VGDW and Commissioner of Taxation (Taxation)
[2020] AATA 3745
•10 June 2020
VGDW and Commissioner of Taxation (Taxation) [2020] AATA 3745 (10 June 2020)
Division:TAXATION AND COMMERCIAL DIVISION
File Number(s): 2019/2251
Re:VGDW
APPLICANT
AndCommissioner of Taxation
RESPONDENT
DECISION
Tribunal:Deputy President Bernard J McCabe
Date:10 June 2020
Place:Sydney
The objection decision is set aside and remitted to the Commissioner for reconsideration on the basis that:
(a)The amount of $18,202.96 identified in the payroll advice of 12 July 2017 was paid in consequence of the termination of the taxpayer’s employment; and
(b)The taxpayer’s position was made genuinely redundant.
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Deputy President Bernard J McCabe
CATCHWORDS
TAXATION – individual income tax – treatment of payments made following termination of employment – whether payments made ‘in consequence of’ termination – discretionary sum paid to applicant following termination – decision set aside and remitted
LEGISLATION
Income Tax Assessment Act 1997 ss 6-5, 82-130, 83-175
CASES
The Commonwealth v Butler (1958) 102 CLR 465 at 476; [1958] HCA 56
Insurance Commission of Western Australia v Container Handlers Pty Ltd (2004) 218 CLR 89; [2004] HCA 24
McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557
Paklan Pty Ltd (in liq) v Commissioner of Taxation (1983) 67 FLR 328Reseck v Federal Commissioner of Taxation (1975) 133 CLR 45; [1975] HCA 38
REASONS FOR DECISION
Deputy President Bernard J McCabe
10 June 2020
This is a case about the tax treatment of a payout received by the taxpayer from his former employer following termination of the taxpayer’s contract of employment. The taxpayer says all or part of the payment should be regarded either as a genuine redundancy payment pursuant to s 83-175 of the Income Tax Assessment Act 1997 (ITAA97) or an employment termination payment within the meaning of s 82-130 of ITAA97. In either event, the payout would attract concessional treatment. The Commissioner of Taxation says the payment should be treated as ordinary income and taxed accordingly.
The case evolved somewhat at the hearing. The real dispute between the parties came down to a difference over the meaning of the phrase ‘in consequence of’ which appears in both ss 82-130 and 83-175. As a practical matter, I must determine whether a payment received by the taxpayer at about the time of his termination was received in consequence of that termination. If it was not received in consequence of the termination, it will be taxable as ordinary income pursuant to s 6-5 of the ITAA97.
What happened?
Most of the facts are not in dispute. The taxpayer is a solicitor. He specialises in commercial litigation. He commenced employment with an incorporated legal practice on or about 4 October 2016. I will refer to the employer company as ‘the firm’ in these reasons.[1] The taxpayer became a director when he joined the firm and was designated as a ‘partner’.
[1] The employer company was not, strictly speaking, a law firm in the traditional sense. It was a company, not a partnership. For reasons (one assumes) associated with the culture of the legal profession, the company paid lip service to old forms by describing its directors as ‘partners’. Interestingly, the letter of offer addressed to the taxpayer (reproduced in exhibit one at p 96ff) explained the individual directors “regard themselves as having a fiduciary duty towards each other” much as they would if they were partners: at [20].
In his oral evidence, the taxpayer explained the firm was a relatively small boutique operation with a small number of partners. Each of the partners oversaw their own practice. Each individual practice headed by a partner was named ‘Team [first name of partner]’ and included subordinate professional and support staff. Some of the firm’s work was litigious, and several of the partners conducted litigation. The firm tended to act on behalf of clients engaged in banking and finance.
The firm apparently decided it needed a commercial litigator who could develop a specialist litigation practice to supplement the advice and dispute resolution work it was already undertaking. The letter of offer from the firm to the taxpayer dated 29 September 2016 incorporated the contract of employment: exhibit one at p 96ff. The letter said the taxpayer was engaged to work for new clients brought into the firm by one partner in particular who acted as rainmaker, or for existing clients that did not have a special relationship with another partner. It was also anticipated some clients with less significant work would be readily referred to the taxpayer by other partners: at [10]-[15]. The letter of offer confirmed the taxpayer’s team would include a junior solicitor, although he pointed out in his oral evidence that a junior solicitor was not engaged until early 2017.
The letter of offer set out the way in which the taxpayer’s remuneration was determined. While it was agreed the taxpayer would receive “base remuneration” of $110,000 ($120,450 if superannuation was included), it went on to provide:
[31]Notwithstanding the base, your remuneration will be 100% performance based. In this regard, you will be paid 27% of your team’s gross fee income (less 100% of unrecovered disbursements) as your gross remuneration (including super).
