Employment termination payment paid by an employer and Article 14 of the 2003 UK Convention

Does Article 14 of the tax treaty between Australia and the United Kingdom (the 2003 UK Convention) contained in Schedule 1 to the International Tax Agreements Act 1953 (the Agreements Act) apply to an employment termination payment which is paid by an employer and calculated by reference to the number of years the employee had worked for the employer?

No, Article 14 of the 2003 UK Convention does not apply to an employment termination payment which is paid by an employer and calculated by reference to the number of years the employee had worked for the employer.

The taxpayer is a foreign resident, and is a resident of the United Kingdom (UK) for the purposes of the 2003 UK Convention.

The taxpayer was employed by an Australian company.

The taxpayer's employer decided to terminate the taxpayer's employment and paid the taxpayer a lump sum termination payment, part of which was calculated by reference to the number of years the employee had worked for the employer.

The payment is an employment termination payment (ETP) for the purposes of Division 82 of the Income Tax Assessment Act 1997 .

Article 14 of the 2003 UK Convention allocates taxing rights between Australia and the UK in relation to 'salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment'.

The term 'salaries, wages and other similar remuneration' is not defined in the 2003 UK Convention. In accordance with Article 3(3) of the 2003 UK Convention, the term shall, unless the context requires otherwise, have the meaning it has under the laws of Australia, with any tax law meaning prevailing over any other meaning under other laws of Australia.

The terms 'salary', 'wages' and 'remuneration' are not defined in Australia's taxation legislation. The term 'salary or wages' is non-exhaustively defined in section 11 of the Superannuation Guarantee (Administration) Act (1992 ). However, this definition is of no assistance as it does not list an ETP.

Accordingly, it is necessary to consider the ordinary and common law meaning of each of the terms 'salary', 'wages' and 'remuneration'. The Macquarie Dictionary and relevant case law clearly demonstrate that these terms commonly refer to 'pay or reward for work or services rendered' (in particular see Mutual Acceptance Co Ltd v. Federal Commissioner of Taxation (1944) 69 CLR 389; (1944) 7 ATD 506, and Chalmers v. The Commonwealth of Australia (1946) 73 CLR 19).

An ETP is not a payment or reward for work or services rendered. An ETP, even where calculated by reference to the number of years of employment with that employer, is paid in consequence of termination of employment to compensate for the loss of employment with that employer. The performance of services does not trigger the legal obligation to pay an ETP; rather the obligation to pay an ETP only arises because of the termination of the employment.

This is consistent with the Commissioner's views in relation to the term 'salary or wages' and redundancy payments made on termination of employment at paragraph 74 of SGR 2009/2 Superannuation Guarantee : Meaning of terms ' ordinary time earnings' and ' salary or wages' .

In accordance with Article 3(3) of the 2003 UK Convention, however, it is necessary to consider whether the context requires a meaning other than the ordinary and common law meaning of the term 'salary, wages and other similar remuneration'. Relevant context for the purposes of interpreting an Australian tax treaty includes the Commentaries on the OECD Model Tax Convention on Income and on Capital (the OECD Commentary).

Paragraph 2.1 of the OECD Commentary on Article 15 of the Model Tax Convention states that member countries have generally understood the term 'salaries, wages and other similar remuneration' to include 'benefits in kind' received in respect of an employment, such as stock options; the use of a residence or automobile; health or life insurance; and club memberships.

Accordingly, if an ETP paid by an employer is a 'benefit in kind' received in respect of an employment, the context would require an ETP to be treated as 'salary, wages or other similar remuneration' for the purposes of Article 14 of the 2003 UK Convention.

'Benefits in kind' referred to in the OECD Commentary are benefits which are provided to employees during their employment in lieu of additional salary or wages. In relation to stock options, the OECD Commentary on Article 15 of the Model Tax Convention states , at paragraph 12: ...stock options are often taxed at a time ... that is different from the time when the employment services that are remunerated through these options are rendered.

This comment recognises that share options are provided in return for services provided by the employee to the employer. Similarly, other 'benefits in kind' referred to in the OECD Commentary are provided in return for the employee's services.

As explained above, an ETP is not a payment for services provided by an employee; it is a payment compensating for the loss of employment. An ETP is therefore not a 'benefit in kind'.

As a result, the treaty context does not require that the term 'salary, wages or other similar remuneration' take on a meaning that would include an ETP.

Accordingly, Article 14 of the 2003 UK Convention does not apply to the ETP derived by the taxpayer because the ETP is not salaries, wages or other similar remuneration derived by the taxpayer in respect of their employment.