Edited version of private ruling

Authorisation Number: 1011589320648

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: Assessability of lump sum settlement payment

1. Is the lump sum settlement payment an employment termination payment under section-82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

2. Is the lump sum settlement payment taxable as a capital gain?

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commenced on:

1 July 2009

Relevant facts:

You were employed by the employer prior to your resignation.

You lodged complaints against the employer with Equal Opportunity and Human Rights Commission (EOC).

The matter, in relation to your complaints, was settled with a Conciliation Agreement (the Agreement).

The Agreement was signed by you, the employer and the EOC at various times during the latter half of the income year.

The Agreement indicates that, without any admission of liability, the employer agreed to pay you a gross lump sum settlement payment comprising of long service leave, annual leave and an ex-gratia payment.

The Agreement also indicates that settlement does not preclude you exercising your rights under the Accident Compensation Act 1985.

In consideration of receiving the gross payment, you agreed to submit a letter of resignation on signing this agreement.

You submitted your resignation letter in accordance with the Agreement, and consequently received the payment within 12 months of your resignation.

A PAYG payment summary - employment termination payment was issued by the employer during the income year. It discloses that the ex-gratia payment was made as an employment termination payment and comprised a taxed element of a taxable component and total tax withheld on that amount.

Relevant legislative provisions:

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 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 Subsection 82-130(2)

Income Tax Assessment Act 1997 Section 82-135

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

Income Tax Assessment Act 1997 Section 118-37

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

The ex-gratia payment, which you received within 12 months of your termination of employment, is an employment termination payment, as it was made in consequence of the termination of your employment and is not a payment which is excluded from being an employment termination payment.

As the ex-gratia payment needs to be included in your assessable income as an employment termination payment, it does not need to be considered under the capital gains tax (CGT) provisions.

Detailed reasoning

Employment termination payment

From 1 July 2007 the taxation treatment of payments made in consequence of the termination of any employment of a taxpayer changed. These payments, formerly known as eligible termination payments, are now called employment termination payments. Where the payment is made during the life of a taxpayer the employment termination payment is known as a life benefit termination payment (subsection 82-130(2) of the ITAA 1997).

Section 995-1 of the 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:

(a) it is received by you:

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

(ii) after another persons death, in consequence of the termination of the other persons 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.

Payment is made 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 employment of the taxpayer.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the Commissioner has issued Taxation Ruling TR 2003/13 which discusses the meaning of the phrase.

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) 133 CLR 45; 75 ATC 4213; (1975) 5 ATR 538 (Reseck) and the Full Federal Court in McIntosh v. Federal Commissioner of Taxation 79 ATC 4325; (1979) 10 ATR 13 (McIntosh).

Both Court's 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.

Therefore, 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.

In your case, you were employed by the employer prior to your resignation.

You lodged complaints against the employer with the EOC.

The matter was settled with an Agreement in which, without any admission of liability, the employer agreed to pay you a gross lump sum settlement payment, including an ex-gratia payment.

In return of receiving the gross payment, you agreed to submit a letter of resignation on signing this agreement.

You terminated the employment from the employer in accordance with the Agreement, and consequently received the payment.

It is evident that your complaint against the employer in the EOC related to the period of your employment and the lump sum settlement payment was received as a result of you reaching a settlement with the employer.

The ex-gratia payment is conditional upon you tendering your resignation. The termination and the payment, therefore, are intertwined and connected. You were not entitled to receive the payment unless you provided a letter of resignation to the employer.

As a result, the ex-gratia payment was received in consequence of the termination of your employment, and the requirement under paragraph 82-130(1)(a) of the ITAA 1997 is 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 settlement payment must be received within 12 months of the employee's termination of employment, unless they are covered by a determination exempting them from the 12 month rule.

As noted above, the Agreement was signed by the parties at various times, and the payment was made by the employer within 12 months of your resignation.

The settlement payment was received no later than 12 months after your termination of employment with the employer. Therefore, the requirement under subparagraph 82-130(1)(b) of the ITAA 1997 is met.

Not a payment mentioned in 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 part of a genuine redundancy payment or an early retirement scheme payment.

In this instance, the long service leave payment and annual leave payment you received as part of the lump sum settlement payment are excluded from the termination payment.

