Edited version of private ruling

Authorisation Number: 1011643482083

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Ruling

Subject: Invalidity segment

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 2010.

The scheme commences on:

1 July 2009

Relevant facts and circumstances

Your client is under 55 years of age.

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

There was no date prior to your client client's 65^th birthday on which they were required to retire under the terms and conditions of their employment with the employer.

Your client has sustained a number of injuries over a few years, some of which required surgery.

Your client was not offered redeployment to another suitable position.

A number of Workcover medical certificates, signed by Dr A, state your client's fitness & unfitness for work at different times.

In both medical certificates and medical reports, Dr B certified that your client is suffering from a medical condition which, in his opinion, is likely to result in your client being unsuited for work duties involved with the employer. However, in the report Dr B also certified specific work that your client is able to perform a job for which they are reasonably qualified by education, training or experience.

In a medical report, Dr C certified that your client cannot perform their duties with their then current employer, however, your client is capable to perform specific work.

In both insurance reports, the Doctors certified that your client would be able to do a job for which they are reasonably qualified by education, training or experience, and name the same work.

In a medical certificate, Dr D certified that your client is suffering from a medical condition which, in their opinion, is likely to result in your client being unfit to work in a capacity as an employee with the current employer.

Your client was medically discharged from the employer in the 2009-10 income year.

A letter from the employer, states that your client's partial and permanent disability benefit payment was calculated according to a specified formula unrelated to the severity of the injury sustained.

A 'PAYG payment summary - employment termination payment' issued in the 2009-10 income year from the employer states your client's lump sum wholly comprised a taxable component and tax was withheld from this component.

Prior to joining the employer your client completed a degree at a University.

Your client has not gained any additional qualification since leaving the employer.

Prior to being medically discharged, your client was able to obtain work in the same occupation Doctor B and Doctor C certified your client as being able to perform. This employment was obtained due to his completion of a relevant university qualification obtained prior to joining the employer.

Your client is currently working three full days and two half days a week with their new employer.

Relevant legislative provisions

Income Tax Assessment Act 1936 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 82-150.

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)

Reasons for decision

Summary of decision

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 two medical practitioners certified that, while your client cannot perform their normal duties with the employer, they specified other paid employment that your client is capable of performing, for which your client is reasonably qualified by education, training or experience.

Consequently, it is considered that the requirement concerning medical certificates has not been satisfied, as all the conditions specified must be satisfied for an employment termination payment to contain an invalidity segment.

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. 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:

(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.

Based on the facts provided the Commissioner accepts the payment satisfies all the conditions of an employment termination payment in paragraphs 82-130(1)(a) and (b) of the ITAA 1997.

Exclusions

The termination payment is the result of a calculation of a partial and permanent disability benefit under the Award, 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).

Personal injury exclusion

Paragraph 82-135(i) of the ITAA 1997 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.

Prior to 1 July 1997, 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, 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 is only made if an employee has suffered a disability as a result of an workplace injury and their employment is subsequently terminated. The amount paid as a lump sum is not based on the degree of injury of an employee. The amount is calculated by reference to the age and salary of the employee at the time of their injury.

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 under the Award. 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 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 under the Award.

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:

(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 becoming ill, your client was employed by the employer.

Payment for stopping gainful employment

As stated above, the payment was made to your client because your client's employment as an employee was terminated. Accordingly, this requirement has been satisfied.

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 a number 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 was made before your client's 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, in a number of medical certificates it was certified that your client is suffering from a medical condition which, in the doctor's opinion, is likely to result in your client being unsuited for work duties involved as an employee with the employer.

However, none of these certificates certify that your client is unable to ever be gainfully employed in capacity for which they are reasonably qualified because of education, experience or training.

In particular, it is noted that the medical reports by Dr C and Dr B both certify that, while your client is unable to perform work as an employee with the employer, they consider that your client will be able to do a job for which they are reasonably qualified because of education, training or experience, and specify that that job.

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

The opinion of both these doctors has been bourn out by the fact that your client is currently working for three full and two half days a week in the vocation they specified.

Conclusion

The partial and permanent 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 2009-10 income year.

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