In May 2023, legislation was introduced to change the way backdated Accident Compensation Corporation (ACC) and certain Ministry of Social Development (MSD) lump sum payments are taxed. This legislation was enacted on 28 March 2024.

The issue

Prior to 1 April 2024, the receipt of a lump sum payment from ACC and MSD that related to more than one income year was taxable at the individual’s marginal tax rate in the year of receipt. It was irrelevant that the lump sum payment may have related to compensation for earlier years. On this approach, the lump sum payment could move the individual into a higher tax bracket which could give rise to provisional tax implications.

If the individual’s tax rate in the year of receipt was higher than their tax rate in earlier years, more tax would be deducted from the lump sum payment resulting in a lesser amount available to support the individual. This outcome was unfair.

The change

Moving forward, from 1 April 2024, a backdated lump sum ACC earnings-related payment or attendant care payment (excluding a reimbursement payment) will be taxed at the individual’s average tax rate, calculated over the four years before receipt of the payment (a formula calculation is included in the legislation). If the average tax rate calculation results in a rate of less than 10.5%, the lump sum payment will be taxed at 10.5%. If the individual’s tax rate in the four years previous was higher than their tax rate in the year of receipt, the back dated lump sum payment or attendant care payment will be taxed at the rate applying for the current year. Effectively, a ‘lower of’ test applies to minimise the tax effect of these payments.

For withholding purposes, a payer of a backdated lump sum ACC earnings-related payment must withhold tax at the rate of 10.5% or the recipient’s average tax rate calculated over the four-year period mentioned above, whichever is the higher (i.e. a minimum withholding rate of 10.5% applies).

A backdated MSD payment that is a recalculation of a ‘main benefit’ payment for one or more earlier income years will be taxed at a rate calculated using a formula. Generally, this formula grosses up the amount of the payment received in the hand. The tax so deducted is a final tax. The types of MSD payments this applies to includes jobseeker support, sole parent support, an emergency benefit.

Inland Revenue has created a webinar explaining the new rules, including an example of the average tax rate calculation.

The tax return

From 1 April 2024 a backdated lump sum ACC earnings-related payment or attendant care payment subject to the new rules will show separately in myIR, similar to PIE income. This will allow the average tax rate calculation to be checked separately from the tax calculation for other income derived and adjusted if required.

Chartered Accountants Australia and New Zealand is pleased to see this positive law change enacted and expect that it will provide much needed support for many going forward.