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Is the taxpayer entitled to a lump sum payment in arrears tax offset under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936), in respect of an amount paid for unused sick leave?

No. The taxpayer is not entitled to a lump sum payment in arrears tax offset for an amount paid for unused sick leave, as the payment is not an 'eligible lump sum' for the purposes of section 159ZRA of the ITAA 1936.

The taxpayer received a lump sum payment in respect of unused sick leave that had accumulated over a number of years.

The taxpayer, an ongoing employee, received the lump sum payment after reaching an agreement with their employer.

The taxpayer did not receive the lump payment for unused sick leave as a consequence of the termination of any employment.

A taxpayer must satisfy the following conditions to be eligible for a lump sum payment in arrears tax offset: • the assessable income of the taxpayer of a year of income includes an eligible lump sum or sums (paragraph 159ZRA(1)(a) of the ITAA 1936); and • the total arrears amount is not less than 10% of the amount (if any) remaining after deducting that total arrears amount from the normal taxable income of the current year (paragraph 159ZRA(1)(b) of the ITAA 1936).

An 'eligible lump sum' is defined as a lump sum payment of eligible income received on or after 1 July 1986 that is included in the assessable income of the taxpayer and which accrued, in whole or in part, in an earlier year or years of income (subsection 159ZR(1) of the ITAA 1936).

The definition of 'eligible income' includes 'salary or wages' to the extent they accrued during a period ending more than 12 months before the date on which they were paid (subsection 159ZR(1) of the ITAA 1936).

The phrase 'salary or wages' is defined in subsection 159ZR(1) of the ITAA 1936 to mean payments covered by, amongst other things, section 12-35 in Schedule 1 of the Taxation Administration Act 1953 (TAA).

Section 12-35 in Schedule 1 of the TAA requires an entity to withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee.

As neither section 12-35 in Schedule 1 of the TAA, nor section 221A of the ITAA 1936 define or provide specific guidance as to the meanings of the words 'salary' or 'wages' they assume their ordinary, common law meaning. Based on case law, it is accepted that the three main characteristics of salary and wages are that: (a) the payment is made in respect of work or services; (b) the payment is an agreed amount as worked out between the parties; and (c) the payment is in respect of employment.

A payment must bear all of the above characteristics to be caught by the common law meaning of salary or wages.

A payment in respect of unused sick leave has all of the above characteristics for the following reasons: (a) an employee's entitlement to a payment for unused sick leave arises as a result of work or services that they have previously provided to the employer; (b) the amount of sick leave is agreed and set out in the employment contract, agency agreement or award that governs the pay or conditions of the employment; and (c) the payment is made under a contract of employment.

Therefore, a payment of unused sick leave to an ongoing employee falls within the ambit of the common law meaning of 'salary or wages'. Accordingly, a payment for unused sick leave is considered 'salary' or 'wages' for the purposes of section 12-35 in Schedule 1 of the TAA.

The definition of 'eligible income' in subsection 159ZR (1) of the ITAA 1936 also requires that the 'salary or wages' (that is, payments covered by section 12-35 in Schedule 1 of the TAA) accrue during a specified period.

However, in the case of a payment for unused sick leave, it is an employee's entitlement to, and not the payment for sick leave, that accrues or accumulates on the basis of the employee's period of service with an employer. A payment for sick leave is conditional upon the occurrence of certain events such as the employee being unable to work by reason of injury or illness, or upon the termination of employment. In this instance, the taxpayer did not become entitled to the unused sick leave payment until an agreement with their employer was reached to pay that amount. No actual payment accrued until that agreement was reached, only a contingent entitlement to sick leave existed.

An actual payment for unused sick leave does not accrue, rather it is the entitlement to unused sick leave that accumulates.

Therefore, a payment for unused sick leave is not 'eligible income' as defined in subsection 159ZR(1) of the ITAA 1936, and that payment is not an 'eligible lump sum' for the purposes of section 159ZRA of the ITAA 1936.

Consequently, an ongoing employee who receives a lump sum payment for unused sick leave is not entitled to the lump sum payment in arrears tax offset in respect of that payment.