A difficult aspect of employment is the unhappy ending.
Occasionally cessation of employment will be followed by litigation regarding matters such as unfair dismissal or claims for underpaid wages. In fact, claims for underpaid wages often also occur where employment continues.
Once claims are settled and amounts paid to resolve the matter employers then need to correctly categorise and treat payments for taxation purposes.
In a recent case, former employees of 7-Eleven franchises had received payments from an entity associated with 7-Eleven Stores Pty Ltd. The payments related to under award wage payments made to the former employees by 7-Eleven franchises at which the employees had worked. The decision can be viewed at Guttikonda & Anor v FC of 2022 AATA 1325 (20 May 2022).
As a result of under award wages payments employees/former employees were entitled to make a claim for underpaid wages. A process had been established by 7-Eleven Stores Pty Ltd whereby a subsidiary entity Independent Claims Pty Ltd would, once amounts were agreed, each employee would enter an agreement with Independent Claims Pty Ltd which would make payment of the agreed amount (which included underpaid wages, interest and superannuation). The amount was subject to tax withholding.
The employees objected against the inclusion of the amounts received (in relation to the wages and interest components there-of) on the basis the amounts were not income but capital in nature (in consideration of disposal of rights).
The matter in dispute was expressed in the judgement as follows:
52. The Respondent contends that the Gross Amount and the Interest paid under each Deed are assessable as ordinary income under s 6-5 of the Income Tax Assessment Act 1997 (Cth). In my view, that is clearly correct.
53. There is an obvious nexus between the Gross Amounts agreed to be paid by Independent to the Applicants and the services provided by the Applicants to their former employers. However these payments are described, they are the product of the services provided by the Applicants and properly characterised as income.
54. The Deeds themselves, in clauses 4 and 5 and Schedule 1, make clear that the payments were rewards for services provided by the Applicants during their employment with the franchisees.
55. The cases referred to by the Respondent demonstrate that the characterisation of a payment for services rendered as income is not lost simply because the payment is in a lump sum, or payment is deferred, or made by someone other than the employer, or is expressed to be in consideration of the disposal of rights.
Employers need to carefully consider how payments made in employment dispute scenarios should be taxed. Merely affixing labels to amounts in legal settlement agreements does not of itself provide characterisation of the amounts being paid nor determine how tax should be applied. Problem areas include settlements involving wrongful dismissal, redundancy, personal injury and as highlighted in this case underpayment of wages.
One of the difficulties for employers is making sure any legal settlement is properly considered (in advance) by the relevant operational areas that discharge tax obligations. It is not uncommon to see a further dispute arise where a settlement has not factored in the correct tax treatment meaning the amount to be paid/received post tax differs to what one or other of the parties considered to be the outcome.
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