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Ruling

Subject: Employment termination payment

Question 1

Is any part of the payment paid under a Deed of Settlement and Release an employment termination payment in accordance with section 83-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is any part of the payment paid under a Deed of Settlement and Release excluded from being an employment termination payment under section 82-135(i) of the ITAA 1997?

Answer

No.

Question 3

If the payment paid under a Deed of Settlement and Release is not an employment termination payment is the payment exempt from tax under paragraph 118-37(1)(a) of the ITAA 1997?

Answer

No as it is an employment termination payment.

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

Your client is under 55 years of age.

Your client commenced employment with the employer and a number of years later suffered because of a work related incident.

Your client commenced treatment with a medical specialist for the illness that was work related.

Your client was later issued a medical certificate that reduced your client's work commitments to X days per week.

Your client was appointed to a managerial position.

Subsequently, another medical certificate was issued further reducing your client's workload to Y days per week.

A letter from the employer, also states your client was on medical restrictions of Y days a week. It was stated this adjustment was temporary up to the end of that year.

Your client was expected to resume full time duties at that point and if not a review of the arrangement was to be undertaken.

A medical report was prepared for the employer providing a medical opinion and advice that your client would not be able to continue in the present work environment and your client should look for a new work environment.

The next month your client signed a Deed of Release and Settlement (the Agreement) with the employer and terminated employment on that day.

It stated in this Agreement your client released the employer from all claims except workers compensation.

The Agreement listed the type of payments to be paid, including accrued annual leave, accrued long leave, and a severance payment, once your client signed the document.

These payments were credited to your client's nominated bank account.

Your client was not dismissed from employment but after advice from the relevant union and in agreement with the employer terminated the employment.

Your client has not been in nor sought employment since the termination of employment.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 27A(1).

Income Tax Assessment Act 1936 Paragraph 27A(1)(n).

Income Tax Assessment Act 1997 Section 82-130.

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

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

Income tax Assessment Act 1997 Subparagraph 82-130(1)(a)(i)

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 Subsection 82-135(i).

Income Tax Assessment Act 1997 Paragraph 118-37(a).

Income Tax Assessment Act 1997 Subsection 301-20(2).

Income Tax Assessment Act 1997 Section 995-1.

Income Tax (Transitional Provisions) Act 1997 Section 82-10.

Reasons for decision

Summary

The payment is not exempt under the capital gains tax (CGT) provisions as it is assessable as an employment termination payment. The payment made under the Deed is also not a payment for personal injury.

The payment is an employment termination payment as defined under subsection 82-130(1) of the ITAA 1997. The total amount is a taxable component to be included in your income tax return for the 2009-10 income year.

Detailed reasoning

From 1 July 2007 the taxation treatment of payments, made in consequence of the termination of any employment of a taxpayer have changed. Payments, formerly known as eligible termination payments, are now called employment termination payments.

Employment termination payment

From 1 July 2007, payments made in consequence of the termination of a taxpayer's employment are known as employment termination payments.

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

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

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

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 employment; 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.

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 the conditions will result in the payment not being considered an employment termination payment.

Paid as a consequence of the termination of your employment

It should be noted that the phrase 'in consequence of the termination of your employment' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

In Taxation Ruling TR 2003/13 (TR 2003/13) the Commissioner has considered the meaning of the phrase 'in consequence of'.

In paragraph 5 of TR 2003/13 the Commissioner states:

… a payment is made in respect of a taxpayer in consequence of the termination of the employment of the taxpayer if the payment 'follows as an effect or result of' the termination. In other words, but for the termination of employment, the payment would not have been made to the taxpayer.

As further stated by the Commissioner in paragraph 6 of TR 2003/13, there must be:

… a causal connection between the termination and the payment, although the termination need not be the dominant cause of the payment. The question of whether a payment is made in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

The phrase 'in consequence of termination of employment' has been interpreted by the courts in several cases.

Of note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 (McIntosh).

In Reseck Justice Gibbs stated:

Within the ordinary meaning of the words a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination… It is not my opinion necessary that the termination of the services should be the dominant cause of the payment.

