Terminating the employment of a person is never a happy
occasion, but things can get worse if a dispute arises over the
taxation of any payments to be made to the departing employee.
In July 2007, the system of taxing termination payments was
changed. Under the new system, payments made in consequence of the
termination of employment which are received within 12 months of
termination are regarded as "Employment Termination
Payments" (ETPs). Certain payments are,
however, specifically excluded from this definition, and, it is
these exclusions which are a common cause of dispute between the
employer and the former employee.
In broad terms, ETPs are taxed as follows:
tax free component includes any payments referable to
employment prior to 1 July 1983 and any invalidity component;
tax offset applies to payments up to a cap of $145,000 (for the
2008/09 income year - indexed annually) so that the tax rate
15% for a recipient at the "preservation age";
30% for a recipient below the "preservation age";
the excess above the cap which is not tax free is taxed at the
top marginal rate.
Each class of payment which is excluded from the ETP regime is,
however, taxed differently. Payments for personal injury (including
psychological damage or mental injury) are tax free. Payments in
relation to genuine redundancies are taxed at concessional rates
and unused annual leave or sick leave payments (unless they refer
to periods pre-1993 or are in connection with genuine redundancy)
are taxed at the normal marginal rates.
From the departing employee's point of view, it is important
that any payment to be made by an employer is properly identified.
For example, if an employee is paid a lump sum for personal injury
(for loss of reputation or stress) and for unfair dismissal, and
the amount is undissected, none of it will be regarded as a tax
free personal injury payment. It would, in all likelihood, be taxed
as an ETP.
In the current economic climate, it is probable that many
terminations will be directly related to redundancy. For the tax
concession to apply it is important that termination is, in fact, a
genuine redundancy. In broad terms, a genuine redundancy payment is
so much of a payment received by the employee who is
"dismissed" from employment because his or her position
is made "redundant" and that exceeds the amount that he
or she would reasonably be expected to have received on a voluntary
The term "dismissal" implies an involuntary
termination (on the employee's part) instigated by the
employer. However, it does include employees who may be asked
whether they would accept a redundancy package as long as the
decision to terminate is made solely by the employer.
In August 2008, the Australian Taxation Office
(ATO) published a draft ruling on redundancy. In
that draft ruling, the ATO indicated that "a job becomes
redundant when an employer no longer desires to have it performed
by anyone." A job is described as a collection of functions,
duties and responsibilities.
A position is therefore made redundant when the functions,
duties and responsibilities formally attached to a position are
determined by the employer to be superfluous to its current needs
and purposes, and the purposes of the organisation.
In describing a termination payment as a genuine redundancy
payment, both the employer and employee must be careful that they
are not simply using the term to facilitate a better tax position
for the employee. Voluntary termination or termination as a result
of poor performance can never be a redundancy.
While structuring a termination payment so that an individual
has the best possible tax outcome is unlikely to be of much comfort
to that individual, failing to do so will add to an already
stressful situation and in all likelihood will end up in a dispute
between the employer and former employee.
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.
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