Lump sum payments on the occasion of retirement

2011 amendment to Income Tax Act corrects unintended change in law regarding lump sum payments on the occasion of retirement.

Section YZ 3 of the Income Tax Act 2007; section YA5C and schedule 22A of the Income Tax Act 2004

Background

The Rewrite Advisory Panel considered a submission that the rewrite of section DF 5 of the 1994 Act into section DC 1 of the 2004 Act contained an unintended change. After consideration, the Panel agreed there is an intended change in the law, and this should be indicated in schedule 22A of the 2004 Act.

Section DC 1 allows a deduction for a lump sum payment made on retirement if the payment is not deductible under any other provision of the Act. Under section DC 1, the deduction is allocated to the income year in which the payment is made.

Key features

Schedule 22A of the 2004 Act is amended to identify an intended change in the timing rule in section DC 1, which relates to the timing for lump sum payments made on the occasion of the retirement of a taxpayer. Section DC 1 of the 2004 Act was re-enacted into the 2007 Act, without amendment.

Application date

The amendment to schedule 22A applies from the beginning of the 2005-06 income year.

However, if a taxpayer has taken a tax position, prior to 22 February 2011, in relation to a lump sum payment on retirement, based on the wording of section DF 5 of the 1994 Act, savings provisions in both the 2004 and 2007 Acts (sections YA 5C and YZ 3 respectively) apply. These provisions continue the effect of section DF 5 of the 1994 Act in relation to that tax position.

Detailed analysis

In the 1994 Act, the corresponding provision to section DC 1 was section DF 5. This section allowed a deduction for a lump sum payment made on retirement if the payment is not deductible under any other provision of the Act.

An amendment to this provision in 2002 linked the timing of the deduction for a lump sum payment on retirement to the accrual expenditure rules for monetary remuneration in section EF 1 of the 1994 Act. Under this rule, a payment of a lump sum retiring payment that was monetary remuneration made after the end of an income year, but within the 63 days of the end of an income year, was allocated to the immediately preceding income year to the year in which the payment was made.

However, section DF 5 of the 1994 Act applied only if the payment was not deductible under the general permission.

The history of section DF 5 shows that the Courts have identified just a few limited circumstances to which the provision would be applied. Examples where the Courts have applied section DF 5 (or earlier corresponding rules) include:

  • a payment to secure a restraint of trade (ie, a capital payment, and a capital receipt for the former employee). This payment was not monetary remuneration;
  • a payment for expenditure incurred after the business has ceased. A payment of this nature incurred after cessation of a business would not satisfy the general permission; and
  • an ex gratia payment to a retiring employee. An ex gratia payment deductible under this provision has no connection to employment, nor is it incurred in carrying on a business. Again, timing rules for monetary remuneration were not applicable.

The linkage between section DF 5 and the 63-day rule accrual expenditure rule in section EF 1 of the 1994 Act was considered to have no real effect, and so that linkage was omitted in rewriting section DF 5. That resulted in the timing of the deduction in section DC 1 of the 2004 Act (and in the 2007 Act) being on a payments basis.