Issue
Is the repayment of a retention bonus by a taxpayer who leaves the Australian Defence Force (ADF) early, excised from the taxpayer's assessable income under section 170 of the Income Tax Assessment Act 1936 (ITAA 1936) in the year that the bonus was assessed?
Decision
Yes, the repayment of the retention bonus by a taxpayer who leaves the ADF early is excised from the taxpayer's assessable income under section 170 of the ITAA 1936 in the year that the retention bonus was assessed.
Facts
The taxpayer was a member of the ADF. The taxpayer was offered an amount (referred to as a retention bonus) to sign on for another five years of service. Under the terms of the contract if an ADF member resigned before the end of that five year period they were required to repay, on a pro rata basis, that part of the retention bonus relating to the period of service that they did not complete.
The taxpayer signed up for the retention bonus. The retention bonus was included on their group certificate (now called a payment summary) and disclosed as assessable income in the year of receipt. One year into the contract the taxpayer resigned from the ADF, and was required to repay four-fifths of the retention bonus. The taxpayer entered into an arrangement to repay the amount due.
Reasons for Decision
A retention bonus is a payment that is made subject to certain conditions including the condition that if the recipient fails to serve the required time, some or all of the payment may be required to be repaid.
The retention bonus is assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) in the year in which it is received ((1958) 9 TBRD Case J20 ; 7 CTBR (NS) Case 130 ; and (1958) 9 TBRD Case J60 ; 8 CTBR (NS) Case 50 ). The fact that the receipt may have to be repaid if certain events subsequently occur does not affect the character of the receipt ( Case A59 69 ATC 334; 15 CTBR (NS) Case 34 ).
The repayment of the retention bonus is not an allowable deduction under the general deductions provisions in section 8-1 of the ITAA 1997 as it is not incurred in the course of earning or deriving assessable income ((1958) 9 TBRD Case J20 ; 7 CTBR (NS) Case 130 ; and (1958) 9 TBRD Case J60 ; 8 CTBR (NS) Case 50 ). The repayment is an amount paid for breach of contract ((1958) 9 TBRD Case J60 ; 8 CTBR (NS) Case 50 ; and (1963) 14 TBRD Case P20 ; 11 CTBR (NS) Case 58 ).
The retention bonus was therefore correctly assessed in the year of receipt, and the taxpayer is not entitled to claim a deduction in the year of repayment of the bonus.
However, the Assistant Treasurer announced on 1 August 2001 a proposed amendment to the taxation law to allow a taxpayer who has to repay assessable income to seek an amended assessment for the year in which that income was originally included in their tax return. The amendment will not apply to repayments that are an allowable deduction or where the recipient is otherwise compensated for the amount to be repaid (for example, where the person receives a personal injury compensation amount from which sickness benefits have to be repaid). The amendment applies to the 1996-97 and later years of income.
The Commissioner will exercise his administrative powers to give immediate effect to the Government's announcement.
Taxation Ruling IT 2623 gives effect to the Commissioner's decision by allowing the amount of retention bonus which is repayable to be excluded from the assessable income of the year in which the bonus was originally assessed. This is subject to meeting the requirement of IT 2623A (an addendum to IT 2623) that the amount has been repaid, or an arrangement is in place to repay it.
A taxpayer may seek an amendment of the tax assessment in which the retention bonus was assessed, subject to the 4 year time limit for amendments set by subsection 170(3) of the ITAA 1936. For the 2000-01 and future income years, the time limit is 2 years if the taxpayer is a shorter period of review taxpayer.
The taxpayer has entered an arrangement to repay the amount due and is therefore able, subject to the statutory time limits, to excise the amount from the assessable income of the year in which it was assessed.