.^[14] These payments include: superannuation benefits; pensions or annuities; unused annual leave payments; unused long service leave payments; and foreign termination payments.

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Some or all of the remaining amounts may be genuine redundancy payments. The extent to which the remaining amounts are genuine redundancy payments is determined by deducting the amount that could reasonably be expected if the employee had voluntarily terminated their employment.

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Section 83-170 then applies to work out the extent to which any genuine redundancy payment so identified is tax-free.

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After going through this process there are two possible remaining amounts. One is any assessable part of the genuine redundancy payment in excess of the tax-free amount. The other is the amount that could reasonably be expected on voluntary termination. These amounts are generally treated as employment termination payments.

51. Therefore, a payment meeting the basic redundancy requirement can be divided into a number of elements, as represented in the diagram below (the height of the rectangle representing total payments made on redundancy):^[15]

The voluntary termination element

52. Assuming that the genuine redundancy payment requirements are satisfied in relation to a payment, subsection 83-175(1) identifies that part of the payment that is specifically attributable to the fact that employment has been terminated because of redundancy. Only this part of the payment can receive tax-free treatment.

53. Subsection 83-175(1) identifies the amount attributable to redundancy by deducting the amount that could reasonably be expected to be received by the employee if he or she had voluntarily terminated employment at the time of being dismissed. In this Ruling, this is referred to as the voluntary termination element of a redundancy payment.

54. Apart from this hypothetical change in circumstances to a voluntary termination instead of a dismissal caused by redundancy, all other circumstances surrounding the termination are assumed to be the same.

55. Accordingly, if the employer and the employee were not dealing with each other at arm's length in relation to the dismissal, this must form part of the circumstances for the purposes of working out the voluntary termination element.

56. It would generally be expected that a greater amount would be paid on redundancy than voluntary termination. This recognises the purpose of redundancy payments, being primarily to compensate for loss of non-transferable entitlements (for example accrued sick leave and accrued long service leave prior to 10 years service) and the peculiar hardship associated with being laid off due to redundancy.

57. Contractual or other entitlements payable by an employer on voluntary termination are generally a sound guide as to what might reasonably be expected. However, this would be less so if the employer and employee are not dealing at arm's length.

58. There may be industry norms that could be used as a guide as to what payments would be made on voluntary termination. It may also be appropriate to compare standard payments made on voluntary termination within a particular company. However, these comparisons must take account of the actual nature of the dealings as influenced by the relationship between the parties.

59. The voluntary termination element of a genuine redundancy payment is subject to tax as an employment termination payment if it is received no later than 12 months after the termination.^[16] Otherwise, this element of the payment is taxed as an ordinary amount of assessable income under section 83-295, unless the Commissioner decides to treat it as an employment termination payment.

The remaining redundancy element

60. The remaining part of the payment (referred to in the diagram at paragraph 51 of this draft Ruling as the 'redundancy element') is a genuine redundancy payment for the purposes of Part 2-40 if all of the relevant conditions in section 83-175 are satisfied.^[17]

61. In the event that the requirements in section 83-175 are not met in relation to the payment, this remaining element is treated in an identical manner to the voluntary termination element. That is, it is an employment termination payment if it is received no later than 12 months after the termination, but is otherwise included in assessable income under section 83-295.

Tax-free amount of a genuine redundancy payment

62. Some or all of a genuine redundancy payment may be non-assessable non-exempt income, and accordingly tax-free, as provided for in section 83-170.

63. The extent to which the payment is tax-free will ordinarily depend on the amount of the payment and the number of whole years to which the payment relates that the employee was employed with the particular employer. There is no requirement for the years of service to be continuous when applying the threshold in section 83-170.^[18]

64. If earlier years of service with a previous employer are carried over and acknowledged on commencement with a new employer that later makes a redundancy payment to an employee, those years of service can be included in working out the tax-free amount of the genuine redundancy payment.

65. For example, this enables earlier years of service with employers within a group of entities to be recognised when an employee is ultimately terminated from one of the employers in the group. This recognition of previous service within the group in working out the termination payment should be documented by the terminating employer.

Taxable amount of a genuine redundancy payment

66. Any amount of a genuine redundancy payment in excess of the tax-free amount worked out under section 83-170 will be taxable as an employment termination payment. This is so even where the amount is received more than 12 months after the termination.^[19]

Multiple payments for one dismissal due to redundancy

67. There will be cases where an employee receives payments in consequence of their dismissal due to redundancy other than as one amount paid at a single point of time. There are many possible variations as to when, how, why and by whom a genuine redundancy payment can be effected. For example, an employee's redundancy payout may be paid as a series of amounts, whether by way of structured instalments or due to cash flow constraints of the payer. It is also possible that amounts paid in consequence of dismissal due to redundancy may be made by more than one payer.

68. While it may be possible to identify more than one 'payment' in some of these circumstances according to the ordinary meaning of that term, the Commissioner considers that the provisions of Part 2-40 operate to unify any such payments as a single sum attributable to redundancy when working out the tax treatment of the payments.

69. Therefore, in these circumstances, it is necessary to properly take account of all other redundancy payments made at the same or an earlier time when working out how to treat a given redundancy payment. The structure of Part 2-40 and provisions governing the tax treatment of the payments contemplates that this cumulative approach be adopted.

70. This requires that all payments made in consequence of the dismissal up to and including the time of the payment in question are assessed against a single voluntary termination element worked out at the time of the dismissal. Similarly, the tax-free amount of genuine redundancy payment can only be claimed once for any given termination of employment because of redundancy.

71. Where multiple redundancy payments are made over more than one income year, this cumulative approach does not require that the payments be brought to account in a single income year. To the extent that the payments are taxable, they are brought to account in the year that they are received.

72. The elements in working out the tax-free amount threshold for a genuine redundancy payment under section 83-170 are indexed annually. In bringing amounts to account in the year that they are received, the total tax-free amount applied under this cumulative approach is that in the latest income year an amount is received.^[20]

Dual capacity employees

73. A dual capacity employee is a person who, in addition to being engaged as an employee of an employing entity, is also a directing mind of or holds an office with that entity. The most common example is a person who is a director of the employer while also being a common law employee of that company. In many cases a dual capacity employee will have decided or actively participated in a decision to terminate their own employment in either or both capacities.

74. Under section 80-5, the concept of employment for the purposes of Part 2-40 is extended to include the holding of an office. Therefore, termination of a dual capacity employee in either employment capacity will be sufficient to be a termination of employment for Part 2-40 purposes, even if the person continues to hold employment with the employer in the other capacity.

75. Otherwise, the same principles apply to a dual capacity employee as apply to a single capacity employee when working out whether a termination payment is a genuine redundancy payment. The ability of a dual capacity employee to act or make a decision to terminate their own employment (either directly or indirectly)^[21] or to actively participate and/or influence such an act or decision does, however, give rise to some particular issues.

76. As noted earlier,^[22] dismissal requires termination of employment without the employee's consent. Careful consideration of all the facts and circumstances is required to determine whether a dual capacity employee has not consented to their termination given the issues recognised in the previous paragraph.

77. In the Commissioner's view, this question is answered by considering the following two matters:

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First, did the person agree to or approve the employer's act or decision to terminate their own employment? If not, the termination is without the person's consent and is therefore a dismissal.

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Secondly, if the person did agree to or approve the employer's act or decision to terminate their own employment, were the circumstances such that the employer's act or decision was dictated by legal or economic compulsion? If so, the termination is without the person's consent and is therefore a dismissal.

78. In relation to the first of these two matters, the agreement or approval of a dual capacity employee to the relevant decision may be express (for example, by actively participating in the decision-making process and assenting to the ultimate decision) or implied by behaviour or conduct.^[23]

79. In contrast, a dual capacity employee may be dismissed where the decision to terminate employment is not a unanimous decision of the directing minds of the employer. If it can be demonstrated that a dual capacity employee did not consent to the decision to terminate their employment, the person is dismissed.

80. In relation to the second of these two matters, a termination decision is dictated by legal or economic compulsion where the circumstances leave the employer's decision-makers with no real or practical choice other than to terminate the employment of the employee or the employees in question. This is consistent with the idea that consent involves the capacity to make a choice between different options.^[24]

81. A common example will be where a company loses the contract that is the only source of its business. In these circumstances, the directors may have no choice but to terminate themselves and the other employees from the jobs that they had performed for the company.

82. In other circumstances, it will be clear that a dual capacity employee consents to the termination of their own employment. While the employer's decision may be made under some constraints or in difficult circumstances, the making of a real choice by the dual capacity employee establishes consent to the termination decision. These cases do not give rise to dismissal from employment for the dual capacity employee.

83. Other issues that need to be particularly considered under section 83-175 where a dual capacity employee is terminated include:

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whether the employee's position is genuinely redundant;^[25]

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whether the amount paid to the employee is in excess of what could reasonably be expected if the employer and employee had been dealing at arm's length;^[26]

•

whether there is a stipulated arrangement to employ the employee in the future at the time of the dismissal; and^[27]

•

what the voluntary termination element is, given the non-arm's length dealing that may have taken place in relation to the termination of employment.^[28]

Examples

Example 1 - Dual capacity employees, loss of business source^[29]

84. Edsel Design Pty Ltd (Edsel Design) provides car design services to Aussie Autos, a large car manufacturing company. Bill and Mary Edsel are directors of Edsel Design, which employs 20 people in its car design operations. Bill is the Administration and Marketing Manager and Mary is the Design Manager.

85. Aussie Autos decides to cease operations as a consequence of several years of losses. Bill and Mary have an emergency meeting with their accounting and business advisers and also decide to cease the operations of Eureka Autos. Their advisers explain that there would be severe costs and risks associated with continuing operations without a source of business.

86. Aussie Autos is Edsel Design's sole client and other opportunities are not available in the short to medium term.

87. Redundancy payments are made to all employees, including Bill and Mary, equal to eight weeks pay over and above unused leave entitlements. None of the employees have an entitlement to redundancy payments under the employment arrangements that are in place.

88. In the past, any employee who retired had habitually received an amount as a retirement bonus. The amount of the bonus is six weeks pay for service of more than 15 years.

89. As Bill and Mary are in their late 50s, they both decide to retire. Edsel Design has been in business under Bill and Mary's guidance for 25 years.

90. While Bill and Mary are dual capacity employees, it is clear from the circumstances surrounding their termination that they are dismissed from their employment because of redundancy. In their capacity as directors they had no real choice but to terminate their own employment along with that of the other employees.

91. Although it may be demonstrated that Bill and Mary are not dealing with each other at arm's length in relation to their dismissal, their years of service and the equivalent treatment of employees dealt with at arm's length demonstrates that the amount that they received is not greater than what could reasonably be expected had they been dealing with Edsel Design at arm's length.

