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Ruling

Subject: Lump sum payments by an employer to employee

Question 1

Will the lump sum payment to be received by the rulee be ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the lump sum payment be an employment termination payment under Division 82 of the ITAA 1997?

Answer

Yes

Question 3

Will the lump sum payment be statutory income under section 15-2 of the ITAA 1997?

Answer

Yes, however because the payment will represent an employment termination payment the exception in paragraph 15-2(3)(a) of the ITAA 1997 applies.

Question 4

If the lump sum payment will be an employment termination payment under Division 82 of the ITAA 1997, will it be an exempt capital payment for, or in respect of personal injury under section 82-135 of the ITAA 1997?

Answer

No

Question 5

If the lump sum payment will result in CGT event C2 happening, will any capital gain be disregarded on the basis that the payment is compensation received for a wrong, injury or illness under section 118-37(1) of the ITAA 1997?

Answer

No

This ruling applies for the following period

1 July 2009 to 30 June 2015

The scheme commenced on

1 July 2009

Relevant facts

The rulee is an employee and due to the nature of the employment duties, the rulee is required to hold a licence issued by a relevant authority. The terms of his employment were set out in a bargaining Agreement (the Agreement). The Agreement provided that where the relevant licence was cancelled or not renewed for medical reasons, the employer would pay either monthly payments, or a lump sum payment (where the employee was unlikely to recover from the condition within a certain period).

The rulee developed a medical condition which resulted in him being unfit to hold the licence, which was cancelled by the authority. There is no suggestion that the medical condition is work related.

As a result of the cancellation of the rulee's licence he was unable to perform his duties and his employment was terminated by the employer.

Historically, the rulee and other similar employees typically insured themselves for loss of licence benefits to provide for monthly benefits and lump sum benefits similar to what is now provided for in the Agreement. The rulee is in the latter category.

During industrial negotiations the employer agreed to maintain an insurance plan covering all of its employees, and to pay the premiums. The various policies held by the employer indemnified the employer against its obligations to provide loss of licence benefits (the benefit payments) to employees.

In recent years the employer has discontinued with the insurance policy and has self-funded the benefit payments to its employees, where it is provided for in the Agreements.

The employment Agreement and the Policy were provided with this application, and although the policy is no longer in existence it is appended to the Agreement to set out the terms and conditions of the benefit payments.

The schedule of benefit payments are appended to the Agreement, and which show the lump sums payable based on the age of the employee, years of service and the position held. An indexation factor applies to increase the benefit payments applicable in each year.

A Deed between the rulee and the employer was sent to the rulee however the rulee has not yet executed the Deed.

The Deed sets out all of the benefits to be paid to the employee by the employer, and sets out the benefits will be payable once the deed is signed, including unused leave entitlements that will be included in the final termination pay.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 15-2

Income Tax Assessment Act 1997 Subsection 15-2(3)

Income Tax Assessment Act 1997 Paragraph 15-2(3)(a)

Income Tax Assessment Act 1997 Division 82

Income Tax Assessment Act 1997 Section 83-130

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

Income Tax Assessment Act 1997 Section 118­20

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Subsection118-37(1)

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Subsection 104-25(2)

Income Tax Assessment Act 1997 Division 110

Income Tax Assessment Act 1997 Division 112

Income Tax Assessment Act 1936 Subsection 27A(1)

Reasons for decision

Note that unless otherwise stated, all references are to the Income Tax Assessment Act 1997 (ITAA 1997).

Question 1

Will the lump sum payment to be received by the rulee be ordinary income under section 6-5?

Detailed reasoning

Subsection 6-5(2) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

· Are earned;

· Are expected;

· Are relied upon; and

· Have an element of periodicity, recurrence or regularity.

While the rulee's entitlement to the lump sum payment arises from the employment Agreement with the employer, it is not earned by the taxpayer as it does not directly relate to services performed. The payment is not a reward for the performance of any services by the rulee. Rather it relates to personal circumstances that have arisen during the rulee's life.

