Federal Court determines payments in place of employee incentives not deductible

At issue in the Federal Court case Clough Limited v Commissioner of Taxation [2021] FCA 108 was whether a lump sum paid by a large engineering firm in consideration for the cancellation of employee entitlements in respect of share options and performance rights are deductible under s 8-1where those options and rights were required to be converted or cancelled upon a change in control of business.

Clough was a large engineering firm and in order to reward and retain key employees it ran both a share option plan and a share and cash-based incentive scheme. 

Following negotiations with its majority shareholder, Clough entered into a scheme of arrangement that saw 100% ownership pass to this shareholder.  During the course of negotiations it was resolved that Clough would pay a lump sum to cancel all the existing employee options and rights outstanding under the two schemes. 

Its change-of-control governing document gave Clough the power to declare that the options and rights would vest immediately in the event of it entering into a scheme of arrangement.

The taxpayer argued that the outgoing satisfied one or both of the positive limbs of s 8-1, as it was made to reward employees for their past efforts and to motivate them to remain with the group following the change in ownership. It was this that the ATO rejected.

The Federal Court decided on the evidence that the amounts paid were not deductible under the positive limbs of section 8-1 as the payment was not incurred:

  • with a view to gaining or producing income, nor
  • necessarily incurred in carrying on a business for the purpose of gaining or producing such income.

As the paying out of the options and rights arose out of the change of ownership requirements, the court held that the outgoing failed to satisfy either of the positive limbs.

Note that this case, along with many other tax issues, is covered in-depth in a session of Tax & Super Australia’s Tax Discussion Groups. Find out more here. The Discussion Groups are complimented by our Tax Notes, which delve into the detail of what you need to know about the latest changes and developments in tax and are filled with diagrams and worked examples.

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