Taxation of Lump-sum Payments on Retirement

21.13. Section 26 (d) of the Income Tax Assessment Act includes in the assessable income of a taxpayer:

‘(d) five per centum of the capital amount of any allowance, gratuity or compensation where that amount is paid in a lump sum in consequence of the retirement from, or the termination of, any office or employment, and whether so paid voluntarily, by agreement or by compulsion of law …’.

21.14. Section 26 (e) of the Act includes in the assessable income of a taxpayer:

‘(e) the value to the taxpayer of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted to him in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by him, whether so allowed, given or granted in money, goods, land, meals, sustenance, the use of premises or quarters or otherwise:

Provided that this paragraph shall not apply to any allowance, gratuity or compensation which is included in the last preceding paragraph …’.

21.15. The effect of section 26 (d), when taken in conjunction with the proviso to section 26 (e), is twofold. Firstly, it includes in assessable income 5 per cent of lump sums that would otherwise be regarded as wholly capital receipts. Examples of such receipts are payments from the trustees of a superannuation fund and compensation for loss of office. Secondly, it includes in assessable income only 5 per cent of lump sums that would otherwise be regarded as assessable in full under either general law principles or under the specific provisions of the first part of section 26 (e). Examples of this latter type of receipt are retiring allowances paid directly by an employer to a retiring employee (including such items as accrued long-service leave and holiday pay) and payments made under a service contract that provides for payment of a lump sum at the satisfactory conclusion of the contract.

21.16. The principle inherent in section 26 (d) of assessing only 5 per cent of a lump sum received on retirement has been followed ever since income tax was first levied by the Australian Government in 1915. The choice of the figure of 5 per cent was plainly arbitrary and reflected in part the inequity of taxing such a sum wholly in the year of receipt when it may have arisen from employment stretching over many years.

21.17. There are no limitations on the amount of any receipt to which section 26 (d) is applicable, nor is there any restriction on the number of occasions on which it may be applied. Thus it is open to a taxpayer who is employed by one of a number of related companies to resign and move to another company within the group and collect a substantial retiring allowance from the first employer which will be assessable only as to 5 per cent. Instances of this happening have been brought to the attention of the Committee where the amounts involved, and the consequent cost to the Revenue, have been extremely large.

21.18. Some control over the application of section 26 (d) in the case of a private company is provided by section 109 of the Act:

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‘109. So much of a sum paid or credited by a private company to a person who is or has been a shareholder or director of the company or a relative of a shareholder or director, being, or purporting to be—

  • (a) …
  • (b) an allowance, gratuity or compensation in consequence of the retirement of that person from an office or employment held by him in that company, or upon the termination of any such office or employment,

as exceeds an amount which, in the opinion of the Commissioner, is reasonable, shall not be an allowable deduction and shall … be deemed to be a dividend paid by the company on the last day of the year of income of the company in which the sum is paid or credited.’

21.19. However, the Commissioner cannot make use of this section if the person receiving the retiring allowance is not within the class of persons prescribed in the section or if the company concerned is a public company.

21.20. Section 26 (d) was examined in the early 1950s by the Spooner Committee which recommended that the operation of the section be limited by restricting the concessional basis of taxation to so much of the retiring allowance as might be regarded as reasonable, having regard to remuneration and length of service. In effect the formula for assessment of retiring allowances and payments from superannuation funds proposed by that Committee was that the amount taxable on the concessional basis be limited to the equivalent of one year's salary for every eight years of service and should not, in any case, be allowed to exceed $30,000. The Spooner Committee further recommended that any payments received by an employee as consideration for entering into a restrictive covenant should be assessable in full, but, somewhat anomalously, recommended that any amounts received by an employee as compensation or damages for the termination of his employment should continue to be assessable only as to 5 per cent and without any limit on the amount received.

21.21. The Government decided to adopt the Spooner Committee's recommendations in principle and proceeded to implement a less generous version of the proposal. The Government's intention was that the amount subject to the 5 per cent basis of taxation be limited to one year's salary for every twenty years of service, with an upper limit of $20,000.

21.22. A Bill that would have given effect to this intention was introduced into the House of Representatives in 1952, but aroused much opposition. The principal ground of objection was that reputable private superannuation schemes had been operating for many years on the assumption that senior executives would be paid lump-sum amounts on retirement which would be substantially in excess of the amounts provided in the formula. If the excess were to be taxed in full, the application of the progressive graduated rate of tax to very large amounts received in a single year of income could result in most of the lump sum being lost in tax. It was contended that this would defeat the legitimate expectations of taxpayers who had been contributing to superannuation funds over a long period on the assumption that they would receive a lump sum on retirement, 95 per cent of which would be tax free.

21.23. As a result of these objections, the clause relating to retirement allowances was deleted from the Bill.

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21.24. The Ligertwood Committee, though aware of the previous Committee's recommendations on the matter, did not mention section 26 (d) in its 1961 report—probably because of what had transpired previously.