92. The amount that Bill and Mary could reasonably be expected to be paid on voluntary termination is equal to six weeks pay. Accordingly, the amount of the genuine redundancy payment received by Bill and Mary is the equivalent of two weeks pay.

Example 2 - Dual capacity employees continuing employment

93. Assume the same facts as in Example 1, except that Bill and Mary seek and find design work before Aussie Autos cease operations. The work involves Bill and Mary providing short-term consultative services to various firms in the car industry.

94. If this work were carried out through Edsel Design, there would be no termination of employment. However, Bill and Mary might do the work through another entity which they control. In circumstances where there is no legal or economic compulsion to have the work being done by an entity other than Edsel Design, Bill and Mary will have consented to the decision to terminate their employment and it would therefore not be considered a dismissal.

95. Alternatively, their redundancy with Edsel Designs may not be considered to be genuine in these circumstances. Depending on the facts, it may also be established that there is an arrangement between Edsel Designs and the new employing entity to employ Bill and Mary.

96. Therefore, in these circumstances, no part of the payment received by Bill and Mary is a genuine redundancy payment.

Example 3 - Dual capacity employee, legal compulsion to cease business

97. Michelle Ozoile is the sole director of Soft Transformations Pty Ltd (Soft Transformations), a company that supplies a range of products based on an oil that softens the skin and is reputed to prevent aging. Michelle manages all the business of the company. The company has operated the business since 2004 and has continuously employed three other staff since opening.

98. The State Government passes a law in 2008 prohibiting the sale of the oil because there is medical evidence that it causes skin disease. Michelle decides to discontinue the business after a meeting with her lawyer makes it clear that she has to abide by the new law. She terminates the employment of all of her employees (including herself) and pays all unused leave entitlements.

99. Michelle's lawyer had drawn up an employment contract for her when the business commenced operations that provided that she would be entitled to the equivalent of 18 months' salary as a redundancy payment in the event that the company could not continue operations. No other employee is entitled to a redundancy payment.

100. Michelle is paid the amount provided for under the contract. Shortly thereafter, she obtains employment with another company as a beauty consultant.

101. In these circumstances, Michelle is dismissed from employment as her termination is legally compelled.

102. However, Soft Transformations and Michelle are not dealing at arm's length in relation to her termination. The amount Michelle receives is in excess of what could reasonably be expected if the parties had been dealing at arm's length. Eighteen (18) months' salary is likely an excessive redundancy amount for a person who has been engaged in employment for four years in a small company such as Soft Transformations.^[30] The original contract giving rise to the payment entitlement was not itself made at arm's length so it cannot be relied on to support that the payment is an arm's length amount. The fact that employees dealt with at arm's length received no redundancy payment further supports this conclusion.

103. Accordingly, no part of the payment received by Michelle is a genuine redundancy payment.

Example 4 - Dual capacity employees, economic compulsion to wind-up business

104. Angelina and Maria Marionetti are directors and the sole employees of a company, Marionetti Kinetics Pty Ltd (Marionetti Kinetics), which manufactures puppets. The company only employs Angelina and Maria to design and make the puppets.

105. The profitability of the business is impacted over a number of years by declining sales. This trend impacts to the point where there is only a small amount of working capital left in the company. After meeting all outstanding liabilities, Angelina and Maria decide to pay out all remaining capital as redundancy payments.

106. These amounts are equal to approximately four weeks salary each for Angelina and Maria. They have carried on the puppet manufacturing business for 10 years.

107. A written agreement is in place between Angelina and Maria to the effect that any capital is to be retained in the company in the event that either Angelina or Maria voluntarily decides to leave the business.

108. Following the closure of the business, Angelina and Maria actively seek employment in the job market. They each find jobs with arm's length employers shortly after the business closes.

109. The entire amounts received by both Angelina and Maria are genuine redundancy payments. The overall state of the business at the time of its closure indicates that Angelina and Maria had no effective choice other than to cease operations. They were therefore dismissed from employment.

110. While the dealing with Marionetti Kinetics is likely not to be at arm's length, the amounts they received do not exceed what could reasonably be expected under an arm's length dealing given their years of service. All other conditions in section 83-175 are satisfied. The voluntary termination element is zero given the arrangement to retain capital in the event that either Angelina or Maria voluntarily terminates their employment.

Example 5 - Dual capacity employees, voluntary sale of business

111. Assume the same facts as in Example 4, except that Angelina and Maria decide to sell the business when sales and profits initially stagnate. There is significant capital retained in the business at the time. Before selling the business, Angelina and Maria pay themselves four weeks salary each.

112. In these circumstances, Angelina and Maria consent to the decision to sell the business and terminate their employment. They are not dismissed from employment. The fact that a decision is made to terminate employment, which can be argued to be the best available or the most rational in the circumstances does not indicate that there is no real or practical choice present in the decision-making process. This is so even where the directing minds have a fiduciary duty to act in the best interests of the employing entity.

113. Accordingly, no part of the payments received by Angelina and Maria are genuine redundancy payments in these circumstances.

Example 6 - Dual capacity employees, loss of critical employee

114. Ming Lee and Leong Chung conduct a business importing antique vases through a discretionary trust, of which Oriental Vases Pty Ltd (Oriental Vases) is the trustee. Oriental Vases employs two employees in addition to Ming and Leong. Ming and Leong are also the two directors of the trustee company.

115. There a number of retailers to which Oriental Vases supply. Ming has particular expertise in sourcing and assessing the value and quality of the vases. Leong is responsible for maintaining relationships with retailers.

116. Following a dispute regarding the operations of the business, Ming resigns and sells his stake in the business to Leong, before setting up his own importing business. Leong seeks to find a replacement for Ming but, due to the specialised nature of Ming's skills, Leong is unable to find a new business partner. Retail clients of the business soon commence dealing with Ming's new business.

117. Leong decides to wind up the business. Having worked in the business for seven years, Leong is paid a redundancy amount equal to approximately 16 weeks pay. This amount is precisely equal to the tax-free amount of a genuine redundancy payment for Leong under section 83-170. The other two employees, who have worked for two and five years respectively, each receive a redundancy payment equal to one weeks pay.

118. Leong is dismissed from employment due to redundancy in these circumstances. He had no real choice other than to cease business when it became clear that ongoing operations were critically dependent on Ming's expertise.

119. However, while Leong could reasonably be expected to receive a greater amount on redundancy than the two arm's length employees, the extent of the discrepancy in their treatment suggest that the amount received by Leong is in excess of what could reasonably be expected had he been dealing at arm's length with Oriental Vases in relation to his termination. The exact payment of the tax-free amount is not a proxy for the arm's length amount and further supports the conclusion that the actual payment made exceeds an arm's length amount.

120. As this is a condition for the payment to be a genuine redundancy payment, no part of the payment received by Leong is a genuine redundancy payment.

Example 7 - Business acquisition leading to redundancy, constructive dismissal

121. Dave Dolphin works as the Sales Manager for the Big Fish Company (Big Fish). It sells swimwear.

122. Big Fish acquires Plankton Pty Ltd (Plankton), a company that sells leisure clothing. As part of the acquisition, Big Fish employs Plankton's Sales Manager, Marion Minky. Marion assumes the role of Sales Manager in respect of all of Big Fish's expanded operations. Dave is offered a role as a swimwear sales representative for a particular district. This offer involves a considerable pay cut. As Dave sees his experience is better suited to the management of a team of salespeople rather than in front line sales, he decides to resign.

123. While Dave may have the skills to do the job he is offered, the job has significantly different duties and functions to that he performed previously. Accordingly, the synergies created by the acquisition of Plankton make Dave's former position redundant.

124. Therefore, a termination payment received by Dave in these circumstances may be characterised as a genuine redundancy payment on the basis that Dave was constructively dismissed due to redundancy.

Example 8 - Business acquisition, acceptance of demotion

125. Assume the same facts as Example 7, except Dave chooses to accept the swimwear sales representative position together with a lump sum payment to compensate him for the loss of his Sales Manager position.

126. In these circumstances, Dave's employment with Big Fish is not terminated. Therefore, the lump sum payment cannot be characterised as a genuine redundancy payment.

Example 9 - Dismissal caused by underperformance, not redundancy^[31]

127. Isis Nefertiti is the Chief Executive of a beauty product and weight reduction company called the Thin Line Corporation Ltd (Thin Line).

128. The company's profits have been decreasing for some time so the company's Board engage a strategic management consultant, who advises them to reorganise the corporate structure. The directors decide to follow the advice of the consultant.

129. However, because the directors are also concerned about the performance of Isis, they decide to terminate her employment as Chief Executive. An acting Chief Executive is appointed to manage the organisational change in lieu of the appointment of a new permanent Chief Executive.

130. A generous payment is made to Isis on her termination, which is stated to be and treated as a redundancy payment by Thin Line's Human Resources Department.

131. No part of this payment qualifies as a genuine redundancy payment as the position of Chief Executive is not redundant. The prevailing or most influential reason for Isis' termination is the Board's concerns with her performance. Thin Line's treatment of the payment as one made due to redundancy does not impact on the proper characterisation of the payment.

Example 10 - Redundancy packages offered following employee expressions of interest

132. Implosion Corp is reducing the size of its operations so that a number of employee positions will no longer be required. It decides to implement a redundancy process and dismiss a number of employees equivalent to the number of positions that are being made redundant.

133. With a view to maintaining industrial harmony, Implosion Corp enters into discussions with the employees as to who would like to nominate for a redundancy package. Following those discussions Implosion Corp dismisses the selected number of employees.

134. Most of the dismissed employees had expressed an interest in receiving a redundancy package. However, some key employees who had expressed an interest in packages were not dismissed.

135. Those employees whose employment is terminated in these circumstances are still considered to be dismissed from employment as they have no control over who the employer chooses for termination, as evidenced by the fact that there are some key employees whom the employer chooses not to dismiss. Assuming all other conditions are met, payments made to the terminated employees under the redundancy packages are genuine redundancy payments.

Example 11 - Working out the components of a termination payment

136. Anne Jones has been an employee of EX Pty Ltd (EX) for 20 years. The Board of EX decides that competitive pressures are such that staff numbers have to be reduced by 50%. Anne is subsequently dismissed from her employment.

137. Anne receives a lump sum payment of $200,000 from EX during the 2007-08 income year. Of this amount, $50,000 represents an unused annual leave entitlement and $50,000 represents an unused long service leave entitlement. Anne's employment contract also provided for a lump sum payment of $20,000 in the event of her resignation or retirement.

138. Subsection 83-175(4) provides that payments mentioned in section 82-135, which includes unused annual leave payments and unused long service leave payments, are not genuine redundancy payments.

139. Accordingly, the first step in working out the tax treatment of the $200,000 is to apply the rules for unused annual leave payments and unused long service leave payments^[32] to the respective amounts of $50,000.

