Edited version of private ruling

Authorisation Number: 1011510992558

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Ruling

Subject: Invalidity segment - partial and permanent incapacity payment

Question

Is any part of the partial and permanent disability benefit payment received by your client exempt from tax as an invalidity segment of an employment termination payment under section 82-150 of the Income Tax Assessment Act 1997?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 2008.

The scheme commences on:

1 July 2007.

Relevant facts and circumstances

Your client was employed on a part-time basis with the Employer.

Your client was injured during training with the Employer.

Your client was not offered redeployment to another suitable position or an administrative officer position, as these were not available from the Employer.

A medical certificate from a medical practitioner certified that your client is suffering from a medical condition which, in his opinion, is likely to result in your client being unable ever to be employed in a capacity for which they are reasonably qualified by education, training or experience.

A medical certificate from a second medical practitioner certified that your client is suffering from a medical condition which, in his opinion, is likely to result in your client being unable ever to be employed in a capacity that they were holding with the Employer, for which they are reasonably qualified by education, training or experience.

A medical certificate signed by a medical practitioner indicated that your client is fit for suitable duties for a specific period of time after the injury.

A medical certificate signed by a medical practitioner indicated that your client is fit for suitable duties for a specific period of time after the injury.

Prior to joining the Employer, your client was employed in mostly casual or temporary positions in other industries. Your client also completed a number of training courses.

Your client obtained a number of qualifications and training after their employment terminated with the Employer.

There is no time prior to your client reaching 65 years of age, where their employment would have been terminated under the terms and conditions of their employment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 27A(1).

Income Tax Assessment Act 1997 Section 27G.

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 82-150.

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 Section 995-1.

Reasons for decision

Summary

The partial and permanent disability benefit payment your client received is considered to be an employment termination payment as it was received in consequence of your client's termination of employment with the Employer.

However, no part of the employment termination payment is considered to be an invalidity segment as it is considered that the requirement concerning medical certificates has not been satisfied.

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

Section 995-1 of the 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 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.

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

· payments 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 three conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. Any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates.

An employment termination payment is paid in consequence of the termination of the taxpayer's 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 employment of the taxpayer.

In this case, it is considered that the payment was made in consequence of the termination of your client's employment. Your client was unable to continue work due to their injury and their employer, after taking into account a recommendation received, retired your client on the grounds of incapacity. The employer also approved your client's payment of a disability benefit.

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.

Therefore, the payment satisfies that first condition under subparagraph 82-130(1)(a)(i) of the ITAA 1997.

The payment is received no later than 12 months after the termination

Paragraph 82-130(1)(b) of the ITAA 1997 requires that the employment termination payment be paid to the taxpayer no later than 12 months after their employment was terminated.

The facts of this case show that the payment was received within 12 months of the termination and therefore satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997.

Exclusions

The termination payment is the result of a calculation of a partial and permanent disability benefit and is unconnected with payments for your client's other entitlements.

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 your client's employment termination payment.

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

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

From 1 July 2007, paragraph (n) 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.

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

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 in 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.

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 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.

In this case, your client was advised that a payment made is only made if an employee has suffered a disability as a result of an on duty injury. The amount paid as a lump sum is not based on the degree of injury of the employee.

Consequently, as seen in the calculation of your client's benefit payment in a letter provided, the level of incapacity is irrelevant as to the amount received. The only criterion is that the employee has suffered an injury and cannot be redeployed elsewhere by the Employer.

The lump sum payments are consideration for, or in respect of the employee's termination of employment and the employee's rights, and not consideration for, or in respect of the employee's injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss to the employee. In other words, the payment is to compensate the employee for the loss of their 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.

Therefore, the payment that your client received from the Employer is not excluded under paragraph 82-130(1)(c) of the ITAA 1997.

Invalidity segment

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

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

An employment termination payment includes an invalidity segment if:

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

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

· the gainful employment stopped before the person's last retirement day; and

· 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.

Gainful employment

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 by the Employer.

Payment for stopping gainful employment

As stated above, the payment is considered to be a payment made on the termination of your client's employment as it satisfied the conditions under subparagraph 82-130(1)(a)(i) of the ITAA 1997.

The employment termination occurred because of the ill-health of the taxpayer

The requirement under paragraph 82-150(1)(b) of the ITAA 1997 is that the termination of employment resulted from the taxpayer's ill health, that is, the ill health was the immediate cause for the termination of the taxpayer's employment.

In this case, the facts show the termination of employment occurred after the Employer took into consideration of the medical reports, which indicated your client was unable to resume normal work due to his disability. Therefore, it is considered that this requirement is satisfied.

The termination of employment of the taxpayer occurred before the last retirement date in relation to the employment.

To qualify as an invalidity component, a payment must be made before a taxpayer's last retirement date. The payment to your client was made before their retirement age of 65. Therefore, the condition in paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied.

Certification from 2 legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed.

In respect of this requirement, it must be demonstrated that the disability was such that:

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.

Therefore, paragraph 82-150(1)(d) of the ITAA 1997 requires that there must be the likelihood that the disability of the taxpayer will preclude the taxpayer from ever being employed in a role, for which the taxpayer is reasonably qualified.

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, section 27G of the Income Tax Assessment Act 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 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.

