Edited version of private ruling

Authorisation Number: 1011475123322

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: employment termination payment and invalidity segment

Question

Is any part of the payment received by your client, exempt from tax as an invalidity segment of an employment termination payment, as defined under section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period

01 July 2008 to 30 June 2009

The scheme commenced on

01 July 2008

Relevant facts

Your client is under 65 years of age.

Prior to commencing with the Employer your client was employed.

Your client commenced employment with the Employer and performed general duties.

There was no date prior to your client's 65th birthday on which your client was required to retire from or terminate employment with the Employer.

Your client was injured at work.

A Medical Specialist stated that your client could not return to full or light work duties and the Specialist supported your client's medical related retirement.

In a medical report to the Employer's WorkCover Insurer, another Medical Specialist offered an opinion that your client was not fit to return to work for the Employer. The Specialist further stated surgical treatment was necessary to improve your client's condition.

Later, a recommendation that your client be medically retired was made to the Employer.

The personnel director issued a letter to your client seeking their consent to be medically retired. In this same letter it was stated it had been determined that your client was permanently unfit for demands of the position with the Employer and your client may be eligible for an incapacity benefit.

A Final WorkCover medical certificate from a general medical practitioner indicated under 'Fitness for Work' your client was fit for permanently modified duties.

An incapacity claim form to the Fund was prepared by your client.

A letter from the Fund to the Employer acknowledged that a claim form in respect of your client was submitted to them.

It also documented that a doctor had completed a medical report & certificate for the claim. The Employer's medical officer report to the Employer was recognized as supporting medical retirement.

The claim was assessed for Incapacity.

A PAYG payment summary - employment termination payment from the Employer states your client was paid a taxable component from which tax was withheld.

Your client's employment termination payment was calculated in accordance with the Award, which calculates partial and permanent incapacity payments based solely on the employee's age at termination and their salary.

A PAYG payment summary - individual non-business for the year ending 30 June 2009 from the Employer, stated your client's gross payments and the tax withheld.

You state your client spent over six months in total away from work because of their injury.

Your client has not made any application nor has your client received any benefit payments from their superannuation scheme.

A Final WorkCover Medical Certificate from your client's medical practitioner states your client has reached maximum medical improvement.

The same doctor later stated in another medical certificate your client has a medical condition which renders your client unfit and unlikely to ever be able to be employed in the capacity for which your client has training, education and experience.

Your client's medical specialist also certified in a medical certificate your client having this medical condition is unlikely to ever be able to return to work in any capacity for which your client was trained, educated or was experienced.

A Certificate of Service states your client employment dates with the Employer and also states your client terminated employment due to medical incapacity.

You state your client was not offered any other position within the Employer, nor was your client offered any rehabilitation or retraining.

Relevant legislative provisions:

Income Tax Assessment Act 1936 Section 27A.

Income Tax Assessment Act 1936 Section 27G.

Income Tax Assessment Act 1997 Subsection 82-10(1).

Income Tax Assessment Act 1997 Subsection 82-10(2).

Income Tax Assessment Act 1997 Section 82-130.

Income Tax Assessment Act 1997 Subsection 82-130(1).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(a).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(b).

Income Tax Assessment Act 1997 Paragraph 82-130(1)(c).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Paragraph 82-135(i).

Income Tax Assessment Act 1997 Section 82-140.

Income Tax Assessment Act 1997 Section 82-145.

Income Tax Assessment Act 1997 Subsection 82-150(1).

Income Tax Assessment Act 1997 Paragraph 82-150(1)(a).

Income Tax Assessment Act 1997 Paragraph 82-150(1)(b).

Income Tax Assessment Act 1997 Paragraph 82-150(1)(c).

Income Tax Assessment Act 1997 Paragraph 82-150(1)(d).

Income Tax Assessment Act 1997 Subsection 82-150(2).

Income Tax Assessment Act 1997 Section 83-295.

Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision

Summary

The payment received by your client from the Employer is an employment termination payment as it was:

- received in consequence of the termination of your client's employment; and

- received within 12 months of the termination of your client's employment.

The employment termination payment comprises:

- A tax free component- which includes an invalidity segment; and

- A taxable component.