140. The balance of $100,000 is a genuine redundancy payment except to the extent of any amount Anne would have been received had she voluntarily retired or resigned. As Anne would have received $20,000 in these circumstances, this voluntary termination element is excluded from being a genuine redundancy payment.

141. Therefore, the remaining $80,000 is a genuine redundancy payment. Under section 83-170, the base amount is $7,020 and the service amount is $3,511 for the 2007-08 income year. Therefore, the tax-free amount of her genuine redundancy payment is $77,240 ($7,020 + (20 x $3,511)). The remaining is $2,760 is an ordinary employment termination payment.

Example 12 - Redundancy payment made in fixed monthly instalments over two years

142. Iris Novello writes jingles for an advertising agency called Inspirations & Insights (I&I). In July 2005, the Board of I&I decides that they no longer require her services. They want to focus on computer graphics as their speciality given their current approach has led to a decline in profits.

143. Iris has been with the agency for 10 years and is entitled to $24,000 if she voluntarily resigns and $120,000 if she is made redundant.

144. An agreement is reached between I&I and Iris that she will be paid her termination payment over two years from July 2005 to June 2007 in 24 equal monthly instalments of $5,000.

145. The tax-free amount, as worked out under section 83-170, is $38,951 in the 2005-06 income year; and $40,703 in the 2006-07 income year. Her voluntary termination element is $24,000.

146. The total amount paid in the 2005-06 income year is $60,000. Of this amount $24,000 is the voluntary termination element, which is an employment termination payment. The balance of $36,000 is tax-free, being less than the tax-free amount in that year of $38,951.

147. In the 2006-07 income year, there is no voluntary termination element to be applied, as it has been exhausted in the 2005-06 income year. Of the $60,000 paid, $4,703 is tax-free ($40,703 - $36,000). The balance of $55,297 is an employment termination payment. This is because it remains a genuine redundancy payment and the 12 month rule for employment termination payments under paragraph 82-130(1)(b) does not apply to genuine redundancy payments because of paragraph 82-130(4)(b).

Example 13 - Redundancy payment made in uneven annual instalments over three years

148. Assume the same facts as in Example 12 except that due to a lack of funds, I&I pay Iris her termination entitlements in annual instalments of $25,000, $35,000 and $60,000 in each of the ensuing three income years (that is the 2005-06 income year, the 2006-07 income year and the 2007-08 income year).

149. The tax-free amount for the 2007-08 income year is $42,130.

150. In the 2005-06 income year, $24,000 of the amount paid is the voluntary termination element, which is an employment termination payment. The remaining amount of $1,000 is tax-free.

151. In the 2006-07 income year, Iris receives a tax-free genuine redundancy payment only, as the whole amount of $35,000 falls within the potential tax-free amount of $39,703 for that year (the tax-free amount of $40,703 for the 2006-07 income year less the $1,000 tax-free amount received in the 2005-06 income year). The voluntary termination element is not applied again as it has been applied against the amount Iris received in the 2005-06 income year.

152. In the 2007-08 income year, the tax-free amount for Iris increases to $42,130. Of this amount, $36,000 has already been exhausted in relation to the 2005-06 and 2006-07 income years. Therefore, of the final amount of $60,000, only $6,130 ($42,130 - $36,000) is a tax-free genuine redundancy payment.

153. The balance of $53,870 ($60,000 - $6,130) is assessed as an employment termination payment even though it is paid more than 12 months after the termination. The 12 month rule for employment termination payments under paragraph 82-130(1)(b) does not apply to genuine redundancy payments because of paragraph 82-130(4)(b).

Example 14 - Redundancy payment made in instalments, for different reasons and by different but related payers

154. Assume the same facts as in Example 13 except that Iris also receives an additional ex gratia payment of $10,000 on termination from a related entity to I&I in the 2005-06 income year.

155. Therefore, in the 2005-06 income year, Iris receives a total of $35,000 ? $25,000 from her employer and $10,000 from the related entity. As in Example 13, $24,000 of this amount is the voluntary termination element, which is treated as an employment termination payment, and $11,000 is a tax-free genuine redundancy payment.

156. In relation to $35,000 paid in the 2006-07 income year, $29,703 ($40,703 - $11,000) is tax-free and the balance of $5,297 ($35,000 - $29,703) is an employment termination payment.

157. In the 2007-08 income year, the tax-free amount increases to $42,130. Of this amount, $40,703 has already been used in relation to the first and second amounts. Therefore, $1,427 of the $60,000 amount received in this year is tax-free, with the remainder of $58,573 being treated as an employment termination payment.

Example 15 - Separate redundancy payments made by unrelated payers

158. On winding up its mining operations in the Big Desert, Dig It Corp dismisses most of their staff because of the genuine redundancy of their positions. The genuine redundancy payments made by the company are worked out according to years of service.

159. Bill Brown receives a genuine redundancy payment of which part is in excess of the tax-free amount. A little later in the same income year the State Government decides to pay all of the workers laid off by Dig It Corp $10,000 because their positions have been made redundant.

160. As any voluntary termination element and tax-free amount has already been applied to the amount paid to Bill by Dig It Corp, the amount paid by the State Government is a genuine redundancy payment in excess of the tax-free amount and is therefore treated as an employment termination payment.

Example 16 - Genuine redundancy payment on termination and further termination payment as a result of litigation^[33]

161. Natalie Jones is dismissed from her position as a Centre Manager within the Reliable Child Care Company (Reliable) after 10 years of service. At this time, Reliable made a strategic decision to have individual child care centres operate as stand-alone businesses and accordingly wished to change the duties and functions undertaken by Centre Managers. Reliable considered that Natalie's skills were not suited to the redefined role.

162. Reliable pay Natalie a termination payment of $50,000 in addition to her unused leave entitlements and treat the payment as a genuine redundancy payment. Natalie is contractually entitled to $20,000 on voluntary termination.

163. Natalie sues Reliable for unfair dismissal and a year and a half after her termination Reliable settles the case by making a further payment of $100,000 to Natalie.

164. As Natalie's position has effectively been made redundant because of the change in the duties attached to it, all or part of the payment is eligible to be treated as a genuine redundancy payment.

165. The voluntary termination element is equal to $20,000, so only $30,000 of the amount paid immediately on termination is a genuine redundancy payment in that year.

166. However, the total payment made in consequence of dismissal because of redundancy once the litigation has been settled is $150,000. Accordingly, $130,000 of this is a genuine redundancy payment.

167. In the year Natalie's employment is terminated, the total tax-free amount of the genuine redundancy payment is $40,703, of which $30,000 ($50,000 - $20,000) is applied.

168. In the year the litigation is settled, the total tax-free amount applying to Natalie is $42,330. As $30,000 of this amount has already been applied in respect of the first payment, $12,330 of the settlement funds is tax-free. Therefore, in respect of the entire genuine redundancy payment of $130,000, $42,330 is tax-free and the balance of $87,670 is an employment termination payment.

Example 17 - New position offered within a company group - arrangement to employ

169. William Scribe is the editor of Newsday, a current affairs magazine. William is also the Executive Director of Newsworth Pty Ltd (Newsworth), the company that conducts the publishing operations for the Newsday magazine. The directors of Global Newsworth Ltd (Global Newsworth), the holding company that owns Newsworth, decide to close the company due to the Newsday magazine having incurred losses over successive years. William holds no position or office with Global Newsworth. The board of Newsworth, including William, vote for the winding up of the company, in accordance with the directions of the board of Global Newsworth.

170. Global Newsworth owns other magazine and newspaper interests. William is offered a position as the Washington editor of a daily newspaper, The National, when Newsworth is informed of its impending closure.

171. The directors of Newsworth pay William a lump sum of $100,000 because of the redundancy of his position with the company. William accepts the new position as editor of the National.

172. In these circumstances, William does not consent to his own dismissal as both director of Newsworth and editor of the Newsday magazine. The decision of the board of Newsworth to wind up the company is compelled by the decision of Global Newsworth, such that there is no real choice to continue the operations of the company. Both positions are redundant.

173. However, the facts indicate that there was an arrangement in place between Newsworth and one or more entities within the Global Newsworth group to employ William at the time of his dismissal. Accordingly, the payment of $100,000 is not a genuine redundancy payment and is therefore assessable as an employment termination payment.

Example 18 - Dual capacity employee - new position offered within a company group

174. Assume the same facts as Example 17, except that William is a director of both Global Newsworth and Newsworth and is not immediately offered new employment at the time the decision is taken to close the Newsworth magazine.

175. If William does not approve the decision to close the Newsday magazine, he would be taken not to consent to his own dismissal as a director of Newsworth and editor of the magazine.

176. However, if William, as a director of Global Newsworth, approves the decision to close the Newsday magazine, he would ordinarily be taken to consent to his own dismissal and there can be no genuine redundancy payment.

177. William will not consent to the decision to close Newsday magazine where the decision of Global Newsworth is a matter of legal or economic compulsion. On the other hand, if the decision is strategic, where the best business opportunities for the group are assessed and the decision to close the Newsday magazine is one involving the weighing up of alternatives, there is a real choice available for William and the other board members when Global Newsworth effectively makes William's positions with Newsworth redundant.

178. A payment of the order of $100,000 on redundancy is found to be common practice in the industry. Therefore, in the event it is found that William and Newsworth are not dealing at arm's length, the amount paid is not in excess of what could be could be reasonably expected to be paid if the dismissal were at arm's length.

179. However, it will also be necessary to consider what could reasonably be expected on voluntary termination in these circumstances to determine the quantum (if any) of any genuine redundancy payment.

Example 19 - New position offered - no arrangement to employ

180. Assume the same facts as in Example 18, except that a month after William's termination with Newsworth, the position of editor of Rich Life, a style magazine, becomes vacant. Directors of the company publishing this magazine, some of whom are also directors of Global Newsworth, decide to offer the position to William.

181. As there was no arrangement at the time of William's termination of employment for him to be employed by another person, the amount he is paid may still be considered a genuine redundancy payment.

Example 20 - Dismissal for mixed reasons

182. Joe Kuhl is the sole director of an ice cream machine manufacturer, Arctic Dreams. The company has five employees who are involved in all the tasks related to the manufacture of the machines.

183. Joe had previously tried to dismiss one employee for disciplinary reasons but the employee had taken legal action to prevent this. Joe accepted the decision at the time but six months later he finds that there has been a drop in orders for the machines such that the company has one surplus employee. Joe decides to dismiss the employee he had previously tried to dismiss for disciplinary reasons.

184. Though the previous problem with the dismissed employee can be considered relevant to Joe's decision to dismiss him it is also the case that the more immediate reason for the dismissal is the redundancy of the position occupied by the employee. Therefore the prevailing or most influential reason for the dismissal is the redundancy of the position.