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, would not now satisfy the condition in paragraph 82-150(1)(d) of the ITAA 1997, which is the rewritten provision for section 27G of the ITAA 1936.

However, the use of the term 'appropriate employment' in the EM suggested the intention that the term 'reasonably qualified' be interpreted as meaning neither over nor under qualified to any significant extent.

Even if a taxpayer's employment is terminated by reason of disability, this does not mean that the second part of the 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 or 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, a medical practitioner certified in a medical certificate that your client is suffering from a medical condition which, in his opinion, is likely to result in your client being unable ever to be employed in a capacity for which they are reasonably qualified by education, training or experience.

In a separate medical certificate, another medical practitioner certified that your client is suffering from a medical condition which, in his opinion, is likely to result in your client being unable ever to be employed in a capacity that they were in with the Employer, for which he is reasonably qualified by education, training or experience.

The certificate from this medical practitioner only certifies that your client is unable to perform work as an employee with the Employer. He did not certify that your client would ever be able to be employed in any paid employment.

In respect of medical certificates, Senior Member Pascoe of the Administrative Appeals Tribunal (AAT) made the following comment in Re Pitcher & Federal Commissioner of Taxation [2004] AATA 218; (2004) 2004 ATC 2042; (2004) 55 ATR 1056; [2005] ALMD 1372 (Re Pitcher), stating that the certification in the case, pursuant to sub-subparagraph 27G(b)(i)(B), was:

…provided after Mr Pitcher had already been in full-time employment. Dr Wood stated that Mr Pitcher "will never be fit for employment" after he had been employed for 1 year with him undertaking full-time employment some 6 months after the report. At the time of Mr Warne's report, Mr Pitcher was in full-time employment and had been in that same employment for 2 years.

In considering the taxpayers cross-appeal against this finding made by the AAT, Justice Ryan of the Federal Court stated in Commissioner of Taxation v. Pitcher [2005] FCA 1154; (2005) 2005 ATC 4813 (Pitcher) that:

It is true that the expression have certified in [sub-subparagraph 27G(b)(i)(B)] is in the perfect tense. However the time at which the use of that tense signifies that the certificates must have issued is not when the termination payment was made but when it fell to be characterised as an invalidity payment in relation to the taxpayer...

I accept, as the Tribunal appeared also to accept, that s 27G reposes in the medical practitioners, not the Commissioner, the attainment of the requisite satisfaction that the taxpayer is unable to be likely ever to be employed in a relevant capacity. However, it remains a question of fact for the Commissioner or the Tribunal whether the two medical certificates on their face have properly answered the question posed by s 27G(b)(i)(B). On my reading of the two certificates in this case, I entertain considerable doubt whether that has occurred.

In the context of the decisions in both Re Pitcher and Pitcher, it follows that for the purposes of paragraph 82-150(1)(d) of the ITAA 1997, the time at which both of these medical certificates must have issued to your client in relation to the payment of $61,615 is no later than when the Commissioner considers your client's invalidity, ie at the time of making this private ruling.

However, it is also clear that where the facts of the case contradict the wording in a medical certificate the Commissioner must determine whether the certificate satisfies the requirements of sub-subparagraph 27G(b)(i)(B) of the ITAA 1936 and paragraph 82-150(1)(d) of the ITAA 1997.

While the medical practitioner certified in a medical certificate that your client, in his opinion, is suffering from a medical condition that is likely to result in being unable ever to be employed in the capacity for which they are reasonably qualified, he stated in a later medical certificate that your client is fit for suitable duties for a specified period of time. This is supported by a recent medical certificate, where a different medical practitioner made a similar opinion in regards to your client's fitness for work for another specified period of time.

It is clearly evident from the above mentioned medical reports that a number of medical practitioners have no doubt that your client is able to engage in employment other than the duties they had with the Employer.

It should be noted that where additional education, training or experience are acquired between the time of an injury and the time a medical certificate intended to satisfy paragraph 82-150(1)(d) of the ITAA 1997 is prepared, the preparing medical practitioner must take them into account in making their declaration in the same way they must take into account all the employment training and experience acquired by the taxpayer, and not just that relating to the employment in which they were injured.

Furthermore, it is also noted that your client attended a number of courses prior to their employment with the Employer. After the termination of their employment, your client continued to pursue further training and accreditations, some related to their pre-employment training. This suggests that your client may be considering a different career path, which must be taken into account by any medical practitioner when certifying your client's ability to work in the future.

Even though the taxpayer in this case has not performed any work since leaving the Employer, on the basis of the content of the medical certificates provided by the two medical practitioners, alongside the other medical certificates provided, it is considered that these certificates do not meet the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997.

Conclusion

The disability benefit payment received by your client from the Employer satisfies all three conditions pursuant to subsection 82-130(1) of the ITAA 1997. Therefore, the payment is considered as an employment termination payment.

The employment termination payment paid to your client by the employer does not satisfy all the requirements under subsection 80-150(1) of the ITAA 1997. Consequently no part of the payment is considered to be an invalidity segment for the purposes of subsection 82-150(1) of the ITAA 1997.

Accordingly, the entire amount is a taxable component of an employment termination payment to be included in your client's income tax return for the 2007-08 income year.

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