Detailed reasoning

Where a person's employment is terminated because of ill-health and the person received an employment termination payment, part of the payment may be tax free. This component is called an invalidity segment.

Therefore, prior to determining if the payment includes an invalidity segment, the payment must be an employment termination payment.

Employment termination payment

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that:

employment termination payment has the meaning given by section 82-130.

Subsection 82-130(1) of the ITAA 1997 declares:

A payment is an employment termination payment if:

It is received by you:

- in consequence of the termination of your employment; or

- after another person's death, in consequence of the termination of the other person's termination; and

- it is received no later than 12 months after the termination (but see subsection (4)); and

- it is not a payment mentioned in section 82-135.

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

- payment for unused annual leave or unused long service leave;

- the tax-free part of a genuine redundancy payment or an early retirement scheme payment;

- reasonable capital payments for personal injury.

Therefore, it can be seen that a number of conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of these conditions will result in the payment not being considered an employment termination payment. Any termination payments that are received more than 12 months after the termination of employment will be assessable income in accordance with section 83-295 of the ITAA 1997.

Payment is received in consequence of the termination of employment

The first condition to be met is that there must be an employment termination payment that is made in consequence of the termination of the taxpayer.

In this case, it is considered that the payment was made in consequence of the termination of your client's employment as your client was unable to continue work due to their injury and was medically discharge from employment.

The payment received by your client from the Employer would not have been approved and paid unless your client's employment was terminated and in this case the termination was based on medical grounds.

Payment is received no later than 12 months after termination of employment

The second condition for the payment to meet the criteria is that the employment termination payment was paid to the taxpayer no later than 12 months after your client's employment was terminated.

The facts of this case show your client's service with the employer was terminated during the same month the termination payment was made. As the payment was received within 12 months of the termination, the requirements of paragraph 82-130(1)(b) of the ITAA 1997 are satisfied.

Not a payment mentioned in section 82-135 of the ITAA 1997

As noted earlier, section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments. These include:

- superannuation benefits;

- payment for unused annual leave or unused long service leave;

- the tax-free part of a genuine redundancy payment or an early retirement scheme payment;

- reasonable capital payments for personal injury.

The termination payment is the result of a calculation of a partial and permanent disability benefit under the Award. It is not a superannuation benefit, a payment for unused annual leave or unused long service leave, nor is it the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

However, consideration must be given as to whether the payment represents a reasonable capital payment for personal injury. If it does, then the payment will not be an employment termination payment under paragraph 82-135(i) of the ITAA 1997.

Paragraph 82-135(i) of the ITAA 1997 states that an employment termination payment does not include:

a capital payment for, or in respect of, personal injury to you so far as the payment is reasonable having regard to the nature of the personal injury and its likely effect on your capacity to derive income from personal exertion (within the meaning of the definition of income derived from personal exertion in subsection 6(1) of the Income Tax Assessment Act 1936);

Payments that fall within this exclusion are payments or benefits that compensate or reimburse the person for or in respect of the particular injury.

Prior to 1 July 1997, former paragraph (n) of the definition of an eligible termination payment in former subsection 27A(1) of the Income Tax Assessment Act 1936 (the former paragraph (n) exclusion) applied to exclude similar payments from being eligible termination payments. The former paragraph (n) exclusion stated:

Consideration of a capital nature for, or in respect of, personal injury to the taxpayer, to the extent to which the amount or value of the consideration is, in the opinion of the Commissioner, reasonable having regard to the nature of the personal injury and its likely effect on the capacity of the taxpayer to derive income from personal exertion.

From 1 July 2007, the former paragraph (n) exclusion has been replaced by paragraph 82-135(i) of the ITAA 1997. However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 stated, in relation to section 82-135 of the ITAA 1997, that:

Consistent with current legislation, certain payments are prevented from qualifying as employment termination payments. …

In light of this, court decisions dealing with the operation of the former paragraph (n) exclusion can be cited with authority in respect of the operation of paragraph 82-135(i) of the ITAA 1997.