The lump sum payment is also a one-off payment and thus does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation and reliance only arises after a process has taken place involving a number of steps, including:

· the employee contracts a medical condition which prevents them from performing their employment duties

· as a result the employee loses their licence

· a claim is submitted, followed by a rigorous claims process

· the employee's employment is terminated, and

· the lump sum payment is made to the employee.

Conclusion

Having regard to the manner in which the rulee becomes eligible for and will ultimately be paid the lump sum payment we consider that the amount is not assessable income under section 6-5.

Question 2

Will the lump sum payment be an employment termination payment under Division 82?

Detailed reasoning

Subparagraph 82-130(1)(a)(i) states:

A payment is an employment termination payment if:

A payment is an employment termination payment if:

(a) it is received by you:

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

Made 'in consequence of' termination of employment

Both paragraph (a) of the definition of ETP under former subsection 27A(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and the definition of employment termination payment under subparagraph 82-130(1)(a)(i) of the ITAA 1997 require that the payment be made 'in consequence of' termination of employment.

The phrase 'in consequence of' is not defined in either the ITAA 1936 or the ITAA 1997. However, the words have been interpreted by the courts in several cases. The Commissioner has also issued Taxation Ruling TR 2003/13 which discusses the meaning of the phrase.

The Full High Court considered the expression 'in consequence of' in Reseck v Federal Commissioner of Taxation (1975) 133 CLR 45; (1975) 6 ALR 642; (1975) 49 ALJR 370; (1975) 5 ATR 538; (1975) 75 ATC 4213 (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 v Federal Commissioner of Taxation (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 (McIntosh) considered the decision in Reseck. Justice Brennan stated:

Though Jacobs J. speaks in different terms, his meaning may not be significantly different from the meaning of Gibbs J. ... His Honour denies the necessity to show that retirement is the dominant cause, but he does not allow a temporal sequence alone to suffice as the nexus. Though the language of causation often contains the seeds of confusion, I apprehend his Honour to hold the required nexus to be (at least) that the payment would not have been made but for the retirement.

In the same case, Justice Lockhart stated:

In my opinion, although the phrase is sufficiently wide to include a payment caused by the retirement of the taxpayer, it is not confined to such a payment. The phrase requires that there be a connection between the payment and the retirement of the taxpayer, the act of retirement being either a cause or an antecedent of the payment. The phrase used in section 26(d) is not 'caused by' but 'in consequence of'. It has a wider connotation than causation and assumes a connection between the circumstance of retirement and the act of payment such that the payment can be said to be a 'following on' of the retirement.

The Courts have held that settlement amounts arising from actions that are in some way connected with the termination of employment are ETPs.

The Federal Court in Le Grand v Commissioner of Taxation (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 139; [2002] FCA 1258; (2002) 124 FCR 53 (Le Grand) held that an amount received for settlement of the claim for misleading and deceptive conduct did not break the causal relationship that existed between the termination of the applicant's employment and the payment of the offer of compromise. The decisions in Reseck and McIntosh were applied with Justice Goldberg stating:

I do not consider that the issue can simply be determined by seeking to identify the "occasion" for the payment. The thrust of the judgments in Reseck and McIntosh is rather to the effect that a payment is made "in consequence" of a particular circumstance when the payment follows on from, and is an effect or result, in a causal sense, of that circumstance. The passages in the judgments to which I referred earlier make this clear. They also make it clear that there need not be identified only one circumstance which gives rise to a payment before it can be said that the payment is made "in consequence" of that circumstance. The passages to which I have referred make it clear that it can be said that a payment may be made in consequence of a number of circumstances and that, for present purposes, it is not necessary that the termination of the employment be the dominant cause of the payment so long as the payment follows, in the causal sense referred to in those judgments, as an effect or result of the termination.

The Full Federal Court in Dibb v Commissioner of Taxation (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126 (Dibb) 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.

The Commissioner in TR 2003/13 considered the phrase 'in consequence of' as interpreted by the Courts. Paragraph 5 of TR 2003/13 states:

… the Commissioner considers that 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.

While paragraph 31 of TR 2003/13 goes on to say:

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.

While a payment may be made for a number of reasons, including out of court settlement or compensation, if the payment follows as an effect or a result of the termination of employment it will be paid 'in consequence' of the termination.