Furthermore, consideration must be given as to whether the specific exemption for personal injury in paragraph 82-135(i) of the ITAA 1997 applies, which 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 a person for or in respect of a particular injury.

In Federal Commissioner of Taxation v. Scully (2000) 201 CLR 148; 2000 ATC 4111; (2000) 43 ATR 718 (Scully) the High Court, in considering former paragraph (n) of the definition of an eligible termination payment in subsection 27A(1) of the Income Tax Assessment Act 1936 (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.

From 1 July 2007, paragraph (n) was 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.

As both paragraphs require that a payment must have regard to the nature of the personal injury and its affect on a person's capacity to derive income from personal exertion, it is considered appropriate to cite cases that refer to the previous legislation in respect of these phrases.

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, a 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 case, the Agreement does not document any details of your personal injury, or consideration details on how the ex-gratia payment was made for, or in respect of your personal injury.

In addition, the Agreement states that employer made the gross settlement payment 'without any admission of liability', and the settlement does not preclude you exercising your rights under the Accident Compensation Act 1985.

In light of the facts above, the ex-gratia payment is consideration for, or in respect of:

· your agreement to the termination of your employment, and

· your agreement not to institute any further proceedings in respect of your allegations,

and is not consideration for, or in respect of any injury you suffered.

The ex-gratia payment was not calculated by reference to the nature and extent of any personal injury, or your loss of income producing capacity. Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the ex-gratia payment made to you.

Therefore, the ex-gratia payment is not a payment mentioned in paragraph 82-130(1)(c) of the ITAA 1997.

To conclude, as all the conditions in section 82-130 of the ITAA 1997 have been satisfied, the ex-gratia payment is an employment termination payment.

Taxation ruling IT 2424

You consider that the ex-gratia payment is a compensation payment in regards to your complaints and it is not liable to income tax in accordance with Paragraph 8 of Taxation Ruling IT 2424 (IT 2424), which states:

On the other hand a payment to compensate for personal injury, injury to feelings, humiliation, embarrassment, depression, anxiety, etc. is not liable to income tax.

However, as explained above, the ex-gratia payment is not considered to have been made to compensate you for any injury, even though the Agreement was reached in relation to your complaints.

It should also be noted that paragraph 9 of IT 2424, which should be read in conjunction with paragraph 8, states that consideration of whether such a payment is an eligible termination payment need also be made.

In your case, there was no finding made in respect of your claims, as you agreed to a settlement, rather than have your claims heard before the EOC.

In this respect, paragraph 4 of IT 2424 states that:

Where a settlement is reached between the parties involved in the dispute or where the Commission finds a complaint of discrimination to be substantiated it is usual for the employer to take action to redress the loss or damage suffered by the employee as a result of the discriminatory conduct. The employer may agree to or be ordered to engage or reinstate the employee, to eliminate discriminatory terms or conditions of employment, to cease engaging in discriminatory or harassing behaviour or to pay compensation for any loss or damage suffered by the employee.

However, the agreement signed by you and the employer makes no reference to redressing discriminatory practices, reinstatement, or acknowledging you have suffered any loss.

It is considered that because your agreement does not include an admission of liability by the employer, or clearly states that the payment was compensation in respect of your claims, IT 2424 does not apply.

Tax Treatment of the ex-gratia payment

The Commissioner states in paragraph 6 of TR 2003/13 that the phrase 'in consequence of' indicates a causal connection between the termination and the payment, and the termination need not be the dominant cause of the payment.

In this case, while there may have been other causes of your entitlement to the ex-gratia payment, the receipt is conditional upon you tendering your resignation, therefore there is a causal connection between the termination and the payment.

As the payment is linked to the termination of employment, it will be paid in consequence of the termination and will be an employment termination payment unless specifically excluded.

As an employment termination payment, the ex-gratia payment wholly comprises a taxable component, and needs to be included in your assessable income for the 2009-10 income year.

Capital gains tax

Section 118-37 of ITAA 1997 provides CGT exemptions on compensation receipts. Section 118-20 of the ITAA 1997 recognises that a capital gain you make from a CGT event can be reduced if, because of the event, a provision of this Act includes an amount, for any income year in your assessable income.

As noted above, the ex-gratia payment you received is an employment termination payment, and needs to be included in your assessable income. Therefore, that payment does not need to be considered under the CGT provisions.

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).