New income tax ruling: Genuine Redundancy Payments

ClearLaw has recently covered some of the reasons why updates may be required to SMSF deeds. These reasons may still be relevant to SMSFs in 'pension phase'. Here's why.

What is a Genuine Redundancy Payment?

A Genuine Redundancy Payment[1] is defined as so much of a payment that an employee receives when they are dismissed from employment:

• if the dismissal arises because the employee's position is genuinely redundant; and
• which exceeds the amount the employee could reasonably be expected to receive for voluntary termination of his or her employment at the time of dismissal.

However, a payment made at the end of a fixed period of employment cannot normally be considered a Genuine Redundancy Payment. This is because for the payment to be characterised as a Genuine Redundancy Payment[2]:

• the employee must have been dismissed before the day they turned 65;
• if the dismissal was not at arm's length, the payment must not exceed the amount that could reasonably be expected to be made if the dismissal was at arm's length; and
• at the time of the dismissal there must have been no arrangement between the employee and the employer (or between the employer and another person) to employ the employee after the dismissal.

How is the tax-free limit calculated?

Genuine Redundancy Payments are tax free up to a limit (Tax Free Limit). The Tax Free Limit is calculated based on the following formula (Formula):[3]

Base Amount + (Service Amount x Years of Service)

In the formula:

• The amounts for each of these components are:

  	2007-2008 income year	2008-2009 income year
  Base Amount	$7,020	$7,350
  Service Amount	$3,511	$3,676

• "Years of service" means the number of whole years in the period, or sum of periods, of employment to which the payment relates.

Any amount that exceeds the Tax Free Limit is taxed as an employment termination payment (ETP).[4] The current rates of taxation for ETPs are:

The Ruling: Taxation Ruling TR 2009/2

In the ruling (TR 2009/2), the Commissioner clarifies the requirements for a Genuine Redundancy Payment as:

1. The payment must be received in consequence of an employee's termination.

   The Commissioner considers that a payment is made in consequence of the termination of the taxpayer's employment if the payment follows as an effect or result of the termination.[6]

2. The termination must involve the employee being dismissed from employment.

   Relevant considerations include:

   • The dismissal must be at the employer's initiative, and there must be no suitable job available for the employee with the employer.
   • If the employee is dismissed because of a restructure, then the Commissioner thinks that 'careful consideration' needs to be given to determine what was the prevailing or most influential cause of dismissal. For a Genuine Redundancy Payment concession to apply, the payment must be attributed to redundancy or dismissal.
   • The same inquiry into the "prevailing or most influential cause of dismissal" must be made in relation to dual employees — who are people employed by an employing entity but also act as a directing mind, or hold an office, with that entity. As dismissal requires termination without the employee's consent, consideration needs to be given to determine whether a dual capacity employee has consented to their termination.

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

   An employee's position is redundant if the employer determines that the position is:

   • superfluous to the employer's needs; and
   • the employer does not want the position to be occupied at all.

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

   Whether a redundancy is a 'genuine' redundancy is determined on an objective basis.

Process for determining tax treatment of Genuine Redundancy Payments

The ruling sets out the following steps that should be undertaken to determine the tax treatment of a Genuine Redundancy Payment:

1. Identify and exclude any amounts that are subject to a more specific tax treatment. As set out in section 82-135, these include:

   1. 1.1 superannuation benefit payments;
   2. 1.2 pension or annuity payments;
   3. 1.3 unused annual leave payments; and
   4. 1.4 unused long service leave payments.
2. Determine the extent to which the remaining amounts (some or all) may be Genuine Redundancy Payments by deducting the amount that could reasonably be expected if the employee voluntarily resigned (Voluntary Termination Amount).
3. Calculate the Tax Free Limit by applying the Formula.
4. Both the Voluntary Termination Amount and the amount over and above the Tax Free Limit are taxed as an ETP.

Questions & more information

For questions or more information about the above article, please call Maddocks in Melbourne (03 9288 0555) and ask for a member of the Maddocks Tax and Revenue Team.

[1]As defined in section 83-175(1) of the Income Tax Assessment Act 1997 (ITAA97)
[2]The conditions are found in section 83-175(2) of the ITAA97
[3]As set out in section 83-170(3) of the ITAA97
[4]Under section 82-135 of the ITAA97
[5]The tax-free component of an ETP comprises payments made because the employee has ceased work due to physical or mental ill-health or where that part of the payment relate to an employment period prior to July 1983 (section 82-140 of the ITAA97).
[6]More information on this topic is set out in TR 2003/13.