Deductibility of Retiring Allowances Paid by Employers
21.25. Amounts paid directly by an employer to a terminating employee, or to the dependants of a deceased employee, are at present an allowable deduction to the employer under either section 51 (1) of the Act, which provides that:
‘51 (1) All losses and outgoings to the extent to which they are incurred in gaining or producing the assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing such income, shall be allowable deductions except to the extent to which they are losses or outgoings of capital, or of a capital, private or domestic nature, or are incurred in relation to the gaining or production of exempt income’,
or under section 78 (1) (c), which provides that:
‘78 (1) The following shall … be allowable deductions:
- (a) …
- (b) …
- (c) Sums which are not otherwise allowable deductions and are paid by the taxpayer during the year of income as pensions, gratuities or retiring allowances to persons who are or have been employees or dependants of employees, to the extent to which, in the opinion of the Commissioner, those sums are paid in good faith in consideration of the past services of the employees in any business operations which were carried on by the taxpayer for the purpose of gaining or producing assessable income.’
21.26. Certain lump sums paid to terminating employees have always been considered to be allowable deductions under section 51 (1). These include accrued holiday and long-service leave pay and certain payments made under service contracts. To the extent that other payments were regarded as being deductible it had been the practice of the Commissioner—in line with what was thought to be the intention of the legislature evinced from the words in section 78 (1) (c)—to apply similar standards of reasonableness in determining the amount of the deduction as those now applied in determining the maximum benefit that may be provided by a tax-exempt superannuation fund under section 23F (2) (h) of the Act.
21.27. However, it has lately become clear that the Commissioner is unable to resist claims that section 51 (1) authorises the full deduction of retiring allowances paid by public companies where it can be established that the payments are made for one or more of the following reasons:
- (a) as a matter of commercial expediency in order to establish harmonious relationships between the management and staff;
- (b) as a means of ensuring greater efficiency; or
- (c) as a means of inducing executives to press themselves to the limit by giving them the prospect of being treated generously on their retirement.
Once the company has established that the payment was made for one or more of these reasons—and in practice it is
not difficult to establish this—then the quantum of the lump-sum payment is for the company itself to determine
and it must be allowed a deduction for the full amount. Instances of amounts of up to $250,000 being paid by
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public companies to retiring executives and deducted under section 51 (1) have been brought to the
notice of the Committee. In some of these cases the executives have also received very large amounts from the
companies’ superannuation funds and also under service contracts. The amounts received by the executives are
reported to have been assessable only as to 5 per cent in their hands.
21.28. It is to be noted that the foregoing applies not only to employees of public companies, but also to arm's length employees of private companies. However, section 109 of the Act imposes an effective limit on the deduction that can be claimed for a retiring allowance paid to a person who is or has been a shareholder or director of a private company or a relative of a shareholder or director. In addition, section 65 gives the Commissioner power to disallow a deduction for a retiring allowance paid by a non-corporate employer to a relative to the extent that the retiring allowance is excessive.
21.29. Even if the deduction is claimed under section 78 (1) (c), the Commissioner may be unable to challenge the amount of the payment. If the payment is made by a public company and approval for the payment has been granted by the shareholders in general meeting, then the Commissioner would be hard-pressed to superimpose his opinion as to the reason for, or the amount of, the payment.