While Justice Jacobs stated:

It was submitted that the words 'in consequence of' import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a 'following on'.

In looking at the phrase 'in consequence of' the Full Federal Court in McIntosh considered the decision in Reseck.

Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment.

Suffice it to say that both Courts' views were that for a payment to be made in consequence of the termination of employment it had to follow on as a result or effect of the termination of employment. Additionally, while it is not necessary to show that termination of employment is the sole or dominant cause, a temporal sequence alone would not be sufficient.

Furthermore, in Le Grand v Federal Commissioner of Taxation [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; 2002 ATC 4907; (2002) 51 ATR 39 (Le Grand), the issue before the court was whether an amount received by the applicant as a result of accepting an offer of compromise in respect of claims brought by him against his former employer, in relation to the termination of his employment was in whole, or in part, an ETP. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an ETP.

Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicant's employment and the payment to warrant the finding that the payment was made "in consequence of the termination" of the applicant's employment. I am satisfied that the payment was an effect or result of that termination in the sense that there was a sequence of events following the termination of the employment which had a relationship and connection which ultimately led to the payment.

Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was articulated by Justice Gibbs in Reseck. Thus, for the payment to have been made in consequence of the termination of employment, the payment must follow as an effect or result of the termination of employment. As earlier stated in paragraph 6 of TR 2003/13, there must be 'a causal connection between the termination and the payment even though the termination need not be the sole or dominant cause of the payment'.

The Full Federal Court in Dibb v Federal Commissioner of Taxation [2004] FCAFC 126; (2004) 207 ALR 151; 2004 ATC 4555; (2004) 55 ATR 786, has applied the above decisions in finding that the payment received by the taxpayer under a Deed of Release to settle various causes of action against the employer following the termination of employment was an ETP.

Paragraph 31 of TR 2003/13 the Commissioner states:

It is clear from the decision in Le Grand, that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of the taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

The essence of this analysis is that if the payment follows as an effect or a result from the termination of employment, the payment will be made in consequence of the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135 of the ITAA 1997.

The question of whether a payment is made in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

In the facts of this case, your client was employed by the employer.

Your client suffered an illness through work related incidents while employed by the employer. Your client consulted with a medical practitioner and underwent medical treatment. Your client's condition deteriorated and your client was working less and less days per week.

Your client's treating medical practitioner completed a report based on their medical opinion and advice about your client's health for the employer.

This culminated in the employer and your client signing a Deed of Settlement and Release (the Deed) dated date X. Your client was advised of the terms that the employer proposed in relation to the cessation of your client's employment.

The Deed provided for a list of termination payments including a severance payment that included a number of weeks for payment in lieu of notice. The remainder of the payment equated to a number of weeks salary based on your client's total employment costs.

Your client agreed to settle all claims and all other employment related issues in the terms contained in the Deed and for your client's employment to terminate. However, your client did not relinquish the claim to workers compensation claims that would relate to any injury or illness.

It is clear from the facts provided that the termination payment being made to your client is made as 'in consequence of the termination of employment'. There is still a causal connection between the termination and the payment. The claims, the termination and the payment are all intertwined and connected. Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

The payment is received no later than 12 months after termination

The second condition for the payment to meet the criteria, as an employment termination payment is stated under paragraph 82-130(1)(b) of the ITAA 1997. The payment must be received within 12 months of your termination of employment, unless you are covered by a determination exempting you from the 12 month rule.

The facts of this case show that your client's employment was terminated. Your client mutually agreed with the employer to settle all claims and terminate employment. The termination payment was made to your client a number of days later, which is within 12 months of your client's termination of employment.

Therefore, it is considered that the payment satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997.

The final requirement under paragraph 82-130(1)(c) of the ITAA 1997 is that the payment is not a payment mentioned in section 82-135 of the ITAA 1997.

Exclusions under section 82-135 of the ITAA 1997

Certain payments made on termination of employment are excluded from being an employment termination payment under section 82-135 of the ITAA 1997. These payments include any accrued annual and long service leave and the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments which do not apply to an employment termination payment.

