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Ruling

Subject : Employment termination payments - exempt from CGT

Questions

Is the ex-gratia payment to be received under a Settlement and Release Agreement in the 2011-12 income year an employment termination payment under subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Is the payment in lieu of notice to be received under a Settlement and Release Agreement in the 2011-12 income year an employment termination payment under subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

Yes.

Yes.

This ruling applies for the following period

Year ending 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

Your client is over their preservation age.

Your client has agreed to resign from their position pursuant to the terms of the Settlement & Release Agreement between your client's employer (the Employer) and your client (the Agreement).

In recognition of your client's service with the Employer and the Agreement, the Employer agreed to provide your client with an ex-gratia payment equivalent.

The Agreement goes on to state that your client releases the company from any claims arising out of, or related to their employment and the termination of that employment (ie the resignation).

Your client will provide the Employer a letter of resignation effective immediately within seven days of the date of the Agreement. The Employer will make a payment including the ex-gratia payment and the payment in lieu of notice within 14 days of the date of the Agreement being returned.

The Agreement has not yet been signed.

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 Section 82-135.

Income Tax Assessment Act 1997 Subsection 82-135(e).

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Summary:

The ex-gratia payment and payment in lieu of notice to be received by your client is an employment termination payment as:

· the payment has been made in consequence of the termination of your client's employment; and

· the payment is received no later than 12 months after termination; and

· no part of the payment is a payment that would be excluded from being an employment termination payment.

Detailed reasoning:

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 of the ITAA 1997.

Subsection 82-130(1) of the ITAA 1997 states that:

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 that termination (but see subsection (4)); and

· it is not a payment mentioned in section 82-135.

An employment termination payment, where the payment is made during the life of a taxpayer, is known as a life benefit termination payment (subsection 82-130(2) of the ITAA 1997).

To determine if the ex-gratia payment and payment in lieu of notice to be received from your client's employer (the Employer) is an employment termination payment all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

Failure to satisfy any of the conditions will result in the payment not being considered an employment termination payment.

Paid as a consequence of the termination of employment

It should be noted that the phrase 'in consequence of the termination of your employment' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

In light of these decisions, the Commissioner discusses the meaning of the phrase in Taxation Ruling TR 2003/13 titled Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of' (TR 2003/13).

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) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 (Reseck) and 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).

In 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 in 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 considered the decision in Reseck. Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment.

Suffice it to say that both Courts' 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.

Furthermore, in Le Grand v. Federal Commissioner of Taxation [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39 (Le Grand), the issue before the court was whether an amount received by the applicant as a result of accepting an offer of compromise in respect of claims brought by him against his former employer, in relation to the termination of his employment was in whole, or in part, an ETP. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an ETP.

Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicant's employment and the payment to warrant the finding that the payment was made 'in consequence of the termination' of the applicant's employment. I am satisfied that the payment was an effect or result of that termination in the sense that there was a sequence of events following the termination of the employment which had a relationship and connection which ultimately led to the payment. True it is that the payment was made not only to settle the applicant's claim for common law damages for breach of the employment agreement but also for statutory damages...

Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was articulated by Justice Gibbs in Reseck. Thus, for the payment to have been made in consequence of the termination of employment, the payment must follow as an effect or result of the termination of employment. As earlier stated in paragraph 6 of TR 2003/13, there must be 'a causal connection between the termination and the payment even though the termination need not be the sole or dominant cause of the payment'.

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

Paragraph 31 of TR 2003/13 the Commissioner states:

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.

The essence of this analysis is that if the payment follows as an effect or a result of 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. The termination of the payment need not be the sole or dominate cause of the payment.

The question of whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case.

In this case, your client has agreed to resign from their position pursuant to the terms of the Settlement & Release Agreement between the Employer and your client (the Agreement).

In recognition of both your client's service with the Employer and your client entering into the Agreement, the Employer agreed to provide your client with an ex-gratia payment.

The Agreement goes on to state that your client releases the Employer from any claims arising out of, or related to their employment and the termination of that employment (ie the resignation).

Consequently, it is clear that the ex-gratia payment and the payment in lieu of notice will be made in consequence of the termination of your client's employment. The termination of employment and the payments are all intertwined and connected.

Because the payment is considered to be received by your client in consequence of the termination of their employment, the requirement under subparagraph 82-130(1)(a) of the ITAA 1997 has been met.

The payment is received no later than 12 months after termination

The second condition is stated under paragraph 82-130(1)(b) of the ITAA 1997. The payment must be received within 12 months of the employee's termination of employment, unless the payment is covered by a determination exempting them from the 12 month rule.

Your client will provide the Employer a letter of resignation effective immediately within seven days of the date of the Agreement. The Employer will make a payment including the ex-gratia payment and the payment in lieu of notice within 14 days of the date of the Agreement being returned, ie within 12 months after the termination of your client's employment. Therefore, the requirement of paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied.

Not a payment mentioned in section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 lists payments that are not employment termination payments. These include (among others):

· superannuation benefits;

· unused annual leave or long service leave payments;

· foreign termination payments covered under Subdivision 83-D of the ITAA 1997; and

· the tax free part of a genuine redundancy payment or an early retirement scheme payment.

The ex-gratia payment and the payment in lieu of notice are not payments that would be excluded from being an employment termination payment.

Tax Treatment of the payment as a Life Benefit Termination Payment (LBTP):

An employment termination payment will comprise of the following components:

Tax free component - this includes the pre-July 83 segment (if any) and/or the invalidity segment (if any); and

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

The tax free component is not assessable income and is not exempt income. The taxable component is included, in full, as assessable income.

The taxable component is subject to tax, depending on the person's age when the payment is received.

Where a taxpayer is over their preservation age, the taxable component of the LBTP is taxed at 15% plus Medicare levy for amounts below the employment termination payment cap of $165,000 for the 2011-2012 income year, and at the top marginal rate for the amount above this cap.

The taxable components of all LBTPs received in an income year, or in respect of the same termination of employment, are counted towards this cap. Any tax-free amounts are not counted towards the cap.

Your client's preservation age is 55 as they were born before 1 July 1960. Consequently, both the payment in lieu of notice and the ex-gratia payment are subject to tax of 15% plus the Medicare levy.

Employment termination payments cannot be rolled over into a complying superannuation fund, complying approved deposit fund (ADF) or to a retirement savings account (RSA) provider.

Further issues for you to consider

Section 118-20 of the ITAA 1997 exempts from CGT a capital gain from a CGT event that is included in an individual's assessable income under a provision of the ITAA 1997. Section 118-22 of the ITAA 1997 states that in applying section 118-20 of the ITAA 1997 an employment termination payment that an individual receives is treated as being included in their assessable income.

As your client's ex-gratia payment and payment in lieu of notice are employment termination payments, the payments are exempt from CGT.

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