[32]We call the difference between your base and your actual earnings commission. Your team is defined as you and any solicitor or paralegal working under you.
The letter of offer also included terms dealing with termination of employment. The text of those terms should be reproduced in full because they are, well, unusual – and they are important to the outcome of the case:
[36] When you leave the firm, through termination or resignation, your base will be stopped, along with your commission.
[37]If you provide the firm with at least 3 months’ notice of your departure, or if you are terminated, the firm may decide to pay you an amount, at the firm’s full and absolute discretion, equal to the commission for monies you billed which are paid after you leave.
[38]whether the firm pays this commission to you depends upon the circumstances of your departure, e.g. whether you maintained goodwill with the firm, your clients were happy with your work, whether you poached any work, whether you used best efforts for the handover of files. The judgement of these factors will be at the sole discretion of the firm.
[39]If the firm chooses to pay you your commission after you leave each payment will be ex gratia. Because some payments are made we are not obliged to make others. We do note however that how we treat our departing fee earners is of enormous importance to staff moral and we aim to be fair and generous where indicated.
[40]If these commission payments are made after you leave they will be regarded as termination payments and subject to the law no tax or super will be paid on them. Where tax or super is required to be paid it will be deducted from them.
The taxpayer accepted the offer. He said he quickly became busy after he commenced work at the firm. He had carriage of several matters but one matter in particular occupied most of his time. It also generated most of his fees. It was a complex dispute being litigated in the Supreme Court of New South Wales. That litigation settled in June 2017.
The taxpayer said in his oral evidence that his practice was making a profit in the first six months of 2017 in the sense that his team – such as it was – managed to bill more than his base salary. The situation changed when the complex litigation matter settled in June. The only other significant matter in the pipeline of work was delayed. The taxpayer said he came under pressure to find replacement clients quickly. Within a short space of time, the firm apparently decided to cut its losses. On or about 5 July 2017, it terminated the employment of the junior solicitor who had been working for the taxpayer. On 7 July 2017, the firm terminated the taxpayer’s employment. The firm made two payments to the taxpayer around the time of the termination.
The firm formally explained the termination in its letter of 7 July 2017: exhibit 1 at p 105. The letter said “we have decided to make your position redundant”. After noting the major case had settled and the other case was not ready, it added: “there is no material workload for you or your junior”.
The evidence leaves no doubt the firm cut the taxpayer’s position – and the position of his junior solicitor, who was terminated at the same time – as part of a reorganisation that was thought necessary because there was not enough work coming in after the major case settled. As the taxpayer explained in the course of his oral evidence, the “entire ‘Team [taxpayer]’ was made redundant in the same week”: transcript at p 11. The taxpayer’s few remaining files were reallocated to other partners in the course of the internal reorganisation. The Commissioner conceded in the wake of the taxpayer’s oral evidence that the taxpayer was terminated because the position was ‘genuinely redundant’ within the meaning of that expression in s 83-175(1): transcript at p 46. I will not address that aspect of the dispute any further.
The termination payments
The redundancy letter dated 7 July 2017 included the following:
As per clause 31 of your conditions of employment letter dated 4 October 2016 your remuneration was 100% performance based. Accordingly your severance package will consist of the agreed percentage (27%) of your recovered fee income calculated exactly as before however from this week onwards you will no longer be paid the base remuneration. This money will be deemed to include your accrued holiday leave.
The money which you receive after this week will have superannuation and tax taken out as usual (and paid to your nominated super fund and the ATO).
I note that we are owed $80,509.00 by your client [name deleted] and that money is due to be paid any day now. I confirm this money and any other money that comes in will be applied to the standard formula.
The firm made two payments to the taxpayer around the time of the termination. Those payments are recorded in payslips the firm provided to the Commissioner under cover of a letter dated 13 December 2018: exhibit 1 at p 114ff. The first payment was described in the pay slip dated 5 July 2017 as ‘base salary’ for the pay period leading up to his termination. The gross amount was $2115.38 with $757 in PAYG withholdings resulting in a net payment of $1358.38. I do not understand there to be any dispute with respect to this amount. Nor could there be: while there was an unusual aspect to the arrangement, the payment was clearly referable to salary, not the termination.