In Commissioner of Taxation v. Scully [2000] HCA 6; 2000 ATC 4111; (2000) 169 ALR 459; (2000) 43 ATR 718; (2000) 74 ALJR 504; (2000) 201 CLR 148 (Scully) the Full Bench of the High Court considered whether a payment made by a superannuation fund as a result of the taxpayer's termination of employment because of invalidity was:

- 'consideration'; and

- consideration 'for, or in respect of, personal injury'.

It was held that the payment was 'consideration' within the broad sense of that term. However, the payment was not 'consideration for or in respect of personal injury to the taxpayer' which would fall within the paragraph (n) exclusion. The clauses of the trust deed which calculated the payment made no attempt to place a monetary value on the taxpayer's injury, nor was it the purpose of superannuation schemes to compensate for personal injury.

Acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stated in their joint decision:

In our opinion, the payment in this case cannot be characterised as consideration... in respect of, personal injury. The fact that the payment is not calculated by reference to the nature and extent of the injury or likely loss to the respondent and the fact that the other benefits are similar to that for total and permanent disablement point inevitably to the conclusion that the payment was consideration... for, or in respect of the respondent's termination of employment and her rights under the Trust Deed and was not consideration... for, or in respect of her injury.

From the foregoing it is apparent that for an amount to meet the definition of consideration in paragraph 82-135(i) of the ITAA 1997, the payment must be for personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

As advised in a letter from the Employer, the payment was calculated in accordance with the Award. Payments under the Award are made where an employee who has suffered a partial and permanent disability (PPD) as a result of an on duty injury and their employment is subsequently terminated.

The amount to be paid as a lump sum under the Award is calculated by reference to the age and salary of the employee at the time of their injury.

Consequently, the level of incapacity is irrelevant as to the amount received under the Award. For example, an employee who is 20% incapacitated will receive the same amount as an employee who is 80% incapacitated provided they are at the same salary level and age at the date of their injury.

The only criterion is that the employee has suffered a PPD and cannot be redeployed elsewhere with the Employer.

The lump sum payments are consideration for, or in respect of your client's termination of employment and your client's rights under the Award and not consideration for, or in respect of your client's injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss to your client. In other words, the payment is to compensate your client for the loss of his employment as a result of the injury sustained rather than to compensate for the injury itself and any subsequent loss of earning capacity.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the lump sum payment being made under the Award.

Therefore your client's payment is not of a type paragraph 82-130(1)(c) of the ITAA 1997 would exclude.

As all the conditions under subsection 82-130(1) of the ITAA 1997 have been met, the payment will be an employment termination payment.

Invalidity segment

Subsection 82-150(1) of the ITAA 1997 states that:

An employment termination payment includes an invalidity segment if:

(a) the payment was made to a person because he or she stops being gainfully employed; and

(b) the person stopped being gainfully employed because he or she suffered from ill-health (whether physical or mental); and

(c) the gainful employment stopped before the person's last retirement day; and

(d) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in capacity for which he or she is reasonably qualified because of education, experience or training.

Section 995-1 of the ITAA 1997 defines being gainfully employed as follows:

gainfully employed means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment.

Until becoming ill, your client was employed on a full-time basis by the Employer. Your client's employment with the Employer was terminated after a committee considered your client was unable to resume normal work due to their disabilities and recommended medical discharge.

Under normal conditions of employment your client would have retired at age 65. Your client was under this age at the time of the termination of their employment. Therefore the conditions in paragraphs 82-150(1)(a), (b) and (c) of the ITAA 1997 have been satisfied.

Certification from two legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed

As noted above, paragraph 82-150(1)(d) of the ITAA 1997 requires that two legally qualified medical practitioners certify that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

Prior to 1 July 1994, it had only been necessary for the termination of employment to occur because the taxpayer was physically or mentally incapacitated and therefore unable to engage in that employment. It did not require there be incapacity to engage in any employment. However, amendments made to the section that applied prior to 1 July 2007, former section 27G of the Income Tax Assessment Act 1936 (ITAA 1936), by the Taxation Laws Amendment (Superannuation) Act 1992 require the incapacity to prevent the taxpayer ever being able to undertake any employment for which the taxpayer is reasonably qualified.

