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Ruling

Subject: Employment termination payment

Question 1

Is the payment made under a Deed of Release an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

2011-12 income year.

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You were employed by the Employer on a probationary basis in the 2011-12 income year.

In early 2012, your employment ceased with the Employer.

In the 2011-12 income year, a Deed of Release (the Deed) was made.

The Employer agreed to a gross amount less any tax withheld upon cessation of your employment and subject to the terms and conditions under the Deed.

A pay advice shows a Life Benefit ETP with tax withheld was made to you.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-10(3)

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Subsection 82-130(1)

Income Tax Assessment Act 1997 Subsection 82-130(2)

Income Tax Assessment Act 1997 Section 82-135

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

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 995-1

Income Tax (Transitional Provisions) Act 1997 Section 82-10

Reasons for decision

Summary

The amount paid to you is a taxable component of an employment termination payment to be included in your assessable income for the 2011-12 income year.

It does not meet the requirements to be a payment for 'personal injury' and therefore is not 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:

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

(c) it is not a payment mentioned in section 82-135.

Subsection 82-130(2) of the ITAA 1997 states:

A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies.

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.

To determine if the payment constitutes 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 three conditions will result in the payment not being considered an employment termination payment. Furthermore, any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule.

Essentially, section 82-130 of the ITAA 1997 states that for a payment to be a life benefit termination payment, it must be made to the taxpayer in consequence of the termination of their employment.

Paid as a consequence of the termination of your 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 Taxation Ruling TR 2003/13 the Commissioner has considered the meaning of the phrase 'in consequence of'.

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 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.

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 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.

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.

In the facts of this case, you were employed by the Employer.

In a Deed of Release (the Deed), it was agreed between both parties of the cessation of your employment with the Employer and a settlement of all claims whatsoever arising out of, and in connection with, the course of your employment.

The Employer agreed to pay you a gross sum subject to the terms and conditions under the Deed. This amount did not include any notice by way of salary or leave entitlements, which were calculated and paid separately.

Therefore, it was agreed that the Employer would make a payment to you to settle all claims arising out of your termination of employment.

It is clear from the facts provided that the termination payment being made to you is made as 'in consequence of the termination of employment'. There is a causal connection between the termination and the payment. The claims, the termination and the payment are all intertwined and connected. Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been 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 payment must be received within 12 months of your termination of employment, unless you are covered by a determination exempting you from the 12 month rule.

The termination payment was made to you within the 12 months of your termination of employment.

Therefore, it is considered that the payment satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997.

The final requirement under paragraph 82-130(1)(c) of the ITAA 1997 is that the payment is not a payment mentioned in section 82-135.

Exclusions under 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 parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments which do not apply to an employment termination payment.

In this case, consideration must be given as to whether paragraph 82-135(i) of the ITAA 1997 will exclude the payment from being an employment termination payment. Paragraph 82-135(i) 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.

In Commissioner of Taxation (Cth) v. Scully (2000) 201 CLR 148; [2000] HCA 6; (2000) 2000 ATC 4111; (2000) 43 ATR 718 (Scully) the High Court, in considering former paragraph (n) of the definition of an eligible termination payment (ETP) in former subsection 27A(1) of the Income Tax Assessment Act 1936 (ITAA 1936) (former 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 Administrative Appeals Tribunal (AAT) has considered the meaning of personal injury for the purposes of the former paragraph (n) exclusion in AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258, McMahon v Commissioner of Taxation (Cth) [1999] AATA 5; (1999) 41 ATR 1056; (1999) 99 ATC 2025 (McMahon) and, more recently, in Re Applicant and Federal Commissioner of Taxation [2005] AATA 583; (2005) 2005 ATC 162; [2006] ALMD 8399; (2005) 59 ATR 1161. In these cases, the decision by the Victorian Supreme Court in Graham v Robinson [1992] 1 VR 279 (Graham v. Robinson) was cited and in each case it was held that personal injury does not extend beyond physical injury or mental illness.

In Graham v. Robinson the Victorian Supreme Court had to decide if emotional hurt (that is, hurt, distress, public scandal, hatred, odium, ridicule and contempt) was a personal injury. In that case Justice Smith stated at 281:

In the absence of express authority, I have come to the conclusion that the expression personal injury does not extend beyond physical injury and mental illness to include emotional hurt. I am encouraged to this view by the fact that the law has rejected grief or sorrow as a form of injury which can be relied on to mount a claim in negligence: Mount Isa Mines Ltd. v. Pusey  (1970) 125 CLR 383, at p. 394 and Jaensch v. Coffey  (1984) 155 CLR 549, at p. 587. It is true that damages are awarded for pain and suffering in the typical personal injury case.  They are awarded, however, where pain and suffering flow from and are connected with physical or mental injury and may therefore be said to be damages in respect of personal injury.

