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Ruling

Subject: Settlement payment made under a deed of release

Question 1

Is the settlement payment made to you under a deed of release an employment termination payment (ETP)?

Answer

Yes.

Question 2

Is the payment subject to Capital Gains Tax?

Answer

No.

This ruling applies for the following periods

Year ending 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

Your employment with the Employer was terminated during the 2011-12 income year.

During the 2012-13 income year, you signed a Deed of Release (the Deed) with the Employer.

The dispute covered by the Deed, concerned an application to Fair Work Australia alleging unfair dismissal and underpayment.

Under the Deed, the Employer agreed to make a payment to you in return for discharge from all claims, suits, demands, and actions arising or connected with your employment.

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

The Employer stated on the Deed that without admissions the payment was made to you for general damages.

You are under 60 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-10.

Income Tax Assessment Act 1997 Section 82-130.

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

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

Income Tax Assessment Act 1997 Subparagraph 82-130(1)(b).

Income Tax Assessment Act 1997 Subparagraph 82-130(1)(c).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 118-20.

Reasons for decision

Summary

The payment made to you is an employment termination payment. As the payment consists wholly of a taxable component, the entire payment will form part of your assessable income for the 2012-13 income year.

The payment is not taxable as a capital gain.

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.

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

a) a payment for unused annual leave or unused long service leave;

b) the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

To determine if a payment constitutes an ETP, all the conditions in section 82-130 of the ITAA 1997 must be satisfied.

Failure to satisfy any of the conditions under subsection 82-130(1) of the ITAA 1997 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.

Paid as a consequence of the termination of your employment

For a payment to be treated as an ETP, the first condition that needs to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer (see subparagraph 82-130(1)(a)(i) of the ITAA 1997).

The phrase in consequence of is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Taking into account the courts decisions on the meaning of this phrase, the Commissioner's view on the meaning and application of the 'in consequence of' test are set out in Taxation Ruling TR 2003/13 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).

While TR 2003/13 considered the meaning of the phrase 'in consequence of' in the context of the eligible termination payments, TR 2003/13 can still be relied upon as both the former provision under the Income Tax Assessment Act 1936 and the current provision under the ITAA 1997 both use the term 'in consequence of' in the same manner.

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 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'.

Therefore 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 ETP 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 this case, you made an application to Fair Work Australia alleging that you were unfairly dismissed and underpaid by the Employer.

Discussions were held between you and the Employer where an agreement was reached. The matter was settled out of court and the Deed was signed by both you and the Employer. As stated under the Deed, it was agreed that the Employer would make a payment to you to be taxed as general damages.

Furthermore, under the terms of the Deed, you also agreed to release and forever discharge and release the Employer from any liability arising out of or connected with the Employer's employment of the Employee, including the cessation of the employment.

The payment made to you clearly arose as a result of the termination of your employment with the Employer. You stated in your ruling application that was for general damages caused by the employer who terminated your employment. This suggests that the payment made to you was 'in consequence of' the termination of your employment with the Employer.

As the payment was made in consequence of the termination of your employment with the Employer, the first condition under paragraph 82-130(1)(a) of the ITAA 1997 has been satisfied.

Payment is received no later than 12 months after termination

In this case, your employment was terminated during the 2011-12 income year and the payment was made to you within 12 months of your termination. Therefore, this condition is satisfied.

Payment is not a payment mentioned under section 82-135

The payment was made to you as a settlement payment under a deed of release. It is not a payment for unused annual leave, unused long service leave, the tax-free part of a genuine redundancy payment or an early retirement scheme payment, or any other payment listed in that section.

Therefore, this condition is satisfied.

Compensation payment in respect of unlawful acts of discrimination

Taxation ruling IT 2424 (IT 2424) deals with compensation payments in respect of unlawful acts of discrimination.

Paragraph 8 states:

8. By way of general comment the determination of the character of a compensation payment, and in particular whether it is liable to tax in the hands of an employee, depends upon the nature of the payment. A compensation payment to make up for lost earnings or in substitution for income which would otherwise have been earned is in the nature of income and is liable to income tax in the hands of the employee. On the other hand a payment to compensate for personal injury, injury to feelings, humiliation, embarrassment, depression, anxiety, etc. is not liable to income tax. It is a payment of a capital nature. Nor is the payment liable to tax under the capital gains tax provisions by reason of the exemption provided in sub-section 160ZB(1) for compensation or damages paid for wrong or injury suffered by a taxpayer to his or her person or in his or her profession or vocation.

