Edited version of private ruling

Authorisation Number: 1011831733004

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Ruling

Subject: Income - salary sacrifice

Question 1

Can paid leave entitlements which are paid by your employer as salary and wages form part of an effective salary sacrifice arrangement (SSA)?

Answer: No.

Question 2

Can income protection insurance payments which are paid by your employer's insurer form part of an effective SSA?

Answer: No.

This ruling applies for the following periods:

Year ending 30 June 2011
Year ending 30 June 2012
Year ending 30 June 2013

The scheme commenced on:

1 July 2010

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· a private ruling application.

· information provided in your phone conversation with the Australian Taxation Office.

You are employed.

You entered into a SSA with your employer.

You and your employer did not agree to salary sacrifice (SS) your leave entitlements.

You sustained a work related injury and as a result of your injury you were unable to work.

You were paid all your accrued leave entitlements.

You employer's insurer has an income protection insurance policy which pays a percentage of employee's income while they are off work as a result of illness or injury.

You are expecting to receive income protection insurance payments from the insurer.

You have requested the insurer to SS the income protection payments you receive into your current SSA with your employer.

The insurer has declined to SS the income protection payments as they can only make the income protection insurance payment directly to you.

Relevant legislative provisions:

Income Tax Assessment Act 1936 section 23L.

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 subsection 6-15(2)

Taxation Administration Act 1953 Schedule 1 section 12-35

Taxation Administration Act 1953 Schedule 1 section 12-120

Reasons for decision

Section 6-5 of the ITAA 1997 provides that the assessable income of an Australian resident includes the income according to ordinary concepts (ordinary income) which is derived during the income year. Payments of salary and wages are ordinary income and are included in your assessable income.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted. Compensation payments which substitute income, such as workers compensation, have been held by the courts to be income under ordinary concepts: FC of T v. Inkster (1989) 20 ATR 1516; 89 ATC 5142.

Periodic payments you receive during a period of disability under a personal accident, income protection or disability insurance policy are assessable on the same principle as workers compensation, that is, they are assessable where they are paid to replace lost earnings: FC of T v. D.P. Smith 81 ATC 4114; (1981)11 ATR 538.

Salary sacrifice arrangement

Benefits in the nature of income are classed as either ordinary or statutory income and are initially caught under section 6-5 or 6-10 of the ITAA 1997. However, subsection 6-15(2) of the ITAA 1997 operates to exclude from assessable income those amounts that are made exempt by a provision of tax law. In the case of benefits provided under an 'effective' SSA, section 23L of the Income Tax Assessment Act 1936 (ITAA 1936) states that fringe benefits are not assessable income.

The Commissioners view on the taxation and superannuation implications of salary sacrifice arrangements (SSAs) is discussed in Taxation Ruling TR 2001/10 (TR 2001/10) Income Tax: fringe benefits tax and superannuation guarantee: salary sacrifice arrangements.

This ruling defines a SSA to mean an arrangement under which an employee agrees to forgo part of his or her total remuneration that he or she would otherwise expect to receive as salary or wages, in return for the employer or someone associated with the employer providing benefits of a similar value. If the salary sacrifice is effective, the employee will only be liable for income tax on the reduced salary and that the employer is liable to pay fringe benefits tax, if any, on the benefits provided.

There are two types of SSAs:

1.         Effective SSA an effective SSA involves the employee agreeing to receive part of his or her total amount of remuneration as benefits before the employee has earned the entitlement to receive that amount as salary or wages.

2.         Ineffective SSA an ineffective SSA involves the employee directing that an entitlement to receive salary or wages that has been earned is to be paid in a form other than as salary or wages.

It can be seen from the above that an SSA requires a contractual relationship between an employer and an employee. The contract between the two parties, employer and employee, is required prior to services being performed. The employment contracts may be amended during the course of an employee's employment to reflect changes made to employment conditions and remuneration arrangements.

Paid leave entitlements

In your case, you were injured at work which has prevented you from carrying out your duties associated with your employment. You have not returned to work since injuring yourself. You and your employer did not agree to salary sacrifice your leave entitlements to be an effective SSA, the amount sacrificed must be agreed to be paid as benefits (leave entitlements) before it is derived. You were paid your leave entitlements. The Commissioner has no discretion to treat the payments of your leave entitlements as an effective SSA arrangement. Therefore, the leave payments made by your employer are included in your assessable income as they are not exempt income under section 23L of the ITAA 1936.

Under section 12-35 of Schedule 1 of the Taxation Administration Act 1953 (TAA 1953) states that an entity must withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee (whether of that or another entity).

The leave entitlement payments you receive from your employer are salary and wages and are subject to section 12-35 of Schedule 1 to the TAA 1953. The Commissioner has no discretion to reduce the tax withheld on these payments under the current taxation provisions.

Income protection payments

Your employer's insurer has an income protection policy which provides for the replacement of a percentage of your income as a result of sickness or injury. The payments that you receive under your employer's income protection policy are considered ordinary income and are included in your assessable income when paid.

As stated above, an effective SSA requires a contractual relationship between the employer and the employee that must be negotiated prior to performing the employment services for which remuneration is received. Your income protection payment is directly related to an insurance policy that is meant to compensate you for the loss of your salary through being unable to perform your duties. There is no employer/employee relationship between the insurer and yourself. Although the income protection payments are paid to replace part of the salary and wages normally earned, they do not, in themselves, represent salary and wages.

Salary and wages are paid as a reward for services performed under a contract of employment. The income protection payments do not relate to the performance of services under a contract of employment but rather are paid under an insurance policy upon the happening of an event specified under the policy in your case, a work place injury.

As there is no employer/employee relationship, a salary sacrifice arrangement cannot be entered into and the income protection payment payments cannot be salary sacrificed. This would be the case regardless of whether your payments came from the insurer via your employer. The Commissioner has no discretion to treat the income protection payments as part of an effective SSA arrangement.

In addition, where payments are made to an individual for compensation, sickness or accident payment, an entity is required to withhold tax subject to section 12-120 of Schedule 1 to the TAA 1953. The Commissioner has no discretion to reduce the tax withheld on these payments under the current taxation provisions.

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