185. Accordingly, any termination payment made to the employee qualifies as a genuine redundancy payment if all other conditions are satisfied.

Previous rulings

186. This Ruling replaces Taxation Ruling TR 94/12, which is withdrawn on and from the issue date of this draft ruling. TR 94/12 outlines the requirements for payments to qualify as approved early retirement scheme payments under section 27E of the ITAA 1936 and bona fide redundancy payments under section 27F of the ITAA 1936. To the extent that the Tax Office views in that Ruling still apply, they have been incorporated into this Ruling.

Date of effect

187. When the final Ruling is issued, it is proposed to apply both before and after its date of issue. However, the Ruling will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 75 to 77 of Taxation Ruling TR 2006/10).

Commissioner of Taxation
27 August 2008

Appendix 1 - Explanation

Overview of the termination payment regime - Part 2-40

188. Part 2-40, incorporating Divisions 80 to 83, deals with payments made on termination of employment. Division 80 sets out some general rules for the termination payment regime. Division 82 provides for the tax treatment of employment termination payments. Broadly speaking, treatment as an employment termination payment is the default for payments made in consequence of termination of employment. Division 83 provides for the tax treatment of other termination payments, including genuine redundancy payments.

189. It is the Commissioner's view that Part 2-40 seeks to provide a comprehensive and cohesive treatment of payments made in consequence of the termination of a person's employment. The treatment of genuine redundancy payments, principally provided for in sections 83-170 and 83-175, is to be understood in the context of the overall termination payment regime.

190. Genuine redundancy payments (together with early retirement scheme payments) are unique among the termination payments treated under Division 83, in that they are capable of being treated as employment termination payments to some extent. That is, genuine redundancy payments are not a mutually exclusive category of payment.^[34] The Commissioner considers that this feature is critical in determining the tax treatment of genuine redundancy payments as it points to an integrated approach to the payments made in consequence of a particular termination.

How do genuine redundancy payments fit within the termination payment regime?

191. An employee whose position becomes redundant and is consequently dismissed from employment may receive a variety of termination payments.

192. The payments may be sourced from legal entitlements of the employee or may be made gratuitously. Payment entitlements may arise under:

•

the employee's employment contract;

•

an industrial agreement that applies to the employee;

•

statute or some other form of special Government funded scheme; or

•

legal proceedings instituted following termination, whether under a court award or settlement.

193. While redundancy payments would ordinarily be made by the employer of the terminating employee, the character of a payment as a 'genuine redundancy payment', or indeed as a termination payment more generally under Part 2-40, does not depend on whether an employer makes the payment.

194. It is also possible that payments may be received over a period of time in respect of a particular termination of employment. This period may extend over a number of income years for the employee.

195. Part 2-40 provides for the interaction of all such payments, including those payments that can be characterised and identified as genuine redundancy payments. The rules in Part 2-40 provide a mechanism by which the various payments made when an employee is terminated because of redundancy can be separated out for tax treatment purposes.

196. Practically speaking, the first payments that need to be identified are those payments that receive a more specific treatment than redundancy payments and employment termination payments. In the case of redundancy payments, this is reflected in subsection 83-175(4), which excludes any payment mentioned in section 82-135, apart from paragraph 82-135(e), from being a genuine redundancy payment. Section 82-135 comprehensively lists any payment that may be made in consequence of termination of employment but is nevertheless excluded from being an employment termination payment.^[35]

197. Some of the payments mentioned in section 82-135 are listed in the table below. The more specific treatment received by these payments is listed in the second column:

198. While the circumstances in which such payments are made may be that of redundancy, the scheme of Part 2-40 characterises them for tax purposes as payments other than redundancy payments.

199. The remaining payments will generally receive concessional tax treatment as either a genuine redundancy payment or an employment termination payment.

200. Although separately defined from an employment termination payment, it is the Commissioner's view that a genuine redundancy payment is an employment termination payment unless and to the extent that it is tax-free, as worked out under section 83-170 and section 83-175. The primary feature that distinguishes the tax treatment of a genuine redundancy payment from that of an employment termination payment is that an identified part of a genuine redundancy payment may be tax-free. Once any tax-free amount is separated, the balance is treated as an employment termination payment.

The basic requirement for a genuine redundancy payment

201. The basic requirement for a genuine redundancy payment is described in the following terms in subsection 83-175(1):

...so much of a payment received by an employee who is dismissed from employment because the employee's position is genuinely redundant as exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of the dismissal. [Emphasis added]

202. The Commissioner considers that there are four necessary components embodied in the basic requirement for a genuine redundancy payment. Each of these concepts are considered and explained in turn below:

•

The payment being tested must be received in consequence of a 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.

Component 1: Payment 'in consequence of' termination

203. It is the Commissioner's view that a payment must be in consequence of termination (by way of dismissal caused by redundancy) before any part of that payment can be treated as a genuine redundancy payment.

204. The purpose of subsection 83-175(1) is twofold - to identify what gives a redundancy payment its essential character; and to identify the amount that can be attributed to the fact of redundancy. The highlighted words in paragraph 201 of this draft Ruling give effect to the first purpose. The second purpose is given effect by contrasting any payment that has this essential redundancy character with an amount that could reasonably be expected on voluntary termination.^[36]

205. Once both of these purposes are taken into account, it is clear that the highlighted words import the need for a causal relationship to exist between the payment and the particular form of termination contemplated by section 83-175. The reference to 'in consequence of' in relation to the voluntary termination element supports the view that the same 'in consequence of' test will establish the necessary causal relationship between the payments being tested and dismissal due to redundancy. The Commissioner's views on the meaning and application of the 'in consequence of' test are set out in Taxation Ruling TR 2003/13.^[37]

206. Section 27F of the ITAA 1936 stated that a bona fide redundancy payment was made in consequence of the dismissal of the taxpayer. There is no explicit requirement in section 83-175 of the ITAA 1997 that a genuine redundancy payment must be made in consequence of termination. However, as explained in the Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006, it was not intended to make substantive changes to the tax regime in respect of genuine redundancy payments.^[38] The provisions relating to these payments were intended to retain their existing application but were redrafted to reflect current drafting approaches.

207. It is also stated in section 83-1, the Guide to Division 83, that the Division sets out the treatment of payments other than employment termination payments that are made in consequence of termination.

208. These materials support the dual treatment of redundancy payments as either tax-free genuine redundancy payments or employment termination payments. The requirement that a payment be made in consequence of dismissal caused by redundancy means that the 'in consequence of' condition in the subsection 82-130(1) definition of employment termination payment will be met.^[39] As it may transpire that part of a genuine redundancy payment is an employment termination payment, the whole of the redundancy payment must have been in consequence of termination.

Component 2: 'Dismissal' from employment

Ordinary meaning of 'dismissal'

209. For a payment to qualify as a genuine redundancy payment, the employee must be dismissed from employment. It is not sufficient that the person loses a particular position with an employer but continues on in some other capacity. Subject to one particular exception discussed below,^[40] all employment with the employer must be severed.

210. In the context of the ITAA 1936 provision dealing with genuine redundancy payments,^[41] the Full Federal Court in Dibb v. Federal Commissioner of Taxation (Dibb) stated that:^[42]

It is only if the employer considers that 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. [Emphasis added]

211. Therefore, demotion within an organisation will not constitute a dismissal for the purposes of section 83-175.^[43]

212. Dismissal is not synonymous with termination but involves an action to terminate employment taken by the employer irrespective of the wishes of the employee. In Smith v. Director-General of School Education (Smith), it was stated:^[44]

we find no difficulty in accepting the ordinary meaning of 'dismissal' ... as being 'the termination of services by the employer without the employee's consent'; we would add that where an employee does not freely consent to the termination, understood in a broad sense, then the circumstances may still amount to a dismissal by the employer as a constructive dismissal...

213. In Advertiser Newspapers Pty Ltd v. Industrial Relations Commission of South Australia (Advertiser Newspapers),^[45] Bleby J noted that the word 'dismissal' was concerned with the consequences of action taken by the employer. His Honour quoted and adopted the definition of 'dismissal' expressed by the Full Industrial Court of New South Wales in Smith, and held that:^[46]

It follows that where an employee voluntarily abandons employment or lawfully terminates the contract (for example by giving the requisite notice) or where the contract of employment terminates by effluxion of time or by agreement, there is no dismissal...

214. It follows from these principles that the question of whether an employee consents to their termination is one of fact. All facts and circumstances of a given case must be assessed to determine whether the employee consents to their termination.

215. Consent in this context refers to the employee choosing to agree to or approve the act or decision to terminate employment in circumstances where the employee has the capacity to make such a choice.^[47] Such agreement or approval may be express or implied.

216. Accordingly, consent is a broader concept than agreement:^[48]

The distinction between consent and agreement is that consent does not necessarily result in a binding contract, it may take the form of party A proposing something and party B indicating that he will go along with it.

217. On the other hand, mere passive acquiescence, while closely related, will of itself not establish consent. Shaw LJ in the English case of Bell v. Alfred Franks & Bartlett Co Ltd drew the distinction between consent and acquiescence in the following terms:^[49]

...the only practical and sensible distinction that can be drawn is that if acquiescence can arise out of passive failure to do anything, consent must involve a positive demonstrative act, something of an affirmative kind.

218. In circumstances where an employee volunteers to accept a redundancy package, there may still be a dismissal. This will occur where the decision to terminate employment is still ultimately that of the employer. The termination of employment is a dismissal here because the employer initiates the process and has the final say in whose employment is to be terminated.

Constructive dismissal

219. As mentioned in Smith,^[50] the concept of dismissal extends to 'constructive dismissal'. This refers to a termination that gives the appearance of employee consent, but in substance reflects the same circumstances as would have been the case if the employee had been dismissed - that is, an employer initiated termination without the employee's consent. In Blaikie v. South Australian Superannuation Board, Olsson J, quoting his own decision in R v. Prince Alfred College^[51] stated:^[52]

The fact that the act of resignation subsumed the act of dismissal does not alter the essential character of the transactions between the parties. By virtue of the implicit waiver of the original act of formal dismissal by the employer, the applicant was, in reality, in a position in which he had resigned because he had been given virtually no option but to do so...

220. For example, if an employer is reorganising or downsizing, an employee may be offered alternative employment that is not appropriate given the employee's qualifications or experience,^[53] or is in a particularly inconvenient location for the employee.

221. An employee who chooses to resign in these circumstances may not be considered to freely consent to their resignation. This would be an instance of constructive dismissal.