In this case, consideration must be given as to whether the personal injury suffered by your client is covered by the specific exemption for personal injury in subsection 82-135(i) of the ITAA 1997 (payments that are not employment termination payments). This subsection states that employment termination payments do not include:

(i) 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);…

This exclusion is for a payment or benefit that compensates or reimburses the taxpayer for or in respect of the particular injury.

In Commissioner of Taxation (Cth) v. Scully (2000) 201 CLR 148; [2000] HCA 6; 2000 ATC 4111; (2000) 43 ATR 718 (Scully) the High Court, in considering paragraph (n) of the definition of an eligible termination payment (ETP) in former subsection 27A(1) of the ITAA 1936 (paragraph (n)), held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In considering the meaning of personal injury for the purpose of the paragraph (n) exclusion, the AAT has cited Graham v Robinson [1992] 1 VR 279 (Graham v. Robinson), in both Case 11,722 and McMahon v FC of T [1999] AATA 5; (1999) 41 ATR 1056; (1999) 99 ATC 2025 (McMahons Case), and held that personal injury does not extend beyond physical injury or mental illness.

The Victorian Supreme Court had to decide if emotional hurt (that is, hurt, distress, public scandal, hatred, odium, ridicule and contempt) was a personal injury in its decision in Graham v. Robinson, where Smith J stated at 281:

In the absence of express authority, I have come to the conclusion that the expression personal injury does not extend beyond physical injury and mental illness to include emotional hurt. I am encouraged to this view by the fact that the law has rejected grief or sorrow as a form of injury which can be relied on to mount a claim in negligence: Mount Isa Mines Ltd. v. Pusey  (1970) 125 CLR 383, at p. 394 and Jaensch v. Coffey  (1984) 155 CLR 549, at p. 587. It is true that damages are awarded for pain and suffering in the typical personal injury case.  They are awarded, however, where pain and suffering flow from and are connected with physical or mental injury and may therefore be said to be damages in respect of personal injury.

Flowing from these decisions, it can be said that there are three types of injury a person can receive:

- behavioural injury - one that involves physical injury (internal and/or external) and/or mental injury that is clearly discernible to a qualified medical practitioner;

- non-behavioural injury - hurt, distress, anxiety, et cetera., that flows from the death of, or serious injury to, a relative or close friend; wrongful dismissal; defamation; et cetera. This type of injury may have legal remedies under the law of torts (for example, defamation, slander), statute (for example, sexual harassment, discrimination), or contract (for example, employment, professional negligence); and

- property injury - damage to a persons property.

Notwithstanding it may be said all three types of injury may be personal, it is considered only the first type (that is, behavioural injury) falls within the meaning of the term personal injury as used in the paragraph (n) exclusion.

The decision in Graham v. Robinson was applied in McMahons Case in relation to a payment for alleged damage to a taxpayers reputation. In McMahons Case, a critical performance appraisal of McMahon and other comments were published in the media. Subsequent to this, McMahons employment was terminated and it was agreed to pay him certain amounts including an amount for the alleged damage to his reputation. Senior Member Block stated:

26 The tribunal also notes the stipulation in the concluding portion of s27A(1)(n) of the ITAA 1936 that the amount of consideration for personal injury is to be regarded as an ETP only to the extent that it is reasonable having regard to the nature of the injury and the taxpayers capacity to derive income from personal exertion. The tribunal considers that the inclusion by the legislature of the words from personal exertion tends to confirm that the section is intended to exclude from the definition of ETP payments in respect of injuries to the person, where such injuries being physical injuries or mental illnesses which have an assessable and identifiable impact on the capacity of the taxpayer to earn income. The tribunal considers in summary that an injury to person is distinguishable from an injury to a persons reputation.

27 For the Reasons set out previously (and bearing in mind that the decision in Graham v. Robinson is binding on the tribunal), the reputation payment was not made in respect of personal injury within s27A(1)(n) of the ITAA 1936; accordingly the reputation payment was correctly assessable as an ETP.