There is also a broader view of the meaning of 'in consequence of the termination of employment'. Paragraph 29 of TR 2003/13 provides that a payment will be in consequence of the termination of employment if the termination is either a cause of the payment or an antecedent event.

A lump sum payment will be assessable as an employment termination payment unless specifically excluded under section 82-135.

In the present issue the employer was until recent times, paying a premium to an insurer to indemnify it against a loss arising from its employer obligation to provide benefit payments, as agreed, to particular employees which occur during the period of insurance. It is a condition of employment under the employment Agreement that the employer maintain this insurance plan.

Employees whose licence is cancelled, suspended or renewal refused for medical reasons, were eligible for a lump sum payment under the Policy.

The Policy did not stipulate there to be a termination of employment in order to be eligible for the benefit. However, clause 26.6.2 of the Agreement links the termination of the individual's employment with the payment of the lump sum payment

An individual may meet the conditions to be eligible for a lump sum, however there was no mention in the Policy when the benefit payment is to be made. It was the employer who determines when the payment is made and the conditions that apply for the payment.

After the expiry of the most recent insurance policy, the employer has been funding the benefit payments. While the Policy is no longer current, the Agreement still has the Policy appended to it for reference purposes. The employer makes the lump sum payments to eligible employees in accordance with the terms of the Policy.

In this case the rulee terminated his employment on medical grounds. He was issued with a Deed of Release shortly afterwards, but has not yet executed it. He has not yet been paid the lump sum, in accordance with the Deed, the amount will not be paid until the Deed is executed by the rulee and returned to the employer.

Not withstanding that the termination of employment occurred in an earlier year to the present year, under the as yet unsigned Deed there is a nexus between the lump sum payment and the termination of employment, therefore, the lump sum payment will be made in 'consequence of the termination of employment' of the rulee.

Conclusion

As payment of the lump sum will be made in 'consequence of the termination of employment', the payment will be an employment termination payment under section 82-130.

Question 3

Will the lump sum payment be statutory income under section 15-2?

Detailed reasoning

The most recent High Court authority on section 15-2 was Smith v FCT (1987) 164 CLR 513; 87 ATC 4883. That decision dealt with the former subsection 26(e) of the ITAA 1936 which substantially became section 15-2.

The wording of 15-2 is potentially very wide and the courts have sought to delineate its application. In Smith a majority of 3 to 2 held that an honorarium paid to a bank employee on successfully completing an external course of study in a way that met the requirements of the bank's study incentive program fell within the scope of section 26(e) and so was assessable (Wilson, Brennan and Toohey JJ, Deane and Gaudron dissenting). Discussion in both the majority and dissenting judgements is useful in considering this scenario.

Wilson J said:

The paragraph will be attracted if the benefit bears the necessary relation either to the employment of the taxpayer or to services rendered by the taxpayer.

Also:

Toohey J. finds it helpful to ask whether the benefit allowed, given or granted is a consequence of the employment of the taxpayer. ... So do I. I also find it helpful to ask whether the benefit is a product or incident of the employment ….

And finally:

… the benefit is the product of a scheme embodied in the rules of the bank, and administered within that organization, designed to encourage not only the efficiency of employees within it but to provide them with the incentive to advance their prospects of promotion within the bank. In my view, the requirement of a relationship between the benefit and the employment necessary to attract the provisions of sec. 26(e) is satisfied.

In short, although the benefit was paid voluntarily, Wilson J found it was still sufficiently related to the employment. Note that the loss of licence payments by the employer in this case are not voluntary, they arise from the employment Agreement and are therefore a contractual right. The payments have a stronger connection to the employment than in Smith.

Brennan J directly made the observation that a contractual right was a circumstance where a connection to the employment can more readily be discerned. He said:

The difficulty is the greater when the allowance is paid not in discharge of a legal obligation but voluntarily. … If an allowance is paid under a contract between the payer and the taxpayer, the consideration for the payment is usually decisive of the matter.

