The release of a recent draft public ruling by the ATO on genuine redundancy payments is a timely reminder for employers to ensure that they are withholding the right amount of tax from termination payments made to employees. The draft public ruling has significant implications for employees on fixed term, casual or project-based contracts and for "dual-capacity" employees, such as company directors who are also employees. These types of employees face additional hurdles before being able to access the tax concessions for genuine redundancy payments.
On 27 August 2008, the ATO released Draft Taxation Ruling 2008/D6 (Draft Ruling). The Draft Ruling outlines the requirements that must be satisfied before a payment to a person whose employment is terminated qualifies for concessional tax treatment as a "genuine redundancy payment". The Draft Ruling replaces a previous ATO public ruling on "bona fide redundancy payments", Taxation Ruling TR 94/12 (Withdrawn Ruling), which was withdrawn on the same day the Draft Ruling was released.
Tax Concessions for Genuine Redundancy Payments
A "genuine redundancy payment" is tax-free up to a threshold amount calculated by reference to the years of service of the employee. For the 2008/09 income tax year the threshold amount is $7,350 plus $3,676 for every full year of service. Amounts in excess of the threshold will generally be taxed as employment termination payments at the rate of 15% (55 or over) and 30% (under 55) for the first $145,000 and at the top personal marginal tax rate for any amount in excess of $145,000.
The Draft Ruling provides that an employee's position is redundant when an employer determines that the functions, duties and responsibilities of that position are "superfluous to the employer's needs" and therefore "unnecessary" and that the employer does not want the position to be occupied by anyone.
This can be contrasted with the Withdrawn Ruling that described redundancy as a situation where "an employer no longer requires an employee to carry out work of a particular kind or to carry out work of a particular kind at the same location". The Withdrawn Ruling further provided that the employer's decision must not be "due to the ordinary and customary turnover of labour". The lack of further guidance on the concepts of "same location" and "ordinary and customary turnover of labour" previously created some uncertainty.
The Draft Ruling also provides that redundancy must be the "prevailing or most influential reason" for the dismissal (if there is more than one contributing cause):
"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."
As such, employers need to be mindful of this when undertaking restructures of their organisations.
Fixed-term, casual and project-based employees
The Draft Ruling provides that, ordinarily, employees on fixed-term, casual or project-based contracts cannot be made genuinely redundant. This may particularly affect workers in the building, construction and mining industries. The rationale is that there is no ongoing employment relationship as the employment was always for a fixed term, on a casual basis or for a specific project. However, where a fixed-term or project-based contract continually rolls-over or a casual employee in fact occupies a long-term position in the same way as other employees, an ongoing employment relationship may be established. In these circumstances, it may be possible for an employee to be made genuinely redundant and to obtain the benefit of concessional taxation of any payment made to them as a genuine redundancy payment.
Dual-capacity employees may also have trouble qualifying for the tax concessions for genuine redundancy payments. This is because in many cases a dual-capacity employee will have decided or actively participated in a decision to terminate their own employment.
The Draft Ruling provides that termination of just one of the capacities of a dual-capacity employee is sufficient for a termination payment to potentially qualify as a genuine redundancy payment. However, the termination must occur without the employee's effective consent. For a dual-capacity employee this may be a difficult hurdle to satisfy as it requires that the person either:
- did not agree with or approve the employer's decision to terminate their employment in either or both capacities; or
- agreed to the termination but did so in circumstances of legal or economic compulsion.
What does the Draft Ruling mean for you?
The release of the Draft Ruling is a timely reminder for employers to ensure that they are withholding the right amount of tax from termination payments made to employees. Where employees on fixed-term, casual or project-based contracts are terminated, both employers and employees alike should be aware that they may face resistance from the ATO if they seek to treat termination payments as genuine redundancy payments. Similarly, dual-capacity employees should be aware that they may face the additional hurdle of proving that their termination was without their consent or was affected in circumstances of legal or economic compulsion.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.