Component 3: Dismissal caused by 'redundancy'

Ordinary meaning of 'redundancy'

222. The concept of redundancy broadly refers to situations where something is superfluous and therefore unnecessary. In subsection 83-175(1) of the ITAA 1997 the thing that must be redundant for the provision to apply is an employee's position. This contrasts with subsection 27F(1) of the ITAA 1936, where it was the bona fide redundancy of the taxpayer that was at issue. The drafting of section 83-175 of the ITAA 1997 more accurately reflects the nature of redundancy in industrial law.^[54]

223. In R v. Industrial Commission (SA); Ex parte Adelaide Milk Co-operative Ltd, Bray CJ stated that:^[55]

...a job becomes redundant when an employer no longer desires to have it performed by anyone.

224. Ryan J in Jones v. Department of Energy and Minerals expanded on Bray CJ's description in the following terms:^[56]

However, it should be noted that Bray CJ's description of what can constitute redundancy is not expressed to be exclusive. His Honour's description was cast in terms of a 'job' in the sense of a collection of functions, duties and responsibilities entrusted, as part of the scheme of the employer's organization, to a particular employee. However, it is within the employer's prerogative to rearrange the organizational structure by breaking up the collection of functions, duties and responsibilities attached to a single position and distributing them among the holders of other positions, including newly-created positions. It is inappropriate now to attempt an exhaustive description of the methods by which a reorganization of that kind may be achieved. One illustration of it occurs when the duties of a single, full-time, employee are redistributed to several part-time employees. What is critical for the purpose of identifying a redundancy is whether the holder of the former position has, after the re-organization, any duties left to discharge. If there is no longer any function or duty to be performed by that person, his other position becomes redundant in the sense in which the word was used in the Adelaide Milk Co-operative case.

225. Accordingly, this approach focuses on the underlying reality or substance of the position, that is, the existence of the functions, duties and responsibilities attached to a position. It does not focus on whether the position, in terms of a name or position number, has been abolished.^[57] A position is redundant when the functions, duties and responsibilities formerly attached to the position are determined by the employer to be superfluous to the current needs and purposes of the organisation.

226. It is clear from the passages cited from the cases at paragraphs 210, 223 and 224 of this draft Ruling that the decision to make an employee's position redundant is fundamentally one made by the employer. This is consistent with the principle that dismissal is a termination of employment at the employer's initiative.

Casual or contracted workers

227. Where an employer decides to bring the employment of a casual employee to an end because the work being performed is not required to be performed for the time being, the termination of the employee may not be because of the redundancy of the position. For instance, the work may be required to be performed at the same time in the following year.

228. A contracted employee may also be employed for a particular project. The completion of the work required to be performed by the employee for the purposes of the project may give rise to a termination payment. This will not ordinarily qualify as a genuine redundancy payment.^[58]

229. However, in some cases an employee may be formally employed as a casual but may, in fact, occupy a long-term position in the same way as other employees.^[59] In that case, the position of the employee could be made redundant.

Determining the cause of dismissal

230. There are various reasons why an employee may be dismissed from employment. Redundancy may be only one of these reasons.

231. In circumstances where more than one reason can be identified for the dismissal, the Commissioner considers that redundancy must be the primary cause of the dismissal. This suggests an analysis of what is the prevailing or most influential cause of the dismissal.^[60] This question is to be answered in light of the facts and circumstances of each case.

232. The classic context for redundancy is the closure, downsizing or reorganisation of part or all of the employer's operations. Redundancy can readily be established as the prevailing or most influential cause of dismissal in the first two of these scenarios.^[61]

233. Where an employer dismisses an employee after a reorganisation of duties, functions and responsibilities, a more careful analysis is required. A restructure of an organisation does not necessarily import redundancy where employees are dismissed following the reallocation or restructure.^[62] 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.^[63]

234. In Re Marriott and Federal Commissioner of Taxation^[64] the employer did not see fit to dismiss the employee after a reallocation of duties, functions and responsibilities within the organisation. In this case, the employee was carrying out duties of a legal nature in the Tax Office. These duties changed upon the reorganisation, in that he was not continuing to directly negotiate settlements or train junior advocates. After carefully considering the evidence before him, Senior Member Lindsay found that there was not a dismissal (in particular there was not a constructive dismissal) and further commented that:^[65]

Whether an employee's termination is by reason of redundancy will require an assessment of the changes to determine if they were beyond or beneath the employee's qualifications, skills or experience.

235. In this case it was considered that the prevailing or most influential cause of termination was the employee's own desire not to undertake the duties, functions and responsibilities he was offered following the reorganisation.

236. Another common reason for a dismissal is the personal acts or default of the employee.

237. In Re Cowling and Federal Commissioner of Taxation (Cowling),^[66] the taxpayer was the Chief Executive Officer of a government business enterprise. He was dismissed in a context where there was to be a reorganisation of the corporate structure of that enterprise. This reorganisation was partly precipitated by a government decision to redistribute the functions of various enterprises.

238. While it was alleged that the employer considered the taxpayer's termination to be caused by redundancy, the evidence indicated that the termination of the taxpayer was principally related to his performance. In particular, evidence tendered before the Tribunal clearly showed that the Board did have ongoing concerns about the taxpayer's performance. An acting Chief Executive Officer was also appointed to replace the taxpayer.^[67]

Component 4: 'Genuine' redundancy

239. Whether a redundancy payment is genuine is to be determined on an objective basis. It is not sufficient that an employer and employee have an understanding that a payment is a redundancy payment or that the employer calls the payment a redundancy payment to give the employee a better taxation outcome. The nature of the termination of an employee does not depend on what was communicated to that employee in relation to the termination.

240. This approach is supported by the decision in Fosters' Group Limited v. Wing,^[68] where the reasons communicated to the employee for his termination were not seen to determine the question of whether the termination was by reason of redundancy.

241. The need for the employee's position to be genuinely redundant establishes that contrived cases of redundancy will not meet the conditions in section 83-175. The following scenarios illustrate cases of contrived redundancy:

•

Where an employing entity is wound-up and some or all of the employees are immediately re-engaged by a new employing entity (this scenario may also be a stipulated arrangement to employ the employees after the dismissal and therefore breach the condition under paragraph 83-175(2)(c)).^[69]

•

Where an employer terminates an employee on outsourcing particular duties and functions and immediately engages that employee to perform the outsourced duties and functions.

Further conditions for a genuine redundancy payment

242. Before a payment that meets the basic redundancy requirement in subsection 83-175(1) qualifies as a genuine redundancy payment, all other conditions in section 83-175 must be met. These conditions, are:

•

The payment must be made before the person turns 65 or an earlier mandatory age of retirement - paragraph 83-175(2)(a);

•

The payment must be made before the end of a fixed period of employment - subparagraph 83-175(2)(a)(ii);

•

The payment must not exceed an arm's length amount in the event that the employer and employee are not dealing at arm's length - paragraph 83-175(2)(b);

•

There must be no stipulated arrangement to employ the person after the termination - paragraph 83-175(2)(c); and

•

The payment must not be in lieu of superannuation benefits - subsection 83-175(3).

Age-based limits

243. An employee receiving a genuine redundancy payment must, at the time of dismissal, be aged less than 65 or less than a younger age of compulsory retirement for the particular position in question. For example, if an employee is required to retire at age 60, then the person can only receive a genuine redundancy payment if he or she is less than 60 years old when the dismissal occurs.

244. A termination payment made to a person who is more than 65 or another age of compulsory retirement at the time of dismissal would be an employment termination payment if the conditions in section 82-130 are satisfied.

Not the end of a fixed-term contract or a project

245. It would normally be the case that someone employed on a contract for a set period could not be dismissed at the end of that period. Their employment would simply terminate because an arrangement stipulated that the employment would cease at that time.

246. Senior Member Sweidan in Winsen v. Commissioner of Taxation^[70] found this to be the case where a person was employed for a succession of fixed periods at the end of the last of which there was no continuation of employment and no renewal of the contract for a further fixed period. While the Senior Member left open the possibility that there could be circumstances in which a rolling series of employment contracts might be of indeterminate duration, the mere fact of past renewal of the contracts could not give rise of itself to such an outcome.

247. Senior Member Sweidan summed up the position on the facts of the case in the following terms:^[71]

Further, in the Tribunal's view, as contended by the respondent, the applicant's argument is misconceived as it is quite clear that the applicant's employment with her employer would necessarily have terminated on 31 December 2002 under the terms of the contract. The applicant's contention that absent a decision by the employer to not renew or extend the contract, termination of the employment would not necessarily have occurred, appears to the Tribunal to be without any foundation in fact or in law. As noted in the decision in Fisher v. Edith Cowan University (No 2) (1997) 72 IR 464:

Facts such as the continuation of the employment position after the expiration of the period of Ms Fisher's contract and Ms Fisher's expectation that she would continue in the position would have been relevant.

248. In many industries workers are employed on a project basis. The fact that a project is completed, even where the project is completed before a designated time, is not a situation where the workers are redundant. For these purposes, the Commissioner considers that termination on completion of a particular task or outcome represents a period of service for the purposes of subparagraph 83-175(2)(a)(ii). If the completion of the task or outcome gives rise to a payment, such a payment would normally be an employment termination payment, not a genuine redundancy payment.^[72]

Arm's length amount

249. The need to satisfy the arm's length amount condition in paragraph 83-175(2)(b) is predicated on establishing, as a matter of fact, that the employee's dismissal from employment by the employer was other than at arm's length.

250. The question of whether parties have dealt with one another at arm's length has been considered in a wide range of statutory contexts. The general principles set out at paragraphs 189 to 199 of Taxation Ruling TR 2006/7^[73] can be applied in determining whether an employer and an employee are dealing with each other at arm's length for the purposes of paragraph 83-175(2)(b).

251. In particular it should be noted that while the ability of one party to control or influence another party is an important issue to consider in working out whether there is an arm's length dealing, it may not determine that such a dealing is not at arm's length.

252. Identifying the nature of the relationship between the parties is merely a step (albeit a very important one) in the course of reasoning whether parties are dealing at arm's length.^[74]

253. In the event that the employer and employee are not dealing at arm's length, it is necessary that the actual redundancy amount paid to the employee be no greater than the amount that could reasonably be expected had the parties been dealing at arm's length. Any excess will cause the condition in paragraph 83-175(2)(b) to be breached. Accordingly no amount of the redundancy payment will be a genuine redundancy payment. The condition in paragraph 83-175(2)(b) does not operate to reduce the amount eligible for genuine redundancy payment treatment to the arm's length amount.

254. The condition in paragraph 83-175(2)(b) is based on determining a hypothetical arm's length amount. The determination of this hypothetical amount proceeds on the basis that all circumstances associated with the termination of the particular person's employment are the same, other than for an assumption that the employer and employee were dealing at arm's length in relation to the dismissal. The comparative amount must assume that there had been real bargaining between the parties. This is to be contrasted with the actual situation, where the parties were not dealing at arm's length.