The circumstances of Smith did not involve a contractual right to payment. Nevertheless in that case Brennan J also found that the requirements of subsection 26(e) were still met:

The relationship between the employment of the appellant and the payment of the allowance was substantial. In my opinion, the employment was a direct cause of the payment. It follows that the allowance was paid "in consequence of" the employment, and thus was paid "in respect of ... or in relation ... to" the employment.

From this it seems likely that Brennan would have had no difficulty in coming to the same decision in Smith if the benefit was provided as part of the employment contract.

Likewise Toohey J was able to find in Smith:

There was an evident connection between the appellant's employment and the sum he received. And in a very real sense the payment was a consequence of the existing relation of employer and employee.

Gaudron J, in her dissenting judgement (with which Deane agreed) came to a different view in Smith because she thought the connection between the benefit and the employment was not sufficiently proximate:

But the motivation of the bank in establishing and maintaining the policy does not provide any relevant causal link between the employment of the taxpayer and the making of any particular payment. The proximate cause of that payment is the successful completion of a subject or a course of study. Less proximate causes of the payment include the employee's undertaking the requisite course work, and enrolling in the course of study. Still less proximate is the existence of the bank's policy under which payments are made. The fact that the policy exists because of the advantages to the bank in having suitably qualified employees does not serve, in my view, to make the payment a payment made in consequence of the relation of employer and employee ….

Earlier she had distinguished the benefit from "a condition of the relation of employer and employee". This strongly suggests that her decision would have been different if the benefit was required to be paid as part of the employment contract.

In summary, if Smith supports the assessability of a voluntary payment by an employer to an employee for completing certain studies, the case is even stronger for a benefit provided under an obligation of the employment Agreement.

The entitlement to a lump sum payment by an employee arises from the collective employment Agreement. It is effectively a term of the employment contract and no different to the employees' entitlement to salary or sick leave. It falls within the words of section 15-2 because it is within the meaning of "… allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment …."

The outcome would almost certainly be different if the payment came to the rulee as a result of an insurance policy held by him personally, as the connection to employment would be substantially removed. The Commissioner's view on these arrangements is contained in Income Tax ruling IT 2230. It states at paragraph 6:

The lump sum benefits were payments made once and for all in consequence of the loss of the contributor's capital asset, his licence to fly, and were of a capital nature.

However in this case, the rulee does not hold an insurance policy, he has rights under his employment agreement for the employer to maintain the insurance plan. However since the most recent insurance policy expired the employer has borne the cost of the benefit payments. As such the employer will be making a lump sum payment to an employee, or former employee in accordance with the employer's obligations under the employment agreement.

Consequently, the lump sum payment will be assessable under section 15-2 unless an exception applies.

Subsection 15-2(3) states that the value of the following (among others) are not included in your assessable income under this section:

(a) a *superannuation lump sum or an *employment termination payment;

(b) an *unused annual leave payment or an *unused long service leave payment;

(c) a *dividend or *non-share dividend;

(d) an amount that is assessable as *ordinary income under section 6-5;

Where the lump sum payment represents an employment termination payment, it is not assessable under section 15-2 due to the exception in paragraph 15-2(3)(a).

Conclusion

The lump sum payment will be assessable under section 15-2 unless an exception applies. Where the lump sum payment represents an employment termination payment, it is not assessable under section 15-2 due to the exception in paragraph 15-2(3)(a).

Question 4

If the lump sum payment will be an employment termination payment under Division 82, will it be an exempt capital payment for, or in respect of personal injury under section 82-135?

Detailed reasoning

Subsection 82-130(1) describes the type of payment that is an employment termination payment, and specifies that it is not a payment mentioned in section 82­135.

Section 82-135 provides a list of payments that are not employment termination payments, relevantly paragraph (i) which describes a payment that is:

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);

If the lump sum payment is a capital payment for a personal injury, then it will be excluded from being an employment termination payment. In these circumstances the lump sum payment will fall for consideration under section 15-2, because the exception for employment termination payments as contained in paragraph 15-2(3)(a) would not apply.

