You may not get many clients who can use this tax offset, but one day you may very well get one in the door who will appreciate your familiarity with, and knowledge about the application of, the delayed income tax offset. The offset has also been labelled the lump sum payment in arrears offset.

It works to alleviate the problem of a taxpayer being expected to pay more tax in a year when a lump sum of back payments is received — where they would be disadvantaged by paying more tax than if the income had been spread over several income years.

The general rule is that employment income is assessable in the income year it is received, regardless of the period the payment covers. This is still the case, however the delayed income tax offset works to restrict the amount of tax payable to the same “marginal” rate that would have applied if it were “received” in the tax year or years it relates to.

The delayed income tax offset applies to limit the tax payable where a lump sum representing an arrears of income is paid for:

  • salary or wages (only applies to the extent the salary or wages were accrued during the period earlier than 12 months before payment)
  • a Commonwealth education or training payment
  • salary or wages paid to a person after reinstatement to duty following a period of suspension (only to the extent the payment was for the period of suspension, even if that period was within the preceding 12 months)
  • deferred payment of a retiring allowance, retirement pension or annuity (or a payment which is a supplement to any of those payments)
  • compensation, sickness or accident pay for incapacity to work (the concession is not available on payments made to the owner of an insurance policy under which the payment is made), and
  • Social Security and repatriation pensions, benefits and allowances paid by Social Security or Veterans Affairs or similar payments made under a law of a foreign country, state or province, but not exempt income.

The whole arrears payment is still included in the assessable income of the taxpayer in the income year it is received, but the tax offset diminishes the amount of tax payable on that component to the amount that would have been payable had the income been received in the income year it accrued.

Salary or wages
Salary or wages for the purpose of the delayed income tax offset is limited to eligible income as defined in legislation (section 159ZR). This includes salary, wages, commissions, bonuses or allowance paid to an employee, an office-holder or a company director (excluding remuneration paid to a director who is also an associate of the company).

Salary or wages does not include:

  • return to work payments (paid to a taxpayer under an agreement, arrangement or understanding to resume performing work or rendering services — these payments are assessable under another section (s26(eb))
  • payments in advance for annual leave or long service leave
  • lump sums paid on retiring or ceasing employment for accrued annual leave or long service leave
  • eligible termination payments (ETPs)
  • payments made under a contract that is wholly or principally for the labour of the recipient (and that are not otherwise subject to PAYG withholding tax purposes), and
  • commissions paid to an insurance or part time canvasser or collector.

Eligibility for the tax offset
To be eligible for the tax offset, the taxpayer must satisfy the conditions set out in section 159ZR:

  • a lump sum must be received from at least one of the eligible sources
  • the payment must have accrued in a prior income year
  • the lump sum must be 10% or more of the taxpayer’s taxable income in the year of receipt after deducting:
    • amounts that accrued in earlier years
    • amounts received on termination of employment in lieu of annual or long service leave and ETPs
    • net capital gains, and
    • any taxable professional income that exceeds the average taxable professional income from the preceding four years.

Amount of the offset
The amount of tax offset allowed is the amount by which the tax payable on the lump sum eligible amount exceeds the tax that would have been payable if the lump sum had been included in the taxable incomes of the two most recent years of income (s159ZRB).

That is: Delayed income tax offset = Tax on arrears – Notional tax on arrears;

where:

  • tax on arrears is the amount of tax (excluding Medicare levy) payable in the income year of receipt. The only tax offsets taken into account when calculating the “tax on arrears” are tax offsets for unused annual leave and long service leave (on termination of employment) and those for ETPs, and
  • notional tax on arrears is the amount of tax that would have been payable on the eligible amount if it was taxed in the year it accrued.

The “notional tax” has two components:

  • recent accrual years amount (notional tax in the two most recent years before the lump sum was received), and
  • distant accrual years amount (notional tax on any accruals in the years before the two most recent years).

The notional tax for distant accrual years is calculated by multiplying the lump sum applicable for those years by the average rate of tax on the arrears for the recent accruals years.

The delayed income tax offset, explained by way of example
A taxpayer receives a lump sum payment of $90,000 in November 2015 representing arrears of pay after successfully defending his suspension from service. He had been suspended from service without pay since July 2012.

The taxpayer’s taxable income in the respective years (not including the lump sum) was:

  • 2012-13: $7,500  
  • 2013-14: $7,500  
  • 2014-15: $40,000

Of the lump sum received in the respective years, these amounts were accrued:

  • 2012-13: $38,000  
  • 2013-14: $32,000
  • 2014-15: $20,000

Because the tax on arrears is the only assessable income for 2015-16 and the taxpayer had no deductions, the tax on this $90,000 would have been $21,247 in the 2015-16 year. Note that the 10% eligibility requirement is satisfied.

Position in 2013-14

  • Taxable income………………………………………………………………………. $7,500
  • Plus: Accrued lump sum………………………………………………………….. $32,000
  • Adjusted taxable income…………………………………………………………. $39,500
  • Notional tax payable on $39,500……………………………………………….. $4,385
  • Less: Tax payable on $7,500…………………………………………………………… ($0)
  • EXTRA tax payable…………………………………………………………………….. $4,385
  • Percentage of tax payable (EXTRA tax payable/accrued lump sum)………. 13.7%

Position in 2014-15

  • Taxable income…………………………………………………………………….. $40,000
  • Plus: Accrued lump sum………………………………………………………….. $20,000
  • Adjusted taxable income…………………………………………………………. $60,000
  • Notional tax payable on $60,000……………………………………………… $11,047
  • Less: Tax payable on $40,000…………………………………………………… ($4,547)
  • EXTRA tax payable…………………………………………………………………….. $6,500
  • Percentage of tax payable (EXTRA tax payable/accrued lump sum)…….. 32.5%

Position in 2012-13

This leads to an average rate to be used for “distant accrual years” using the following formula:
(Year 1 % + Year 2 %) / 2 = (13.7% + 32.5%) / 2 = 23.1%

  • Accrued lump sum…………………………………………………………………………. $38,000
  • Average tax rate calculated……………………………………………………………….. 23.1%
  • Distant accrual year amount…………………………………………………………….. $8,778

Calculation of offset

  • Tax on lump sum in 2015-16……………………………………………………………. $21,247

Less:

  • EXTRA tax payable 2013-14……………………………………………………………….. ($4,385)
  • EXTRA tax payable 2014-15……………………………………………………………….. ($6,500)
  • Distant accrual year amount……………………………………………………………… ($8,778)
  • Delayed income tax offset……………………………………………………………………. $1,584