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Ruling

Subject: Employment termination payment

Question:

Is the settlement payment received by you an employment termination payment?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You commenced employment with your employer (the Employer) in the 2004-05 income year.

In the 2009-10 income year your employment was terminated as a result of involuntary redundancy.

You state that your employment was terminated under a particular clause of an employment agreement (the Agreement) which stated amongst other matters, that the clause relates to situations where an employee's job is still required and the employee will be replaced subsequent to action under the clause.

In the 2010-11 income year you received an employment termination payment (ETP) from the Employer. The ETP comprised wholly of a taxable component from which tax was withheld.

You subsequently made a claim with an authority alleging your dismissal by the Employer was 'Harsh, Unjust and Unreasonable' within the meaning of an Act.

A settlement was subsequently entered between you and the Employer (collectively referred to the 'parties') as shown in a deed (the Deed).

In the Deed the Employer denied the allegation but the parties agreed to settle the matter as follows:

(a) the Employer would pay you a lump sum amount (the Payment) which would be taxed as an employment termination payment,

(b) the Payment would be made shortly after the Deed was signed;

(c) the Employer would soon after signing the Deed provide you a written statement of service which also stated the reason your employment was terminated;

(d) upon receipt of the Payment and the written statement you would:

(i) release and forever discharge the Employer from any liability past, present or future from all claims arising out of your employment with the Employer, including the cessation of that employment; and

(ii) lodge a Notice of Discontinuance.

(e) the Employer would release you from any claim arising out of or connected with your employment with the Employer;

(f) each party would undertake that neither would make any disparaging comments about the other in terms of their employment relationship;

(g) the agreement shall remain confidential but can be disclosed to other entities under certain circumstances; and

(h) nothing in the terms of settlement release the Employer from any liability to you arising under any law relating to workers compensation.

In the 2010-11 income year you received the Payment from the Employer in accordance with the Deed. The Payment was treated as an ETP and wholly comprised a Taxable component from which tax was withheld.

Subsequent to the Payment being made this affected payments you were receiving from a government agency (the Agency).

You sought a review from the Agency in relation to how the Payment affected the payments made by the Agency.

As a result of the review it was ultimately decided by a Tribunal (the Tribunal), which had authority to review decisions made by the Agency, that:

(i) the Payment should not affect the payments made by the Agency, and

(ii) the Payment was not considered a termination payment for the purposes of the legislation under which the Agency made payments to you.

Your below your preservation age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 1-3

Income Tax Assessment Act 1997 Subsection 82-10(2).

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.

Acts Interpretation Act 1901 Section 15 AC

Taxation Administration Act 1953 Section 357-85 in Schedule 1

Reasons for decision

Summary

The settlement payment you received from your former Employer is an employment termination payment (ETP) for income tax purposes as:

(i) it was made in consequence of your termination of employment; and

(ii) satisfies all the other conditions in the income tax legislation for it to be treated as an ETP.

Detailed reasoning

Employment termination payment

A payment made to an employee is an employment termination payment (ETP) if the payment satisfies all the requirements in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997) and is not specifically excluded under section 82-135.

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 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.

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.

· capital payments for personal injury.

In consequence of the termination of your employment

In determining whether a payment is an ETP the first condition requires that the payment is received by the employee in consequence of the termination of their employment.

The phrase 'in consequence of' is not defined in 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 (TR 2003/13) which discusses the meaning of the phrase.

Many of the court cases and TR 2003/13 discuss 'in consequence' in relation to payments which were formerly known as 'eligible termination payments'. (that is, payments made prior to 1 July 2007 under Subdivision AA of Division 2 of the Income Tax Assessment Act 1936 (ITAA 1936)).

Notwithstanding the legislative changes use a different style and forms of words, it should be noted that this does not necessarily mean rewritten tax provisions are to be viewed differently to the old provisions where the ideas remain the same (section 15AC of the Acts Interpretation Act 1901 and section 1-3 of the ITAA 1997).

Further, a public or private ruling about a provision of the ITAA 1936 is also taken to be a ruling about the corresponding provision of the ITAA 1997, such as the case of eligible termination payments and employment termination payments, so far as the provisions express the same ideas (section 357-85 in Schedule 1 to the Taxation Administration Act 1953).