Taxation ruling TR 95/35 contains the Commissioner's view on the capital gains tax treatment of compensation receipts. It states at paragraph 219:

'Injury' is not defined in Part IIIA. Most of the case law in this area considers the meaning of the word 'injury' in the context of a person's working environment. The term is generally defined in the legislative enactments and in a number of jurisdictions the definition includes 'disease'. The key phrase in early workers' compensation legislation was personal injury by accident'. No reference was made to 'disease'. However, in interpreting the meaning of 'injury' the Courts included 'disease' (for example, Innes or Grant v. G&G Kynoch (1919) AC 765; Martin v. Manchester Corporation (1912) 106 LT 741; 28 TLR 344.)

Consequently, we consider that a disease or medical condition falls within the definition of 'personal injury'.

By virtue of having a certain medical condition, the rulee was declared medically unfit to perform their employment activities, and his licence was cancelled.

The Policy contains the conditions to be met for payment of capital benefits, and clauses in the Policy confirm that the purpose of the policy is to indemnify the employer against its obligation to provide loss of licence benefits to employees.

Although the Policy has expired and was not replaced, the Agreement states that the Policy is appended for reference purposes only. The individual's eligibility for the lump sum payment and the amount of the payment is determined in accordance with the Policy.

The severity or nature of the illness is not a factor that is considered in determining the individual employee's eligibility for the payment, except that it must result in the loss of licence. Under the Policy, the amount of the lump sum payment is calculated by reference to the seniority and years of service and not by reference to the severity of the illness or the loss of income earning capacity.

The various clauses in the Agreement and the Policy confirm that the capital benefits are payable to compensate the employee for the loss of licence, and not for the medical condition or illness itself. Therefore we consider that the lump sum payment is not a capital payment for a personal injury, and the exception in section 82-135 does not apply.

Conclusion

As a result of the rulee's licence being cancelled on medical grounds, he became entitled to make a claim for the lump sum payment. However the rulee's entitlement to a lump sum payment arises from the loss of licence and not for any illness or injury. Consequently, section 82-135 does not apply to except the payment from being an employment termination payment.

Question 5

If the lump sum payment will result in CGT event C2 happening, will any capital gain be disregarded on the basis that the payment is compensation received for a wrong, injury or illness under subsection 118-37(1)?

Detailed reasoning

The rulee's entitlement to receive a lump sum payment is a CGT asset under subsection 108-5(1) being a right that is acquired when his application for the payment is approved.

CGT event C2 under section 104-25 happens when the rulee's entitlement to receive the payment is satisfied. The time of the CGT event under subsection 104­25(2) is when the payment is made.

The rulee will make a capital gain from the event if the amount of the lump sum payment exceeds his cost base which is calculated under Division 110 as modified by Division 112.

Subsection 118-37(1) provides that any capital gain or loss is disregarded from a CGT event relating to one of ten items listed. Of relevance in this case are the first two paragraphs:

· compensation or damages you receive for any wrong or injury you suffer in your occupation;

· compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally;

Any resultant capital gain is not disregarded under paragraph 118-37(1)(a) because the money the employee receives is not paid to compensate for any violation or infringement of their rights suffered in their employment, nor is it paid to compensate them for any physical or mental damage they suffer to their person in their employment. In contrast, the proceeds are received for the loss of a licence as distinct from any underlying illness or injury.

Paragraph 118-37(1)(b) also does not apply to the lump sum payment, as the amount is not paid to compensate the rulee for any wrong, illness or injury suffered by him or his relative. As discussed in question 4, both the Policy document and the Agreement confirm that the rulee's entitlement to the lump sum payment arises from his loss of licence on medical grounds, and not from the illness or medical condition directly.

Consequently any capital gain or loss made by the rulee on the happening of CGT event C2 is not disregarded under subsection 118-37(1).

However as it is our view that the lump sum payments are assessable under section 82­130 as an employment termination payment, the anti-overlap rule in section 118­20 will apply to reduce any capital gain the rulee may make from CGT event C2 happening.

Conclusion

Subsection 118-37(1) does not apply to disregard any capital gain the rulee may make from CGT event C2 happening, when his right to the lump sum payment is satisfied. However to the extent that the payments are assessable income the capital gain would be reduced by the anti-overlap rule in section 118-20.

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