In this case, you have argued that the payment should not be taxed as it is a compensation payment for personal injury, injury to feelings, humiliation, embarrassment, depression and anxiety.

However, the Deed states that the Employer will make the payment to you without any admissions. Furthermore, the Deed provides that the payment was made to you as a settlement payment under a Deed of Release. Consequently, no finding or admission has been made in respect of personal injury, injury to feelings, humiliation, embarrassment, depression and anxiety, and therefore, the payment is not compensation for any of those claims.

However, as discussed above, because the Deed provides that in return for the payment, you release the employer from any claims you may have arising out of your employment or the cessation of that employment, the payment will be an employment termination payment.

Taxation of ETP

A payslip issued to you by the Employer during the 2012-13 income year shows that the payment comprised solely of a taxable component. As the payment is an ETP, the entire amount will therefore form part of your assessable income during the 2012-13 income year.

The tax payable on the ETP depends on your age when your employment is terminated. If you have reached preservation age in the income year your employment is terminated, a maximum rate of 16.5% (including the Medicare levy) applies on payments up to the ETP cap amount. If you have not reached preservation age in the income year, a maximum rate of 31.5% (including the Medicare levy) applies to the ETP up to this cap. This is referred to as receiving concessional tax treatment. ETP amounts greater than this cap, regardless of your age are taxed at the highest marginal tax rate of 46.5% (including the Medicare levy).

As your date of birth is after 1964, you have not reached your preservation age of 60 years in the income year in which you were terminated. The ETP cap amount for the 2012-13 income year is $175,000. As the ETP that you received is below the ETP cap amount for the 2012-13 income year, this amount will be subject to concessional tax treatment, taxed at a maximum rate of 31.5% (including the Medicare levy).

From 1 July 2012, employment termination payments may also be subject to the 'whole-of-income cap'. This cap is $180,000 less your other taxable income for the year.

Any part of an ETP you receive that exceeds the whole-of-income cap may be taxed at 46.5%, regardless of whether or not it exceeds the ETP cap amount.

Capital gains tax

The general CGT exemptions provisions are found in subdivision 118-A of the ITAA 1997. Included amongst them is an anti-overlap provision, section 118-20, which ensures that an amount cannot be assessable under both the CGT provisions and non CGT provisions. The effect of the anti-overlap provision is to reduce the amount of any assessable capital gain by any amount which is also assessable under non CGT provisions and by amounts which are exempt income.

In your ruling application you stated that the payment made to you by the Employer under the deed of release should not be taxed as the payment was for general damages caused including loss of reputation, stress and illness.

The settlement payment is assessable as an ETP under section 82-130 of the ITAA-1997 as explained above in response to Question 1. The combined effect of section 118-20 and section 82-130 is that where a capital payment is assessable under a non-CGT provision, then it is treated as being assessable under that non-CGT provision.

In this regard, it is relevant to note the following comment made by Senior Member Dwyer of the Administrative Appeals Tribunal (AAT) in AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258 at paragraph 31:

I accept Mr Gibb's submission that if the payment is caught, as I am satisfied it is, by s 27A(1), there is no advantage to the applicant in the fact that it would have been exempt by virtue of s 160ZB(1), if it were not so caught. …

The above was in respect of the eligible termination payment provisions which, prior to 1 July 2007, were contained in the Income Tax Assessment Act 1936 (ITAA 1936). The term 'eligible termination payment' was defined in former subsection 27A(1) in the ITAA 1936 and included any payments made in consequence of the termination of employment. Subsection 160ZB(1) of the ITAA 1936 was replaced by section 118-37 of the ITAA 1997 for the 1998-99 and later income years.

Section 118-37 of the ITAA 1997 deals with exemptions from capital gains of compensation or damages for wrong or injury suffered by a taxpayer. While the payment you received is not compensation or damages for wrong or injury, the principle still applies.

Therefore, as the settlement sum is to be included as assessable income under section 82-130 of the ITAA 1997 (the non CGT provision) it is to be disregarded as a capital gain under sections 118-20 of the ITAA 1997. The fact that the payment may also be assessable as a capital gain does not change the fact that it is assessable under another provision of the ITAA 1997.

Accordingly, the settlement payment that you received from the Employer under the Deed of Release is excluded from the capital gains tax (CGT) provisions.

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