The second payment was made on or about 12 July 2017 – that is, after the taxpayer was terminated on 7 July. The payroll advice records an amount of $18,202.96 described as “Commission” but also labelled “Wages”. I was told $7,099 of that amount was paid to the Deputy Commissioner of Taxation as PAYG withholdings. An amount of $11,103.96 was ultimately paid to the taxpayer. A small amount was also apparently paid to the taxpayer’s superannuation fund, but nothing turns on that payment for present purposes.
The firm referred to the amount due on 12 July as a ‘severance package’ in the redundancy letter. The taxpayer uses different language. He describes the amount due on 12 July as an ‘ex gratia payment’ contemplated in the contract of employment.
The taxpayer says that payment was made ‘in consequence of’ the termination. He says his claim was supported by email correspondence from the firm dated 24 July 2017. The correspondence was reproduced in the taxpayer’s statutory declaration: exhibit 2 at p 10. The email was apparently written after the termination had become contentious. The partner who hired (and fired) the taxpayer made a number of observations in the course of remonstrating and threatening the taxpayer. In particular, the partner said:
As I told you at the time [ie when the separation was discussed on or about 6 July 2017], and I told you when you were hired, and as is clearly stated in your employment contract, all commission paid to you after you leave would be ex gratia. [Underlining in original]
The partner went on to chastise the taxpayer for belatedly complaining about the termination arrangements. The partner said that if the taxpayer was now disavowing what had been agreed, the firm would sue to recover the ex gratia payment. He concluded by practically daring the taxpayer to commence proceedings against the firm.
The letter is remarkable for the patent nastiness of its tone, but that is irrelevant for present purposes. The taxpayer says that, for all the bluster, the letter makes clear the firm did not regard itself as being bound to pay the taxpayer anything in connection with termination. The ex gratia payment was regarded as a genuine ‘act of grace’ that was motivated by a desire to be (and to be seen to be) ‘fair and generous’ to departing staff, as explained in clause [39] of the contract of employment. While the amount of the ex gratia payment was calculated with reference to the remuneration formula in the contract of employment, the taxpayer points out there is no doubt from his employer’s behaviour (and from a fair reading of the written contract) that the firm regarded the formula as a guide only. The firm expressly reserved the right to pay more than the formula indicated, or less, or nothing at all at its absolute discretion following his departure.
That brings us to the nub of the dispute. The Commissioner says the ‘ex gratia payment’ was merely a payment of what the taxpayer would have received under the contract of employment if he had remained employed. There was no causal connection between the payment and the termination. In the absence of that causal connection, I was told the taxpayer could not satisfy the requirements of either s 83-175[2] or s 82-130[3] and should be taxed accordingly.
[2] Section 83-175(1) provides:
(1)A genuine redundancy paymentis so much of a payment received by an employee who is dismissed from employment because the employee's position is genuinely redundant as exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of the dismissal.
[3] Section 82-130(1) provides:
The expression ‘in consequence of’ has been considered before. In Reseck v Federal Commissioner of Taxation (1975) 133 CLR 45; [1975] HCA 38, the High Court considered the use of the expression in the former s 26(d) of the Income Tax Assessment Act 1936. Gibbs J explained (at [7]):
… Within the ordinary meaning of the words a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination. In the present case the payment did follow as a result of the termination of the taxpayer's services. It is not in my opinion necessary that the termination of the services should be the dominant cause of the payment. …
Jacobs J reached a similar conclusion in the same case. His Honour said (at [5]):
… It was submitted that the words "in consequence of" import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a "following on". …
Brennan J reflected on those analyses in McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557. His Honour pointed out the payment could not be said to be a consequence of the termination merely because the payment post-dated the end of his contract of employment. A temporal link alone was not sufficient: at 560. His Honour suggested the “required nexus to be (at least) that the payment would not have been made but for the retirement”. Toohey J reached a similar view, explaining (at (564) of the Full Court’s decision:
The connection was not simply temporal; retirement was a prerequisite to payment and in that sense there was a ‘following on’…
The Commissioner referred me to a number of authorities where the courts have interpreted the reasoning in Resack and McIntosh. I was referred in particular to the decision of the Full Federal Court in Paklan Pty Ltd (in liq) v Commissioner of Taxation (1983) 67 FLR 328 where Northrop and Fisher JJ suggested (at 348) the question was:
…whether there was sufficient causal nexus between the payment and the retirement to make the retirement the occasion of the payment. This is essentially a question of fact. …
In these proceedings, the Commissioner argued in written submissions there was no causal connection between the termination and the payment because the taxpayer was only paid money he would have been entitled to receive if he had continued in employment because he had done the work and generated the fees.
