The High Court recently heard the taxpayer’s appeal from the Full Federal Court’s decision in Blank v Commissioner of Taxation (2015 FCAFC 154).
The case concerns the treatment of a profit share arrangement put in place by the parent company of the taxpayer’s employer. The arrangement involved the parent company issuing ‘certificates’ to the taxpayer, on a one-for-one basis with the taxpayer’s subscription for shares in its own holding company. These certificates could be assigned, with the issuer’s consent, to the employee’s family trust or controlled entity. The issuer subsequently redeemed the certificates, and paid the taxpayer proceeds of several million dollars, calculated using a formula based on the profits of the issuer.
The taxpayer argued that the value of the rights issued to him, at the time of their issue, was the income derived from the his personal exertion. The rights were capital assets, capable of being turned to pecuniary account, and the gain realised on their subsequent disposal was a capital gain and not income from personal exertion. The Commissioner argued that the certificates were merely representative of a formula by which the employer group would calculate the taxpayer’s entitlement to profit share payments, which should be taxed on receipt as deferred salary and wage income.
The Commissioner relies on the fact that prior to being paid out by his employer, the rights could only be assigned to an entity under the taxpayer’s control. Thus, the amount was received as a result of “the performance of [an employer’s] promise to pay money on satisfaction of the conditions on which that performance depended” – having the character of deferred compensation for services rendered.
In a split decision, the Full Federal Court had found in favour of the Commissioner.
The case is relevant for the tax position of a wide variety of profit share arrangements currently adopted by employers. Where an employee acquires contingent rights from his or her employer to receive future payments from the employer group, when is the appropriate time to recognise the income or benefit that arises from the employment? Is it at the time the employee acquires those rights, or when the employee receives the payments?
A key element in the majority decision in the Full Federal Court was whether the taxpayer could have converted the certificates to money at the date of issue, or at some other time prior to their redemption by the issuer. In their reasoning on this point, the majority disregarded the employee’s apparent ability to dispose of their certificates to their associated entity.
The parties’ submissions to the High Court apply or distinguish a number of long standing decisions on income and on employee benefits, including Abbott v Philbin, Donaldson, McArdle, McNeil, Scott, and Tenant v Smith. It is to be hoped that the High Court’s ultimate decision will establish some recognisable principles which will assist employers and taxpayers in identifying the time at which the employment-related income or benefit arises.