Accordingly, it should be noted that 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.

In paragraph 6 of TR 2003/13, the Commissioner recognises that:

The phrase requires 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.

As previously mentioned 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 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 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 of the ITAA 1997.

In your case, you were employed with the Employer until your employment was terminated in the 2009-10 income year.

Shortly after your employment was terminated, a lump sum payment was paid to you as an ETP by the Employer.

Subsequent to your termination of employment, you entered into legal proceedings as you alleged the Employer was 'Harsh, Unjust and Unreasonable' within the meaning of an Act.

In the 2010-11 income year you received, in accordance with a settlement deed (the Deed), an additional lump sum payment (the Payment) from the Employer.

Though the Payment made to you resulted from a claim you made as a result of legal proceedings, it is considered that the Payment was inconsequence of your termination of employment as indicated by paragraphs 31, 32, 47 and 48 in TR 2003/13 which relate to 'Settlement of litigation proceedings.'

Paragraphs 31 and 32 in TR 2003/13 state:

31. 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.

32. The Federal Court in Raymond Joseph Dibb v. FC of T adopted the approach of Goldberg J in Le Grand. At issue was whether a payment received by the taxpayer under a deed of release, following the settlement of Federal Court proceedings against his former employer, was an ETP. In deciding the payment was an ETP, Heery J held that the length of time between the termination of employment, the commencement of court proceedings and payment following settlement did not sever the causal connection between the termination and the payment. It was sufficient that the subject matter of the litigation was the termination. Heery J found at 296 that:

'The various causes of action whether breach of contract, conspiracy, breach of fiduciary duty or contravention of the Trade Practices Act were, as Goldberg J would say (Le Grand at [36]), 'interwoven and intertwined' with the termination. The payment was a consequence of the settlement, which was a consequence of the Federal Court proceeding, which in turn was a consequence of the termination.'

Paragraphs 47 and 48 in TR 2003/13 provide an example, relevant to your case, which state:

47. Fred Brown was dismissed from his employment. He believed that he had been treated unjustly and took legal action against his former employer for unfair dismissal. Approximately 18 months later, Fred and his former employer agreed to an out of court settlement and a lump sum was paid to Fred soon after.

48. The payment was made in consequence of the termination of employment. Although the dominant cause of the payment was the claim brought by Fred against his former employer, there is still a causal connection between the termination and the payment of the settlement. But for the termination of employment, Fred would not have brought legal action against his former employer. The legal action, the termination and the payment are intertwined.

Notwithstanding you had received a prior ETP payment from the Employer, it should be noted that that payment does not negate the Payment from being 'in consequence of the termination of employment' as:

(i) TR 2003/13, and particularly paragraphs 31, 32, 47 and 48 in that Ruling, show the Payment made in March 2011 was made in consequence of your termination of employment; and

(ii) there is nothing in the income tax legislation to indicate there being a limit on the number of payments that an employer can make in relation to the termination of an employee's employment.

In view of above, the Payment made to you under the Deed is considered to be 'in consequence of the termination of employment.'

Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

Payment received no later than 12 months after termination

In addition to meeting the other conditions for a payment to be an ETP, paragraph 82-130(1)(b) of the ITAA 1997 specifies that the 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 shown in the facts, your employment was terminated in the 2009-10 income year and the Payment was made to you within 12 months of your termination of employment.

Accordingly, as the Payment was made within 12 months of the termination of your employment, the requirement in paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied.

A payment mentioned in section 82-135 of the ITAA 1997

As previously mentioned, section 82-135 of the ITAA 1997 excludes certain payments from being an ETP. These payments include:

· a payment for unused annual leave

· a payment for unused long service leave

· the tax-free part of a genuine redundancy payment

· capital payments for personal injury.

In your case, the facts provided, and the discussion below in relation to whether any part of the Payment is a genuine redundancy payment (GRP), show that the Payment did not include any of the payments mentioned in section 82-135 of the ITAA 1997 which would preclude any part of the payment from being an ETP.

