Making the most of Transitional Termination Payments (TTP) under “simpler super”

Background

Employers frequently make payments to departing employees that are triggered as a result of employment terminating in a variety of circumstances including corporate restructuring, sale of business, outsourcing and off-shoring. The kinds of payments involved include pay in lieu of notice, redundancy and ex gratia payments. Up until 1 July 2007 such payments could be made tax efficiently, with cash payments subject to lower tax rates, and some payments rolled over into superannuation being exempt from PAYG tax. Since 1 July 2007, new laws mean employers and employees may need to avoid terminating contracts and other workplace arrangements in order to preserve the tax effectiveness of certain termination payments.

The “simpler super” changes

On 1 July 2007 major changes were made to the taxation of superannuation under the “simpler super” regime. The changes removed the ability of a number of employees to have employment termination payments, known as Life Benefit Termination Payments (LBTPs), paid tax efficiently under pre-existing rules. Under transitional grandfathering provisions, some employees continue to be covered by pre-existing rules and are able to receive tax efficient LBTPs. To qualify for grandfathering, an employee must have a LBTP entitlement arising from a written contract, law, instrument or workplace agreement in existence just before 10 May 2006, and the LBTP must be paid between 1 July 2007 and 30 June 2012.

Implications for employees and employers

For many employees, including those who entered into new contracts of employment after 10 May 2006, the ability to receive tax efficient LBTPs has been lost. Those employees who qualify for, and are aware of, an entitlement to grandfathered LBTPs, will wish to preserve such entitlement. An entitlement to grandfathering may be lost if the contract, agreement or award entitling an employee to LBTPs is replaced or terminated, or the applicable LBTP provisions are varied.

For employers of employees with entitlements to grandfathered LBTPs, it will be important to be aware of the entitlement and ensure that they do not unintentionally remove their employees’ grandfathering entitlements.

Life Benefit Termination Payments (LBTP)

LBTPs are payments made by an employer to an employee as a result of the employee’s employment being terminated for any reason apart from death. LBTPs include:

• payments in lieu of notice
• redundancy compensation in excess of the tax free amount
• unused sick leave entitlements (required to be paid out)
• payments for unused rostered days off
• ex-gratia payments or ‘golden handshakes’.

• payments for unused annual or long service leave entitlements
• salary, wages or allowances
• payments in consideration for a restraint of trade
• compensation for personal injury
• the tax free portion of bona fide redundancy and approved early retirement scheme payments.

Transitional Termination Payments (TTP)

From 1 July 2007, LBTPs are either paid under the new regime, in which case they fall in the category of Employment Termination Payments (ETPs), or under transitional grandfathering rules, in which case they are known as Transitional Termination Payments (TTPs).

For an LBTP to be a TTP (and qualify for grandfathering) it must arise out of:

• a written contract
• an Australian or foreign law, or instrument under such law, or
• a workplace agreement under the Workplace Relations Act 1996,
• in force just before 10 May 2006, and remaining in force. The TTP must be received by the employee between 1 July 2007 and 30 June 2012.

The major benefit of a TTP is that some or all of the payment may be rolled over, PAYG tax free, into superannuation.

The new regime

Under the new regime ETPs:

• must be taken in a cash lump sum
• cannot be rolled over into superannuation
• are not subject to tax on any Tax Free Component (arising out of service pre 30 June 1983) with the remainder being concessionally taxed at 31.5% up to a limit of $140,000, with the balance taxed at 46.5%.

Recently the Australian Tax Office (ATO) issued an interpretative decision about when LBTPs will qualify for grandfathering. If the ATO’s view is adopted by the courts, an employee’s eligibility to favourable tax treatment under grandfathering, may be lost if the contract, agreement or award entitling an employee to a LBTP is replaced, even if the employee’s LBTP entitlement is mirrored in a new instrument. Although no court has yet been asked to determine the issue, given the ATO’s view, employers should be careful when dealing with instruments that entitle employees to TTPs to ensure that they do not, unintentionally, disentitle employees to grandfathered LBTPs.

When a TTP entitlement may be lost

The following are examples of situations where an employee’s TTP entitlement may be lost:

• a new employment contract being created or coming into force as a result of an employee’s:
  • promotion
  • demotion
  • transfer
  • secondment
  • new role
• the applicable agreement or award expiring (although in many cases, despite expiry the TTP entitlement will remain in place)
• the applicable agreement or award being terminated
• a new contract, agreement or award applying to an employee as a result of:
  • restructuring
  • business acquisition
  • sale
  • outsourcing
  • merger
  • liquidation
  • receivership
  • administration.

Employers should review existing contracts, agreements and awards which entitle employees to LBTPs, to determine if such employees are eligible to TTPs. Where TTP entitlements exist, there may be resistance from employees to new contracts or agreements being created (or possibly even variations being entered into) which may disentitle them to TTPs. Employers will need to determine if TTP entitlements can be retained while achieving their business objectives. Where loss of TTP entitlements is unavoidable, employers may find themselves under pressure from employees to provide an additional benefit to make up for the benefit of TTPs being lost.

Employers should review their existing Human Resource practices applicable to employees with TTP entitlements, to ensure that they do not unintentionally disentitle employees to TTPs. The most common scenario where this may occur is where an employee’s terms of employment are being varied. Common practice may be to replace an employment contract or agreement with a new one. However this may result in an employee’s TTP entitlements being lost. Employers should consider changing their practices to ensure that, where practicable, variations to employment terms are entered into rather than replacements. For example, if an employee is being seconded, a secondment letter could be created containing terms specific to the secondment, which refers to and does not replace the core employment terms in the original contract (including the TTP). In addition, rather than replacing an employment contract or agreement where it has become outdated, or where an employee’s position has changed, a variation could be entered into which replaces the out of date or irrelevant provisions but does not affect the TTP entitlement.

Conclusion

While the direct benefit of tax efficient TTPs goes to departing employees, there are often flow on benefits to the employer. Employees can depart employment with the maximum possible net payment at no extra cost to the employer. While it will not always be possible to retain TTP entitlements, employers should be mindful whenever a TTP entitlement may be lost and consider any alternatives to reduce the risk. Where uncertainty exists about whether a TTP entitlement exists, may be lost, or could be retained, employers should seek expert advice.

For further information, please contact your usual PricewaterhouseCoopers Legal adviser, or:

Neil Napper, Partner PricewaterhouseCoopers Legal Employment law Tel +61 2 8266 6647