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Authorisation Number: 1011527061079

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Ruling

Subject: Employment Termination Payment - Invalidity Segment

Question:

Is any portion of the payment received by your client exempt from tax as an invalidity segment of an employment termination payment in accordance with section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes

This ruling applies for the following period:

Year ended 30 June 2008

The scheme commenced on:

1 July 2007

Relevant facts:

Your client is under 55 years of age.

Your client commenced employment with the employer a number of years ago.

Prior to commencing work with the employer, your client was employed part-time in another field of work.

Your client has a history of previous injuries.

Your client sustained a further injury during the period of the employment with the employer.

Your client was deemed permanently unfit to perform their duties with the employer and was not offered other placement positions with the employer.

Two qualified medical practitioners have certified, in two medical certificates that your client is suffering from a medial condition which, in their opinion, is likely to result in your client being unable ever to be employed in any form of employment for which your client is reasonably qualified by education, training and experience.

A further report from the employer's representative stated that your client is not medically or psychologically fit for the full range of duties of the substantive position on a permanent basis. In addition, it states that your client is not psychologically fit for alternative duties or a return to work plan with the employer.

Your client was medically discharged from the employer in the 2007-08 income year.

A PAYG payment summary - employment termination payment shows that the payment is a transitional termination payment comprised wholly of a taxable component and there was tax withheld.

The payment was made in the 2007-08 income year.

Accrued annual leave was excluded from the employment termination payment.

Your client's last retirement date under normal conditions would have been at age 65.

Your client has not been employed or pursued any studies, courses or training since the discharge from the employer.

Your client was a member of a superannuation fund (the Fund).

Your client received a superannuation lump sum payment from the Fund and there was tax withheld.

This ruling is given on the basis of the facts stated in the description of the scheme as set out above. Any material variation from these facts (including any matters not stated in the description above and any departure from these facts) will mean that the ruling will have no effect. No entity will then be able to rely on this ruling as the Commissioner will consider that the scheme has been implemented in a way that is materially different from the scheme described.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 995-1.

Income Tax Assessment Act 1997 Section 82-130.

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 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 82-140.

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

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

Income Tax Assessment Act 1936 Section 27G.

Reasons for decision

Summary

The payment is an employment termination payment which includes an invalidity segment under section 82-150 of the ITAA 1997 as:

· the payment is made to your client because they stopped being gainfully employed;

· your client stopped being gainfully employed because they suffered from ill-health;

· your client's employment stopped before they last retirement day; and

· two legally qualified medical practitioners have certified that, because of ill-health, it is unlikely that your client can ever be gainfully employed in a capacity for which they are reasonably qualified because of education, experience or training.

The tax free invalidity segment of the payment received by your client in the 2007-08 income year is worked out by applying the formula in subsection 82-150(2) of the ITAA 1997.

As the payment is a transitional termination payment and your client was under preservation age when the payment was made, the excess amount will be taxed at a maximum rate of 30% plus any Medicare levy and, if applicable, Medicare levy surcharge.

Detailed reasoning

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

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.

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:

(a) it is received by you:

(i) in consequence of the termination of your employment; or

(ii) after another person's death, in consequence of the termination of the other person's employment; and

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

(c) 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 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.

Payment is received in consequence of the termination of employment

The first condition to be met is that there must be a 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 an injury. The employer's health consultant compiled a health assessment from a number of medical reports. Retirement on medical grounds was recommended to the employer who approved your client's termination of employment and the payment of a partial and permanent disability benefit under the Award.

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 is considered to be received 'in consequence of' the termination of your client's employment. Accordingly, the condition in subparagraph 82-130(1)(a)(i) of the ITAA 1997 is satisfied.

Payment is received no later than 12 months after the termination

The second condition for the payment to meet the criteria, as an employment termination payment stated under paragraph 82-130(1)(b) of the ITAA 1997, is that the employment termination payment was paid to the taxpayer no later than 12 months after their employment was terminated.

From the facts of this case your client terminated employment during the2007-08 income year and the employment termination payment summary issued in the 2007-08 income year states that the payment was made in the 2007-08 income year.

As a result, 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.

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 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 (ITAA 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) Act 2007 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) 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 'for, or in respect of, personal injury'.

While it was held that the payment was 'consideration' within the broad sense of that term, 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 be excluded from being an employment termination payment under 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 in the letter that the payment was calculated in accordance with the Death and Disability Award (the Award). Payments under the Award are made where an employee has suffered an on duty injury and their employment is subsequently terminated.

The amount paid was determined under the Award. The amount is calculated by reference to the age and salary of the employee at the time of the injury.

Consequently, the level of incapacity is irrelevant as to the amount received under the Award. The only criterion is that the employee has suffered an injury and cannot be redeployed elsewhere within the organisation.

The lump sum payment is a capital payment for, or in respect of your client's termination of employment and your client's rights under the Award, not a capital payment 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 her 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.

In addition, the Commissioner accepts that the payment is a transitional termination payment under section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA).

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.

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 your client became ill your client was gainfully employed on a full-time basis with 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 satisfies 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 in 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 during the 2007-08 income year after the representative of the employer stated that your client is permanently unfit for the full range of duties of the position of an employee with the employer. 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 the taxpayer's last retirement date.

The payment was made in the 2007-08 income year when your client was under 55 years of age well before the 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 at the time of termination 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 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) Act 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 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, after examining the contents of the medical reports provided it is considered that there are two reports that satisfy the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997.

Two qualified medical practitioners have certified in two medical certificates, that your client is suffering from a medical condition which, in their opinion, is likely to preclude your client from ever being able to be employed again in a capacity for which they are reasonably qualified by education, training or experience.

As two medical practitioners have provided certificates that attests to your client's being unable to ever be employed in a capacity for which they are reasonably qualified because of education, training or experience, it is considered that the final condition of subsection 82-150(1) of the ITAA 1997 has been satisfied.

Tax exemption for an invalidity payment

Under section 82-140 of the ITAA 1997 the invalidity segment included in an employment termination payment is tax free.

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

· Tax free component this includes any invalidity segment and pre-July 83 segment; and

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

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:

Amount of employment termination payment	x	Days to retirement
		Employment days + Days to retirement

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.

Conclusion

The employment termination payment paid to your client by the employer satisfies all the requirements of subsection 82-150(1) of the ITAA 1997.

This invalidity segment is included in the employment termination payment and it is tax free. The remaining portion is a taxable component of a life benefit termination payment to be included in your income tax return for 2007-08 income year.

As the payment is a transitional termination payment and your client was under preservation age when the payment was made, the excess amount will be taxed at a maximum rate of 30% plus any Medicare levy and, if applicable, Medicare levy surcharge.

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