The provision which relates to whether any part of a payment constitutes a GRP is section 83-175 of the ITAA 1997. For a payment to be a GRP, all the conditions in section 83-175 need to be satisfied.

The Commissioner has also issued Taxation Ruling TR 2009/2 (TR 2009/2) which discusses GRPs and provides guidelines in relation to sections 83-170 and 83-175 of the ITAA 1997.

Without going into all of the requirements of section 83-175 of the ITAA 1997, it should be noted that one of the major requirements is that the termination of employment is a dismissal caused by redundancy.

TR 2009/2 discusses 'Dismissal caused by redundancy' as follows:

23. ….dismissal is a particular mode of employment termination. Section 83-175 further requires that the dismissal be caused by redundancy of the employee's position, and not for some other reason.

24. As is the case in determining if there is a dismissal, the reason for a dismissal is to be established in light of the facts and circumstances of each case. The redundancy of the relevant position must be the prevailing or most influential reason for the dismissal if there is more than one contributing cause.

25. An employee's position is redundant when an employer determines that it is superfluous to the employer's needs and the employer does not want the position to be occupied by anyone. Accordingly, it is fundamentally the employer's decision that a position is redundant. On occasion the decision may be unavoidable due to the circumstances surrounding the employer's operations.

28. A dismissal is not caused by redundancy where personal acts or default are the prevailing or most influential cause for the termination. For example, a person may be dismissed due to unsatisfactory performance or behaviour.

Though your termination of employment was the result of an involuntary redundancy, it should be noted that this does not equate to your position being made redundant for the purposes of subsection 83-175(1) of the ITAA 1997.

The facts in your case show that the termination of your employment was made under a particular clause of an employment agreement (the Agreement) which stated amongst other matters, that the clause relates to situations where an employee's job is still required and the employee will be replaced subsequent to action under the clause.

In light of paragraph 25 in TR 2009/2 and the clause in the Agreement, it can be seen that your position with Employer was not terminated due to redundancy for the purposes of subsection 83-175(1) of the ITAA 1997 as the position has not abolished and the Employer intended to place someone else in the position.

Accordingly, as one of the requirements for a GRP has not been satisfied, no part of the Payment can be treated is a GRP.

Consequently, it is considered that the Payment is not of a type mentioned in section 82-135 of the ITAA 1997.

Conclusion:

The Payment received by you is an ETP as it satisfies all of the conditions in section 82-130 of the ITAA 1997.

An employment termination payment may comprise of a:

· Tax free component - as provided in section 82-140 of the ITAA 1997, this includes an invalidity segment within the meaning of section 82-150 of the ITAA 1997 (if any) and/or a pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997 (if any); and

· Taxable component - the amount remaining after deducting the tax free component from the total payment, as prescribed in section 82-145 of the ITAA 1997.

As shown in the facts, the Payment does not contain an invalidity segment within the meaning of section 82-150 of the ITAA 1997 but is comprised wholly of a taxable component.

Subsection 82-10(2) of the ITAA 1997 provides that the taxable component of a life benefit termination payment (LBTP), which the Payment in your case satisfies, is assessable income. Accordingly, it is included in your income tax return for the 2010-11 income year.

In relation to the rate of tax that applies to the Payment, subsection 82-10(3) of the ITAA 1997 specifies that a taxable component is subject to tax and the rate applied depends on the recipient's age.

As you are less that your preservation age, the Payment has been taxed at a maximum rate of 30% plus Medicare levy. Accordingly, the tax which the Employer withheld from the Payment is correct.

Further to the above, it should be noted the fact that the Payment was not considered to be a termination payment by the Tribunal does not change or affect the above decision.

The tax treatment of the Payment is a matter determined by the Commissioner of taxation through the administration of the Income Tax Legislation (the ITAA 1936, ITAA 1997 and its regulations).

In the case of the Tribunal's decision, the matter it determined was whether the Payment was a termination payment in relation to how it affected payments made to you by the Agency. This is a matter which, as stated by the Tribunal took into account the relevant legislation, that is the legislation under which the review was made and that under which the Agency payments are made. As such, the Tribunal's decision has no bearing on the taxation treatment of the Payment.

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