255. The amount that could reasonably be expected to have been made had the parties been dealing at arm's length in relation to the dismissal is a matter to be established by evidence. That evidence must be sufficient to identify an amount that, on a reasonable basis, is not less than the actual amount paid.^[75] All relevant factors need to be assessed and balanced to determine what could reasonably have been expected in arm's length circumstances.

256. Whether the actual amount paid is reasonable given the circumstances associated with the terminated employee's employment is a very significant evidentiary factor in determining what could reasonably be expected under paragraph 83-175(2)(b).

257. In a redundancy context, these circumstances principally contemplate:

•

the number of years of service provided by the terminated employee to the employer; and

•

the value of the employee's remuneration package (to the extent that this value itself reflects arm's length dealings) at the time of termination.^[76]

258. Other relevant matters include:

•

what the employee's contract provides for in the event of redundancy (to the extent any such provision reflects an arm's length dealing);

•

standard redundancy payment practices within the industry;

•

the overall financial position of the employer at the time of the dismissal; and

•

the nature of the work undertaken by the employee.

259. The Commissioner considers that it is also important to take into account any arm's length dealings entered into by the employer in respect of employees who are made redundant.^[77] Of particular relevance are arm's length dealings involving other employees whose employment is terminated at the same time as the employee in question. While not determinative for these purposes,^[78] such dealings must, in the Commissioner's view, be weighed in assessing what amount could reasonably be expected to be made had the parties been dealing at arm's length.

260. When comparing any arm's length dealings entered into with the relevant non-arm's length dealing for these purposes, it is necessary to properly recognise the different circumstances that apply to the respective employees. For example, some of the factors highlighted at paragraphs 257 and 258 of this draft Ruling are likely to vary from employee to employee. The payment of different redundancy amounts to arm's length and non-arm's length employees can often be readily explained by reference to these factors.

261. However, if the dealings at arm's length have taken place on a clearly different basis to those other than at arm's length, the Commissioner considers it highly likely that paragraph 83-175(2)(b) will not be satisfied in relation to the non-arm's length dealing.

262. Further, the Commissioner does not consider the relevant tax-free amount for a particular employee, as worked out under section 83-170, to be a proxy for the amount that could reasonably be expected to be paid had the parties been dealing at arm's length. While this amount takes into account an employee's years of service with the employer, it does not take any account of other important factors, in particular the value of the services provided by the employee or the comparable treatment of employees who are made redundant in the same set of circumstances.

263. The Commissioner also considers that recognition of previous unpaid or outstanding service (for example, additional hours worked over the course of employment) or the failure to make payments other than redundancy payments to which an employee is otherwise entitled on termination (for example unused leave payments) is not to be taken into account for these purposes. Alternatively, to the extent that these factors are considered relevant, they would also be reflected in the amount that could reasonably be expected to be made on voluntary termination^[79] and therefore would not impact on the calculation of the genuine redundancy payment amount.

No stipulated arrangement to employ

264. Under paragraph 83-175(2)(c), an arrangement to employ an employee after his or her termination may prevent a dismissal giving rise to a genuine redundancy payment. An arrangement in this context is defined widely:^[80]

arrangement means any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

265. For the condition in paragraph 83-175(2)(c) to be failed, it is necessary for the employment arrangement to be entered into between either:

•

the employer and the employee; or

•

the employer and another entity.

266. Accordingly, if the employee has independently entered into an arrangement with another entity for that entity to employ him or her after the time of the dismissal from the original employer, the condition in paragraph 83-175(2)(c) will still be met. On the other hand, given the breadth of the meaning of 'arrangement', an implied understanding between two related companies at the time of an employee's dismissal with one of those companies to the effect that the employee will be employed at a later time with the other is sufficient for this condition not to be met.

Payment in lieu of superannuation benefits

267. Subsection 83-175(3) provides that a genuine redundancy payment does not include any part of a payment that was received by an employee in lieu of superannuation benefits to which the employee may have become entitled at the time the payment was received or at a later time.

268. Paragraph 82-135(a) and subsection 83-175(4) together provide that a superannuation benefit is not a genuine redundancy payment. Payments from a superannuation fund to a fund member because of that membership are a superannuation benefit. Payments made pursuant to entitlements in similar superannuation plans or under superannuation-related legislation are also defined to be superannuation benefits.^[81]

269. For subsection 83-175(3) to apply, the payment in lieu of superannuation benefits would generally be made by an employer or some other entity. The words 'in lieu' indicate that the subsection intends to cover redundancy payments to the extent that they are being substituted for payments covered by the table in subsection 307-5(1).

Tax treatment of redundancy payments

Elements of a redundancy payment

270. As noted at paragraph 196 of this draft Ruling, the first step in working out the tax treatment of redundancy payments is to exclude any payments that receive a more specific tax treatment. Subsection 83-175(4) gives effect to the exclusion of these amounts from the concept of a genuine redundancy payment.

271. Once these payments have been excluded and it is established that any remaining amounts meet the conditions for genuine redundancy payment treatment, those amounts may be divided into three elements so as to identify their treatment for tax purposes:

•

The voluntary termination element: this is the amount up to that which could reasonably have been expected to be paid on voluntary termination in comparable circumstances to those applying at the time of the redundancy. This generally will be an amount that could be expected to be paid in the case of resignation or retirement as relevant to the particular circumstances of the employee. For instance, a person retiring after many years with a particular employer might expect an amount well in excess of that expected to be paid to a short-term employee.

•

The tax-free amount of the redundancy element: any excess of the redundancy payment made above the voluntary termination element, but only up to the amount worked out under section 83-170 for the particular employee concerned.

•

The taxable amount of the redundancy element: any further excess of the redundancy payment made above the total of the voluntary termination element and any tax-free redundancy element.

272. The voluntary termination element is subject to tax as an employment termination payment if it is received no later than 12 months after the termination. As this payment would ordinarily have been made on termination, it is treated as an employment termination payment under section 82-130 as a payment made in consequence of termination.

273. Where this payment is made more than 12 months after the termination of employment it is assessable as ordinary income under section 83-295.^[82]

274. The tax-free element of any amount in excess of the voluntary termination element is worked out under section 83-170 as the base amount plus the service amount by the years of service. These amounts are indexed. The tax-free amount of the redundancy element is neither assessable income nor exempt income. Under paragraph 82-135(e) it is not an employment termination payment.

275. However, any amount in excess of the sum of the voluntary termination element and the tax-free amount is an employment termination payment. The 12 month rule does not apply to it because of paragraph 82-130(4)(b), which excludes genuine redundancy payments from its operation.

Working out the voluntary termination element

276. The voluntary termination element is an integral part of working out the amount of a genuine redundancy payment. The purpose of deducting this element from the payments otherwise made in consequence of the employee's termination^[83] is to identify the extent to which those payments are specifically attributable to termination because of redundancy.

277. Like the arm's length amount worked out under paragraph 83-175(2)(b), the voluntary termination element is a hypothetical amount.^[84] All the circumstances associated with the termination of the person's employment are the same other than for an assumption that the employee voluntarily resigned or retired. This is to be contrasted with the actual situation, where the employee was dismissed because of redundancy.

278. The principles that apply in working out the voluntary termination element are in many respects similar to those applying to working out the arm's length amount under paragraph 83-175(2)(b). All relevant factors need to be assessed and balanced to determine what might reasonably be expected in the hypothetical circumstances. Some of the factors that may be taken into account for the purposes of arm's length amount test, particularly those listed at paragraph 258 of this draft Ruling applied to a voluntary termination context,^[85] may also be relevant.

279. That said, there are important differences between the voluntary termination element test and the arm's length amount test.

280. The hypothetical test for the arm's length test amount assumes an arm's length dealing. In contrast, if the dealings between employer and employee on termination are not arm's length, this factor must remain constant when working out the voluntary termination element. The Commissioner does not consider it appropriate to make a comparison with amounts paid to arm's length employees who voluntarily terminated their employment for these purposes.

281. In addition, the contractual entitlements of an employee on voluntary termination are less significant if the dealing between an employer and an employee on termination is other than at arm's length. In contrast, if the dealings between employer and employee are at arm's length, the contractual entitlements of the employee on voluntary termination will be the most important factor in working out what could reasonably be expected.

282. Overall, it would generally be expected that the amount paid to an employee in the event of redundancy would be greater than that paid in the event of voluntary termination. This recognises that the purpose of redundancy payments is in part to compensate the employee for the inconvenience and hardship caused by the particular circumstances associated with redundancy.^[86] In contrast, a payment in lieu of notice is to help in adjusting to new circumstances. Nevertheless, such a payment may still be treated as a genuine redundancy payment, on the basis that it may not have been reasonably expected on voluntary termination of employment.

283. Finally, the Commissioner considers that the amount that could reasonably be expected in the event of voluntary termination is not as heavily dependent, as is a redundancy package, on the number of years of service provided by the employee or the value of the employee's remuneration package at the time of termination. The common practice across a wide range of industries is to calculate redundancy packages based on these two factors. It is noted that these factors will particularly impact on the extent to which an employee is inconvenienced or suffers hardship in the event of redundancy.

284. Nevertheless, it is reasonable to expect that employees who have provided extensive service to an employer or whose services are significantly valued by the employer are more likely to receive an ex gratia payment on voluntary termination.

Only one voluntary termination element and one tax-free amount applied per termination caused by redundancy

285. In the simplest case, a redundancy payout would be made by one payer (typically the employer) as a single amount based on one payment source (for example, a contractual or industrial agreement entitlement of the employee or in some cases an ex-gratia payment).

286. However, it is also conceivable that amounts paid in consequence of dismissal due to redundancy could be paid in instalments or as a series of payments, have different sources or be made by more than one payer.

287. The Commissioner's view is that, of their nature, termination payments, including genuine redundancy payments, are tied to the particular termination to which they relate. This relationship is embodied in the 'in consequence of' test.

288. Therefore, the treatment of all termination payments that are not specifically excluded from being either genuine redundancy payments or employment termination payments is determined by treating all amounts paid in consequence of the termination as a single bundle of payments referable to that termination. This is consistent with the legislatively enshrined principle of interpretation that the singular includes the plural unless the contrary intention appears.^[87]

289. The Commissioner considers the overall statutory context of Part 2-40 suggests that this approach is the intended outcome. The need to cover a termination payment made in instalments was originally the basis on which the term 'payment' was used in the original eligible termination payment provisions. 'Payment' was used in preference to 'lump sum'. The Commissioner considers that this evidences an intent that a series of termination payments that was not an annuity should be seen to form part of an overall payment on termination.

290. This is outlined in the relevant Explanatory Memorandum^[88] as follows:

'eligible termination payment' is to be defined exhaustively in relation to a taxpayer by reference to all of the possible circumstances in which may be made a payment to which the new Subdivision AA is to apply. Whereas paragraph 26(d) of the Principal Act, which is being repealed by this Bill, applies only to amounts paid 'in a lump sum', the term 'eligible termination payment' is not so limited. As a result, the provisions of proposed Subdivision AA will apply where, for example, a taxpayer's entitlement to a benefit from a superannuation fund is paid by way of 2 or more instalments. The definition will accordingly overcome the decision of the Federal Court of Australia in the case Federal Commissioner of Taxation v. Knight.