The EM to the Taxation Laws Amendment (Superannuation) Bill 1992 confirms this. In explaining the test for invalidity, the EM stated the following:

To clarify the test for incapacity and to place the onus of determining invalidity on legally qualified medical practitioners, from 1 July 1994 the incapacity of the person will have to be certified by two medical practitioners.

The relevant test is also to be modified so that the invalidity payment concession is extended only to people who are unable to undertake any form of employment for which they are reasonably qualified. A person who is unable to continue his or her current employment, but is able to undertake other appropriate employment, will not have access to the concession. (emphasis added)

Therefore, a person, who is unable to continue to perform the duties of his or her current employment, but is able to undertake other appropriate employment for which they are reasonably qualified because of education, experience or training, would not now satisfy the condition in paragraph 82-150(1)(d) of the ITAA 1997, which is the rewritten provision for former section 27G of the ITAA 1936.

The EM does not elaborate further. However, the use of the term 'appropriate employment' in the EM suggests the intention that the term 'reasonably qualified' be interpreted as meaning neither over nor under qualified to any significant extent.

It is clear from reading the provision that the onus for determining invalidity (ill-health) is ascribed to the two legally qualified medical practitioners. Fulfilling that responsibility would involve, not only a medical opinion as to the taxpayer's physical and mental capabilities but also consideration as to what constitutes appropriate employment, based upon the taxpayer's education, training and experience.

Even if a taxpayer's employment is terminated by reason of disability, this does not mean that the second part of test for invalidity is satisfied. The two parts are independent. The fact that the medical practitioners have to determine invalidity does not mean that the medical practitioners have to determine the reason for termination.

A person's employment can be terminated because of disability, irrespective of whether two medical practitioners form an opinion as to whether the disability will prevent the taxpayer from ever being able to be employed in a capacity for which the taxpayer is reasonably qualified because of education, training and experience.

Further, the requirement that the disability is likely to result in the taxpayer being unable ever to be employed in a capacity for which he or she is reasonably qualified extends to full-time employment, part-time or casual employment. A person who is not able to work full-time but can work part-time or casual in any employment for which the taxpayer is reasonably qualified will not receive the concessional component.

In your client's case, two legally qualified medical practitioners have certified that as a result of their injury your client will never be able to be gainfully employed in a capacity for which your client is reasonably qualified because of education, training or experience.

It is considered that the two certifications satisfy the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997. Therefore, the final condition of subsection 82-150(1) has been satisfied.

Components of an employment termination payment

An employment termination payment made after 1 July 2007 comprises the following components:

- Tax-free component - this includes the pre-July 83 segment (if any) and/or the invalidity segment (if any); and

- Taxable component - the amount remaining after deducting the tax free component from the total payment.

- The tax-free component of an employment termination payment is not assessable income and is not exempt income (subsection 82-10(1) of the ITAA 1997). However, the taxable component is assessable income (subsection 82-10(2)) and subject to tax, depending on the person's age when the payment is received.

Calculation of invalidity segment

As noted above, the invalidity segment of an employment termination payment is included in the tax-free component (section 82-140 of the ITAA 1997). As a consequence, the invalidity segment is not assessable income and is not exempt income.

The amount of the invalidity segment is worked out by applying the formula in subsection 82-150(2) of the ITAA 1997:

Work out the amount of the invalidity segment by applying the following formula:

where:

days to retirement is the number of days from the day on which the person's employment was terminated to the last retirement day.

employment days is the number of days of employment to which the payment relates.

Tax treatment of taxable component

The remaining amount the total payment less the tax-free amount) is a taxable component of the employment termination payment as defined in section 82-145 of the ITAA 1997. This component is to be included in your client's tax return for the 2008-09 income year.

For recipients below preservation age, the taxable component of an employment termination payment is:

- for amounts below the employment termination payments cap ($145,000 for the 2008-09 income year) - taxed at a maximum rate of 30% plus Medicare levy (and Medicare levy surcharge, if applicable); and

- for amounts above the cap - at the top marginal rate plus Medicare Levy (and Medicare levy surcharge, if applicable).

Preservation age is the age at which a person can access their superannuation benefits generally on retirement. For persons born after 30 June 1964, their preservation age will be 60. Your client was under preservation age on the last day of the income year in which the payment was made.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).