Flowing from these decisions, it can be said that there are three types of injury a person can receive:

(a) behavioural injury - one that involves physical injury (internal and/or external) and/or mental injury that is clearly discernible to a qualified medical practitioner;

(b) non-behavioural injury - hurt, distress, anxiety, et cetera., that flows from the death of, or serious injury to, a relative or close friend; wrongful dismissal; defamation; et cetera. This type of injury may have legal remedies under the law of torts (for example, defamation, slander), statute (for example, sexual harassment, discrimination), or contract (for example, employment, professional negligence); and

(c) property injury - damage to a person's property.

Notwithstanding it may be said all three types of injury may be personal, it is considered only the first type (that is, behavioural injury) falls within the meaning of the term personal injury as used in the former paragraph (n) exclusion.

The decision in Graham v. Robinson was applied in McMahon in relation to a payment for alleged damage to a taxpayer's reputation. In McMahon, a critical performance appraisal of McMahon and other comments were published in the media. Subsequent to this, McMahon's employment was terminated and it was agreed to pay him certain amounts including an amount for the alleged damage to his reputation. Senior Member Block stated:

26 The tribunal also notes the stipulation in the concluding portion of s27A(1)(n) of the ITAA 1936 that the amount of consideration for personal injury is to be regarded as an ETP only to the extent that it is reasonable having regard to the nature of the injury and the taxpayers capacity to derive income from personal exertion. The tribunal considers that the inclusion by the legislature of the words from personal exertion tends to confirm that the section is intended to exclude from the definition of ETP payments in respect of injuries to the person, where such injuries being physical injuries or mental illnesses which have an assessable and identifiable impact on the capacity of the taxpayer to earn income. The tribunal considers in summary that an injury to person is distinguishable from an injury to a persons reputation.

27 For the Reasons set out previously (and bearing in mind that the decision in Graham v.  Robinson is binding on the tribunal), the reputation payment was not made in respect of personal injury within s27A(1)(n) of the ITAA 1936; accordingly the reputation payment was correctly assessable as an ETP.

To reiterate, for an amount to be excluded from the definition of an ETP by virtue of former paragraph (n), there must be a behavioural type personal injury.

From 1 July 2007, former paragraph (n) has been replaced by paragraph 82-135(i) of the ITAA 1997.

Whilst the wording of the new provision differs slightly from the wording contained in former paragraph (n), the operation of the new provision remains the same. This is illustrated by the following statement made in the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006, in relation to section 82-135 of the ITAA 1997:

consistent with current legislation, certain payments are prevented from qualifying as employment termination payments.

Further, section 1-3 of the ITAA 1997 states:

(1) This Act contains provisions of the Income Tax Assessment Act 1936 in a rewritten form.

(2) If:

(a) that Act expressed an idea in a particular form of words; and

(b) this Act appears to have expressed the same idea in a different form of words in order to use a clearer or simpler style;

the ideas are not to be taken to be different just because different forms of words were used.

In light of the foregoing it is clear that cases that refer to the previous legislation can be cited with approval in relation to the new provisions.

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 be excluded 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, you were in receipt of the gross payment. You agreed to the terms and conditions under the Deed to settle all claims which you may have had against the employer in respect of any claim whatsoever arising out of and in connection with the employment and its cessation.

The amount made to you as a lump sum amount is a single undissected lump sum payment and was not calculated by reference to the nature and extent of injuries or its likely effect on your capacity to derive income from personal exertion. No consideration was given to injuries in determining the level of payment. In other words, the payment was to settle all claims you may have had against the employer and terminate employment rather than to compensate for injuries and any subsequent loss of earning capacity.

The payment is clearly not for, or in respect of, personal injury.

Therefore, as paragraph 82-135(i) of the ITAA 1997 does not apply, the requirement in paragraph 82-130(1)(c) is satisfied.

Consequently, the payment is considered to be an employment termination payment as the payment satisfies all the requirements in section 82-130 of the ITAA 1997, and is not specifically excluded under section 82-135.

Tax treatment of an employment termination payment

An employment termination payment made after 1 July 2007 will be comprised of the following components:

· Tax fee component - this includes the post-June 1994 invalidity or pre-July 83 component (if any); and

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

The taxable component is subject to tax, depending on the person's age, as follows:

* Preservation age is the age at which retirees can access their superannuation benefits. This will be 55 for persons born before 1 July 1960 and between 55 and 60 for persons born after 30 June 1960.

The $140,000 cap on concessionally taxed employment termination payments is indexed annually to average weekly ordinary time earnings. For the 2011-12 income year, the cap is $165,000.

The taxable components of all life benefit employment termination payments received in an income year are counted towards this cap. Any tax-free amounts are not counted towards the cap.

In this case, you are under the preservation age on the last day of the income year in which the payment was made. Therefore, the payment is a taxable component of an employment termination payment and included in your assessable income for the 2011-12 income year.

As the payment is under the ETP cap of $165,000, you are entitled to a tax offset that ensures that the rate of income tax on the amount does not exceed 30% in accordance with subsection 82-10(3) of the ITAA 1997. In addition, the Medicare levy may apply.

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