To reiterate, for an amount to be excluded from the definition of an ETP by virtue of paragraph (n), there must be a behavioural type personal injury.

From 1 July 2007, paragraph (n) has been replaced by subsection 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.

It is therefore appropriate to cite cases that refer to the previous legislation.

The payment in Scully was held not to be in respect of 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 subsection 82-135(i) of the definition of employment termination payment, 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.

In your client's case, the termination payment is a single lump sum payment which bears no relation to a capital payment for, or in respect of, personal injury to your client.

Accordingly, it is considered that subsection 82-135(i) of the employment termination payment definition under section 82-135 of the ITAA 1997 does not apply to the termination payment.

It is clear, therefore, that the requirement in paragraph 82-130(1)(c) of the ITAA 1997 is satisfied in this instance.

Consequently, the payment would be considered to be an employment termination payment as the payment satisfies all the requirements in section 82-130 of the ITAA 1997, and is not specifically excluded under section 82-135 of the ITAA 1997.

Capital gain exemption

The general exemptions provisions (from CGT) are found in Subdivision 118-A of the ITAA 1997. Included amongst them is an anti-overlap provision, section 118-20, which ensures that an amount cannot be assessable under both the CGT provisions and non-CGT provisions. The effect of the provision is to reduce the amount of any assessable capital gain by any amount which is also assessable under non-CGT provisions or by amounts which are exempt income under non-CGT provisions.

Section 118-22 of the ITAA 1997 is a related section, which recognises that a CGT event could give rise to an employment termination payment as well as a capital gain. It ensures that, for the purposes of section 118-20 only, the whole of the payment is included as assessable income.

The combined effect of these two sections is that where a capital payment is assessable under a non-CGT provision (in this case as an employment termination payment) then it is treated as being assessable under that non-CGT provision.

Therefore an employment termination payment is excluded from being a capital gain.

A payment may be disregarded as a capital gain by the operation of section 118-37 of the ITAA 1997 (which replaced former subsection 160ZB(1) of the ITAA 1936 for the 1998-99 and later income years).

In this regard it is relevant to note the following comment made by Senior Member Dwyer of the Administrative Appeals Tribunal (AAT) in AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258 at paragraph 31:

I accept Mr Gibb's submission that if the payment is caught, as I am satisfied it is, by s 27A(1), there is no advantage to the applicant in the fact that it would have been exempt by virtue of s 160ZB(1), if it were not so caught. …

In this case, as the payment is to be included as assessable income because it is an employment termination payment as defined under subsection 82-130(1) of the ITAA 1997, it is to be disregarded as a capital gain under sections 118-20 and 118-22. The fact that the payment may also be disregarded as a capital gain under section 118-37 does not change the fact that it is assessable as an employment termination payment.

Accordingly, no part of the settlement payment is assessable under the CGT provisions because it is included in the taxpayer's assessable income as an employment termination payment.

Taxation of employment termination payments

Employment termination payments cannot be rolled over into a complying superannuation fund, complying approved deposit fund (ADF) or to a retirement savings account (RSA) provider, unless the payment qualifies as a transitional termination payment under section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA).

An employment termination payment made after 1 July 2007 will be comprised of the following components:

Tax fee component this includes the post-June 1994 invalidity or pre-July 83 component (if any); and

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

The taxable component is subject to tax, depending on the person's age, as follows:

* Preservation age is the age at which retirees can access their superannuation benefits. This will be 55 for persons born before 1 July 1960 and between 55 and 60 for persons born after 30 June 1960.

The $150,000 cap on concessionally taxed employment termination payments is indexed annually to average weekly ordinary time earnings.

The taxable components of all life benefit employment termination payments received in an income year are counted towards this cap. Any tax-free amounts are not counted towards the cap.

Your client is under preservation age on the last day of the income year in which the payment is being made. Therefore, as the payment is under the $150,000 cap, the payment will be taxed at a maximum rate of 30% plus Medicare levy.

A tax offset will apply to ensure the amount of tax is not greater than 30% plus Medicare levy in accordance of subsection 301-20(2) of the ITAA 1997.

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