The taxpayer suggested that the expression should not be read so as to require a strict causal connection between termination and payment. To this end, he referred to the third member of the Full Court in McIntosh who discussed the meaning of the expression ‘in consequence of’. Lockhart J suggested an interpretation that is subtly different (and potentially wider) than the meaning suggested by Brennan and Toohey JJ. After referring to Reseck and the reasoning of Jacobs J in particular, Lockhart J said (at 571) the expression ‘in consequence of’ extended to payments that were not strictly speaking caused by the termination but which “nevertheless followed on the termination of employment and had connection therewith”. Lockhart J added:
In my opinion his Honour did not use the words ‘following on’ as referring merely to a temporal progression of events. Rather his Honour had in mind a connection between the retirement from or the termination of employment and the payment in question as well as a temporal progression of events. I do not read the words of his Honour as excluding a connection that is causal in character; rather his Honour enunciated a wider test than the one merely of causation and expressed it as ‘following on’; a concept that may in an appropriate case include a relevant causal connection. …
The taxpayer points out this more liberal construction of the expression finds support in some of the other authorities, including Insurance Commission of Western Australia v Container Handlers Pty Ltd (2004) 218 CLR 89; [2004] HCA 24 where McHugh J observed (at [45]):
…the expression “a consequence of” emphasises the result or effect of the driving rather than the driving causing the result. This distinction is important in an insurance context where cause is frequently – perhaps usually – equated with “proximate” or “dominant” cause. Although "consequence" involves notions of causation, the term "consequence" - with its emphasis on effect - places less emphasis on the proximity of cause and effect than the term "cause" may do in various contexts.
McHugh J cited at [45] the reasoning of Taylor J in The Commonwealth v Butler (1958) 102 CLR 465 at 476; [1958] HCA 56 who explained:
an ‘effect’ may be caused, in the legal sense, by circumstances apparently remote for the chain of causation may be shown to have continued unbroken by any other intervening cause to the effect in question.
Both Container Handlers and Butler dealt with words in a statute regulating liability in an insurance context, which is different to the situation we are discussing here. Yet I am not sure the difference between the two approaches – to the extent there is one – makes much difference to the outcome here. Ultimately, I am satisfied there is a causal connection between the termination and the lump sum amount referred to in the payroll advice of 12 July 2017. The connection arises because, under the terms of the contract of employment, the firm’s obligations to pay a departing employee any amount ceased upon termination. The decision to pay any amount thereafter is referable to the termination clause of the contract. It makes no difference that the ex gratia payment in this case was calculated by applying a formula to the amount of fees the taxpayer had generated so that his payout mirrored what he would otherwise have been paid as salary if the contract had continued. There was no obligation in the contract to pay that amount, or any other amount, once termination occurred. I accept the taxpayer may have had one eye on the taxation consequences for him when he corresponded with the firm to discuss the payment. I also acknowledge the payment advice dated 12 July referred to the amount in question as ‘wages’ although I think it would be a mistake to substitute labels applied in a software package or perhaps by a book-keeper for the substance of the agreement between the parties. Both parties approached the payment as part of a severance package that they were free to negotiate, and whose quantum was not fixed even if there was an obvious reference point. The termination was, in that sense, the occasion of the payment – and not just in a temporal sense.
Conclusion
This case arises because of an irregular employment bargain that was struck between the taxpayer and his former employer. The employer retained for itself the discretion to provide a payout to departing employees that would ordinarily be a question of entitlement. When that payout was made, it was properly referable to the termination, not the employment. That payout can be contrasted with the payout of base salary which occurred on or about 4 or 5 July. The payout of that earlier amount was plainly referable to the taxpayer’s employment and the obligation to pay that amount persisted notwithstanding the termination.
The objection decision is set aside. The matter is remitted to the Commissioner for reconsideration on the basis that:
(c)The amount of $18,202.96 identified in the payroll advice of 12 July 2017 was paid in consequence of the termination of the taxpayer’s employment; and
(d)The taxpayer’s position was made genuinely redundant.
I certify that the preceding 30 (thirty) paragraphs are a true copy of the reasons for the decision herein of Deputy President Bernard J McCabe
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Associate
Dated: 10 June 2020
Date(s) of hearing: 21 January 2020 Date final submissions received: 6 January 2020 Applicant: In person Solicitors for the Respondent: Australian Taxation Office
(1) A payment is an employment termination payment if:
(a) it is received by you:
(i) in consequence of the termination of your employment; or
(ii) after another person's death, in consequence of the termination of the other person's employment; and
(b) it is received no later than 12 months after that termination (but see subsection (4)); and
(c) it is not a payment mentioned in section 82-135.
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