291. It is also the case that employment termination payments and genuine redundancy payments are not primarily identified by their source or limited to payments by the employer of the terminating employee. A payment need only be made in consequence of the termination of employment to qualify.

292. Accordingly, the intended treatment of genuine redundancy payments recognises that only one voluntary termination element and one tax-free amount will be applied in respect of any and all redundancy payments made in consequence of a particular termination.

293. Where the voluntary termination element is particularly large, a different approach may result in no amount being afforded genuine redundancy payment treatment. Likewise, multiple applications of the tax-free amount may result in differential treatments of taxpayers in comparable positions based merely on the form in which they receive their redundancy payments. The Commissioner considers it unlikely that Parliament would have intended these outcomes.

Application of basic principles to dual capacity employees

What is a dual capacity employee?

294. A 'dual capacity' employee is a person who, in addition to being engaged as an employee of a particular entity, is also a directing mind or office holder of that entity.

295. It is a very well established principle of corporations law that a person can act in these two capacities. Authority for the principle can be traced back to the decision in Salomon v. Salomon & Co Ltd.^[89] This case established the proposition that a company has an existence separate and distinct from its directors and shareholders, even where the company is managed and controlled by one person.

296. In Lee v. Lee's Air Farming Ltd,^[90] the decision in Salomon was relied upon in finding that a person may function in the dual capacities of director and employee in relation to a company. It was held that, as a company is a separate legal entity, a contract of employment may exist between an individual and the company even where the individual is also the only director of the company and the individual acted as an agent of the company to arrange the employment contract.

297. A directing mind of a corporate entity ordinarily holds an office with that entity. Section 80-5 provides that the holding of an office, which would include holding a position as company director, is considered to be employment for the purposes of Part 2-40. Therefore, a dual capacity employee is considered to have dual employment under Part 2-40 - employment in the capacity of a common law employee and employment in the capacity of a company director.

298. As stated in Grealy v. Federal Commissioner of Taxation:^[91]

The word 'office' usually connotes a position of defined authority in an organisation, such as director of a company or tertiary educational body, president of a club or holder of a position with statutory powers.

299. A managing partner in a partnership also occupies an office.^[92]

300. It follows that a 'dual capacity' employee may decide or actively participate in a decision to terminate their own employment in either or both capacities of employment.

301. A particular form of dual capacity employment is a person who holds a position as or akin to a 'managing director' of a company. It is conceivable that such a person may be terminated from their role as managing director, yet retain a role as a 'non-executive' director of the company.^[93] This could occur in both small closely held companies and in larger companies.

Termination of employment in one capacity

302. The Commissioner considers that section 80-5 gives effect to a limited exception to the general principle that a person must be terminated from all employment with a particular employer before it can be said that there has been a termination of employment for Part 2-40 purposes.^[94]

303. This recognition of dual employment in the case of a dual capacity employee enables the conditions in section 83-175 to be met where such an employee is dismissed from employment in only one of their two capacities. This will be particularly relevant where a person is terminated from their common law employment, but remains a director of the employing entity.

304. If a dual capacity employee has their employment terminated in one capacity but not the other, it is important that any payment made in consequence of that termination reflects the circumstances of the terminated capacity only.

305. However, if the person's dual capacities are effectively integrated such that the loss of the one gives rise to the loss of the other, then there is a dismissal from one employment. This would be the case where a managing director loses their role as manager and the directorship is also lost as a matter of course.

Dismissal of dual capacity employees

306. As discussed earlier,^[95] the defining feature of termination of employment by way of dismissal is that the termination occurs without the employee's consent. Whether the employee consented to a termination decision is a question of fact to be assessed in light of the circumstances of each case.

307. Consent refers to the employee choosing to agree to or approve the act or decision to terminate employment in circumstances where the employee has the capacity to make such a choice, which may be express or implied.

308. Where a dual capacity employee terminates their own employment or actively participates in a collective decision to that effect, the question of whether the person consented to the termination requires careful consideration.

309. The Commissioner considers that a person's consent does not depend on the capacity in which they are acting. This is because consent is a state of mind peculiar to a person. Accordingly, in the Commissioner's view, it is not possible for a person to consent to a decision in one capacity (for example, as a director of the employer) yet not consent to the same decision in another capacity (for example, as an employee of the employer). In a different dual capacity situation, it has been suggested that 'it is a little difficult to say that [a person] is not himself consenting to what he himself does or purports to do'.^[96]

310. In any case, it is noted that in many scenarios (particularly those involving small businesses run by closely-held companies controlled by one or two directing mind employees) there is no real distinction between the actions undertaken by a dual capacity employee in each of their two capacities.

311. If a person does not agree to or approve an act or a decision to terminate their employment the termination is without the person's consent.

312. Nevertheless, if the person agreed to or approved their termination because it was dictated by legal or economic compulsion such that there was no real or practical choice, that termination, too, would be without the person's consent.

313. Apart from these two types of circumstances, the Commissioner considers that a dual capacity employee will consent to their own termination, and accordingly there will be no dismissal for the purposes of section 83-175.

314. The principal case in the first of these two scenarios is where a dual capacity employee is actively involved in the termination decision, but can demonstrate that he or she did not agree with the ultimate decision that was made. Such a termination will be without consent, even where the employee agreed with the circumstances that led to the termination. For example, it may have been unanimously agreed that there is a need to reduce the number of directors of a company (as often occurs in the case of a business merger), but there is disagreement about which directors should remain.

315. The circumstances that existed in Re Long and Commissioner of Taxation (Long)^[97] are illustrative of the second of the two scenarios.

316. In Long, the employing company lost the contract that was the underlying source of its business. That contract was terminated by the other party to the agreement.

317. Mrs Long was an active director of the employing company who also performed an office management role within the company's business. When the business source contract was terminated, the directors unanimously decided to wind up the business and retrench all the employees, including Mrs Long. The issue in the case was whether a termination payment that was paid to her was a bona fide redundancy payment (the equivalent of a genuine redundancy payment under the ITAA 1936).

318. Senior Member Pascoe found that Mrs Long had not consented to her own termination of employment but had been obliged, on the particular facts of the case, to terminate her own employment. Therefore, this qualified as a dismissal, as the termination of employment 'was forced on Mrs Long as both a director and employee'.^[98]

319. Whether the decision to terminate employment was dictated by legal or economic compulsion requires an assessment of the facts and circumstances of each case. As Senior Member Pascoe found in Long:^[99]

In common with many areas of revenue law, an answer will depend on the particular facts of each case. Here, I am satisfied that where all work of the employer ceased as a result of external circumstances beyond the control of the employer and all employees, including the directors in their capacity as employees, are made redundant, such termination meets the requirements of that paragraph of s 27[F]. The termination was forced on Mrs Long as both a director and employee.

320. Matters that are relevant in assessing the facts and circumstances of each case include:

•

the chronology of events that led to the termination of employment, particularly those events that were the immediate context for the termination;

•

the process by which the directing minds of the employer reached the decision to terminate employment;

•

the financial position of the company at the time of the termination;

•

any independent advice that was sought as to the ongoing viability of the business and/or the employee's position;

•

the state of the employer's business operations at the time of the termination relative to the time when the alleged compulsion did not exist; and

•

the chronology of events following the termination of employment, particularly the timing of any new employment for the dual capacity employee and how that employment came about.

Arm's length amount

321. Often it can be readily inferred that the employer and the employee are not dealing at arm's length when the employment of a dual capacity employee is terminated. In the case of a company with a single controlling mind, it is possible that a person will in effect be dealing with themselves in respect of their own termination.

322. If the parties are not dealing at arm's length, paragraph 83-175(2)(b) requires a comparison of the actual non-arm's length situation with a hypothetical arm's length situation. The question then becomes what amount could reasonably be expected to be paid to an equivalent employee dealt with at arm's length in the circumstances as they existed at the time of the dismissal?

323. Senior Member Pascoe, in making his decision on this issue in Long,^[100] had regard primarily to what an employee in similar circumstances to the taxpayer could reasonably expect to be paid. He took particular account of the taxpayer's overall remuneration package and her years of service with the company. As discussed at paragraphs 256 and 257 of this draft Ruling, reference to these matters is especially relevant when working out the arm's length amount.

324. In the Commissioner's view, weight should also be given in these circumstances to:

•

What entitlements, if any, the employee has to receive a redundancy payment and, if there is an entitlement, whether this reflects an arm's length dealing between the parties;

•

The economic circumstances of the employer at the time of the dismissal, particularly where there is no legal entitlement to a redundancy payment (this can be contrasted to looking only to the expectations of the employee in an ideal situation where there is no issue in regard to the employer's capacity to pay); and

•

How any employees dealt with at arm's length were treated in light of the application of other relevant factors to those employees (that is relative levels of salary, years of service and entitlements and the economic circumstances of the company).

No stipulated arrangement to employ and 'genuine' redundancy

325. It is particularly conceivable, given the nature of a dual capacity employee, for there to be an arrangement to employ such an employee after the time at which he or she is terminated. Such an arrangement may be in place between the employee and the original employer or between the original employer and another entity, particularly a related entity to that employer. In either case, this will cause the condition in paragraph 83-175(2)(c) not to be met.

326. Dual capacity employees who are active controlling minds of the original employer may also seek to structure their employment arrangements in a way that entitles them to a genuine redundancy payment even though they remain continuously employed in substance. Contrived cases of this nature are unlikely to give rise to a 'genuine' redundancy.

Voluntary termination element

327. When working out the voluntary termination element in cases where dismissal is not at arm's length, the Commissioner considers that a determination of what could reasonably be expected cannot be made by hypothesising what the amount of the payment would be if the situation was at arm's length. The basis of the voluntary termination hypothesis in subsection 83-175(1) should not be conflated with the arm's length amount hypothesis in paragraph 83-175(2)(b). The actual circumstances at the time should be taken into account, including the fact that the parties are not operating at arm's length, if this is the case.

328. The question, then, would be what amount could reasonably be expected to be received by the employee in consequence of his or her voluntary termination at the same time and otherwise in the same circumstances as the dismissal.

329. Senior Member Pascoe in Long^[101] approached this question on the basis that a voluntary termination would occur 'in circumstances where ongoing employment was available'. The Commissioner considers this approach is appropriate given the nature of the hypothesis.

330. However, adopting this premise should not give rise to an assumed set of facts that differ from the facts of the case. In many cases it would be expected that a dual capacity employee would be paid an amount on voluntarily terminating their employment, even where there is no contractual entitlement to a payment. This is particularly so where the redundancy payment is not based on a contractual entitlement. What a reasonable amount might be would depend on the facts and circumstances of the case, taking into account the factors referred to in paragraphs 276 to 284 of this draft Ruling.

Appendix 2 - Alternative views

Issue 1: Dismissal necessarily following from redundancy

331. In Fosters Brewing Group Ltd v. Industrial Commission of South Australia,^[102] Mullighan J stated that termination from employment by reason of redundancy amounted to a dismissal from employment. His Honour said:^[103]

...termination of employment due to genuine redundancy is, nevertheless, a dismissal from employment. The very nature of termination of employment due to redundancy means that the employee is dismissed from the employment. It is the employer who brings the employment to an end. Employment may be brought to an end in various ways, such as death of the employee, retirement, resignation or dismissal. Termination of employment by dismissal is nonetheless a dismissal even when lawful and on proper notice.

332. This statement was made in the context of considering whether a lawful dismissal in the form of a genuine redundancy could be 'harsh, unjust or unreasonable'. The employer was in financial difficulties and needed to restructure its many enterprises.

333. In this case the parties agreed that the dismissal was the result of the former employee's position with Fosters becoming redundant. Mullighan J noted that the concepts of retrenchment and redundancy involved lawful termination of employment on notice. The facts of the case and the statements made by Mullighan J are in accordance with the ordinary meaning of 'dismissal' as established in Smith, Advertiser Newspapers and similar cases, namely, the termination of services by the employer without the employee's consent. The case amounted to the termination of services of a Fosters' employee without the employee's consent because it was a genuine redundancy and the employee ultimately had no choice.

334. In cases involving the genuine redundancy of an employee who is not a controlling mind or is not a dual capacity employee actively involved in the employer's decision-making process, the Commissioner accepts that the vast majority of cases will involve a dismissal. A redundancy occurs where an employer 'no longer desires to have performed the job which the employee was doing'. It follows that the termination of the employment of a person in these circumstances will most likely be without the genuine consent of that person.

335. Therefore, the Commissioner considers that Mullighan J's statement to be generally correct insofar as it applies to a person who is not a dual capacity employee actively involved in the employer's decision-making process, which were the facts faced by His Honour.

336. In contrast, the redundancy of a dual capacity employee actively involved in the employer's decision-making process necessarily involves that person determining that he or she no longer desires to have performed the job that he or she had been doing. As explained in Appendix 1,^[104] the Commissioner considers that this cannot involve consent in one capacity (as a director) and a lack of consent in the other capacity (as an ordinary employee). The consent test applies to an individual, rather than to a particular capacity of an individual.

Issue 2: Dismissal from a position sufficient for a genuine redundancy payment

337. In Advertiser Newspapers^[105] an employee of a newspaper was demoted from a full-time position as a foreman back to a position as a printing machinist. While the employee protested from the outset at his demotion he recommenced working as a printing machinist. The Full Court of the Supreme Court of South Australia found that the employee had been dismissed pursuant to section 105 of the Industrial and Employee Relations Act 1994 (SA).

338. In so doing, the Full Court concluded that where a contract of employment is terminated, as opposed to being varied by mutual agreement, employment under that contract must also cease and there will be a termination of employment. The employee was therefore dismissed from employment when he was demoted because his employment contract as a foreman was terminated without his consent.

339. This decision may form the basis of an argument that a dismissal because of redundancy under section 83-175 need only involve removal from a particular employment position without the consent of the employee.

340. The Commissioner does not adopt this view. Instead, the Commissioner considers that the employee must be dismissed from all employment with the employer, subject to the specific exception for dual capacity employees,^[106] before section 83-175 can apply. This view is supported by the authorities dealing with the tax treatment of redundancy payments, in particular Dibb.^[107]

341. For the purposes of Part 2-40, employment is to be distinguished from the occupation of a particular position. This is reinforced by the condition in paragraph 83-175(2)(c) that there be no arrangement between the employer and the employee to employ the latter after the time of the dismissal.

Appendix 3 - Your comments

342. You are invited to comment on this draft Ruling. Please forward your comments to the contact officer by the due date.

343. A compendium of comments is also prepared for the consideration of the relevant Rulings Panel or relevant tax officers. An edited version (names and identifying information removed) of the compendium of comments will also be prepared to:

•

provide responses to persons providing comments; and

•

publish on the Tax Office website at www.ato.gov.au.

Please advise if you do not want your comments included in the edited version of the compendium.

Appendix 4 - Detailed contents list

344. The following is a detailed contents list for this Ruling:

Not previously issued as a draft

2007/19683

TR 94/12
TR 2003/13
TR 2006/7
TR 2006/10
CR 2001/1

genuine redundancy payments
employment termination
employment termination payments
employment and industrial relations
dismissal
redundancy & retrenchment
redundancy or early retirement scheme payments

ITAA 1997
ITAA 1997 Pt 2-40
ITAA 1997 Div 80
ITAA 1997 80-5
ITAA 1997 Div 82
ITAA 1997 Subdiv 82-A
ITAA 1997 Subdiv 82-B
ITAA 1997 82-130
ITAA 1997 82-130(1)
ITAA 1997 82-130(1)(a)
ITAA 1997 82-130(1)(b)
ITAA 1997 82-130(4)
ITAA 1997 82-130(4)(b)
ITAA 1997 82-135
ITAA 1997 82-135(a)
ITAA 1997 82-135(e)
ITAA 1997 Div 83
ITAA 1997 83-1
ITAA 1997 Subdiv 83-A
ITAA 1997 Subdiv 83-B
ITAA 1997 83-170
ITAA 1997 83-175
ITAA 1997 83-175(1)
ITAA 1997 83-175(2)
ITAA 1997 83-175(2)(a)
ITAA 1997 83-175(2)(a)(ii)
ITAA 1997 83-175(2)(b)
ITAA 1997 83-175(2)(c)
ITAA 1997 83-175(3)
ITAA 1997 83-175(4)
ITAA 1997 83-180
ITAA 1997 Subdiv 83-D
ITAA 1997 83-295
ITAA 1997 Div 301
ITAA 1997 Div 302
ITAA 1997 Div 303
ITAA 1997 Div 304
ITAA 1997 Div 305
ITAA 1997 Div 306
ITAA 1997 Div 307
ITAA 1997 307-5(1)
ITAA 1997 995-1(1)
ITAA 1936
ITAA 1936 26(d)
ITAA 1936 Pt III Div 2 Subdiv AA
ITAA 1936 27E
ITAA 1936 27F
ITAA 1936 27F(1)
ITAA 1936 27H
ITAA 1936 Pt IVA
Acts Interpretation Act 1901 23(b)
Industrial and Employee Relations Act 1994 (SA) 105

Advertiser Newspapers Pty Ltd v. Industrial Relations Commission of South Australia
[1999] SASC 300
(1999) 74 SASR 240
(1999) 90 IR 211

Bell v. Alfred Franks & Bartlett Co Ltd
[1980] 1 All ER 356
Blaikie v. South Australian Superannuation Board
(1995) 65 SASR 85
(1995) 64 IR 145
Bob Jane T-Marts Pty Ltd v. Commissioner of Taxation
[1999] FCA 1366
(1999) 94 FCR 457
99 ATC 5100
(1999) 43 ATR 98
Case 12/98; AAT Case 12,997
98 ATC 183
(1998) 39 ATR 1073
Dibb v. Commissioner of Taxation
[2004] FCAFC 126
2004 ATC 4555
(2004) 55 ATR 786
Federal Commissioner of Taxation v. Consolidated Press Holdings Ltd and Ors (No 1)
(1999) 91 FCR 524
[1999] FCA 1199
99 ATC 4945
(1999) 42 ATR 575
Federal Commissioner of Taxation v. Knight
(1983) 83 ATC 4275
(1983) 14 ATR 214
Federal Commissioner of Taxation v. Peabody
(1994) 181 CLR 359
94 ATC 4663
(1994) 28 ATR 344
Federal Commissioner of Taxation v. Sealy
(1987) 78 ALR 387
87 ATC 5076
(1987) 19 ATR 582
Federal Commissioner of Taxation v. Spotless Services Ltd
(1996) 186 CLR 404
96 ATC 5201
(1996) 34 ATR 183
Fisher v. Edith Cowan University (No 2)
(1997) 72 IR 464
Foster's Brewing Group Ltd v. Industrial Commission of South Australia
(1993) 61 SASR 329
51 IR 228
Fosters Group Ltd v. Wing
[2005] VSCA 322
(2005) 148 IR 224
Grealy v. Federal Commissioner of Taxation
(1989) 24 FCR 405
89 ATC 4192
(1989) 20 ATR 403
Hart and Another v. Commissioner of Taxation
[2002] FCAFC 222
(2002) 121 FCR 206
2002 ATC 4608
(2002) 50 ATR 369
Jones v. Department of Energy and Minerals
(1995) 60 IR 304
Lee v. Lee's Air Farming Ltd
[1960] 3 All ER 420
Lincoln Mills (Aust) Ltd v. Gough
[1964] VR 193
Optus Mobile Pty Ltd v. Federal Commissioner of Taxation
[1999] FCA 519
99 ATC 4492
(1999) 42 ATR 105
Optus Mobile Pty Ltd v. Federal Commissioner of Taxation
[1999] FCA 1403
99 ATC 5070
(1999) 43 ATR 21
R v. Industrial Commission (SA); Ex parte Adelaide Milk Supply Co-op Ltd
(1977) 16 SASR 6
R v. Prince Alfred College
(1979) 46 SAIR 598
Re Cowling and Federal Commissioner of Taxation
[2006] AATA 646
2006 ATC 2395
(2006) 64 ATR 1025
Re Hains (deceased); Barnsdall v. Federal Commissioner of Taxation
(1988) 81 ALR 173
88 ATC 4565
(1988) 19 ATR 1352
Re Long and Commissioner of Taxation
[2007] AATA 1269
2007 ATC 2155
(2007) 66 ATR 806
Re Marriott and Federal Commissioner of Taxation
[2004] AATA 806
2004 ATC 2191
(2004) 56 ATR 1265
Re Wilmer's Trusts; Wingfield v. Moore
[1910] 2 Ch 111
Salomon v. Salomon & Co
[1897] All ER 33
Smith v. Director-General of School Education
(1993) 31 NSWLR 349
51 IR 204
Westfield Holdings v. Adams
(2001) 114 IR 241
Winsen v. Commissioner of Taxation
[2006] AATA 119

Butterworth's Australian Legal Dictionary, 1997, Butterworths, Sydney
Young, Peter W, 1986, The Law of Consent, 1st edn, The Law Book Company Limited, Sydney
Explanatory Memorandum to the Income Tax Assessment Amendment Bill (No. 3) 1984
Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006