Edited version of your private ruling

Authorisation Number: 1012481491209

Ruling

Subject: Ex-gratia payment

Question

Is the ex-gratia payment paid to you under an agreement assessable as an employment termination payment?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2013

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

You commenced employment with your former employer (the Employer) over 10 years ago.

During the relevant income year your representative and the Employer (the parties) agreed to orders made by a conciliation officer in relation to a matter between you and the Employer.

The orders included your representative and the Employer agreeing to your claim for compensation pertaining to injures being rejected.

Attached to the orders there was also a signed agreement between the parties which stated that:

1. The Employer agreed to pay you a lump sum ex-gratia payment; and

2. You agree to resign.

You provided a document which was signed in the relevant income year which relates to your resignation of employment with the Employer.

A letter has been provided wherein the Employer states that:

(a) the lump sum payment was paid on a commercial risk basis to resolve a dispute between the parties;

(b) the amount of the lump sum was arrived at by the Employer after taking into consideration the costs associated with further proceedings; and

(c) the payment was not paid by way of an employment termination payment.

A copy of a form which was completed by the Employer in relation to the lump sum payment which was sent to a government department shows amongst other items:

· the date of your injury/illness;

· the date you last worked with the Employer;

· the claim was for workers' compensation;

· the type of lump sum payment was made in accordance with a the order;

· the Employer was the only payer involved;

· the total gross lump sum settlement; and

· the date in relevant income year by which the lump sum payment would be released to you.

Your representative stated that you accepted the lump sum payment from the Employer in regard to likely future medical costs associated with your claim and the potential loss of future income you may incur as a result of you not having the capacity to work while your injury was treated.

You had already reached your preservation age when the lump sum payment was paid.

Relevant legislative provisions

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 Paragraph 82-130(1)(a).

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

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

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 82-140.

Income Tax Assessment Act 1997 Section 82-145.

Income Tax Assessment Act 1997 Section 82-150.

Income Tax Assessment Act 1997 Section 82-155.

Reasons for decision

Summary

The payment made to you as the result of an agreement is an employment termination payment. The total amount of the lump sum payment is a taxable component to be included in your income tax return for the relevant income year.

Detailed reasoning

Employment termination payment

A payment made to an employee is an employment termination payment 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:

82-130(1) 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 persons death, in consequence of the termination of the other persons 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.

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.

The Full High Court considered the expression in consequence of in Reseck v FC of T (1975) 133 CLR 45; 6 ALR 642; 49 ALJR 370; 5 ATR 538; 75 ATC 4213 (Reseck). Justice Gibbs stated:

Within the ordinary meaning of the words a lump 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 v FC of T (1979) 25 ALR 557; 10 ATR 13; 45 FLR 279; 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.

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.

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.

Where, under a deed of release, before any payment is payable the taxpayer is required to resign from employment, it has been held that a payment not paid specifically in relation to that termination is, nevertheless, also an ETP.

In Le Grand v. Commissioner of Taxation (2002) FCA 1258; 124 FCR 53; 195 ALR 194;2002 ATC 4907; 51 ATR 139 (Le Grand), the payment received was not only in respect of the termination of employment. In holding the payment for damages to also be an ETP, Goldberg J stated at paragraph 35:

I am satisfied that the payment was an effect or result of that termination in that there were 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 applicants claim for common law damages for breach of the employment agreement but also for statutory damages...

Justice Heerey in Dibb v. Commissioner of Taxation 2003 ATC 4613; (2003) 53 ATR 290; [2004] ALMD 5781; [2003] FCA 673 (Dibb) stated that:

22. The concept of a payment in consequence of the termination of any employment was expounded by the High Court in Reseck v FC of T 75 ATC 4213; (1975) 133 CLR 45 and by the Full Court of the Federal Court in McIntosh v FC of T 79 ATC 4325; (1979) 25 ALR 557. These authorities are analysed by Goldberg J in Le Grand v FC of T 2002 ATC 4907 at 4911-4913 [25-30] and 4914 [33-34]; (2002) 195 ALR 194 at [25] to [30] and [33] to [34]. I adopt his Honours analysis.

23. In my opinion the Commissioner was correct in ruling that the payment under the Deed was made in consequence of the termination of the applicants employment with AVCO. True it is there was a substantial lapse in time between the termination and the commencement of Federal Court proceeding and a further period of time until settlement. However the reason for that delay was the time taken up with the litigation first in the Commission and then in the Federal Court itself. The subject matter of the litigation in the Federal Court was clearly the termination, the allegedly wrongful way AVCO effected it and its financial and other consequences for the applicant. 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 ATC 4915 [36]; ALR [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.

This reasoning was accepted by the Full Federal Court in Dibb v. Commissioner of Taxation (2004) 207 ALR 151; 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126 by Justices Spender Dowsett and Allsop in determining the appeal against Justice Heerey's decision.

In the present case, there was a dispute (the dispute) between you and the Employer regarding your claims for compensation in relation to injuries (the injuries) you sustained.

The facts show orders made by a conciliation officer, which confirmed the rejection of your claims to injuries, were agreed to by the parties (i.e. your representative and the Employer).

In addition to the orders there was attached an agreement (the Agreement), signed by the parties, under which you would be paid a lump sum ex-gratia payment (the Payment). As part of the Agreement you were also required to resign from your employment.

The Courts have held that settlement amounts arising from actions that are in some way connected with the termination of employment are payments made in relation to the taxpayer in consequence of the termination of their employment.

In your case, it is noted that a letter from the Employer indicates the dominant cause for the Payment being made was to, on a commercial risk basis, resolve the dispute. Despite the dominant purpose, there is a causal connection between the termination of your employment and the Payment.

Given the nature of the dispute, the Agreement, the termination of employment and the Payment, it is considered they are all intertwined and connected.

Based on the principles stated in Reseck, McIntosh, Le Grand and Dibb and the Commissioner's views expressed in TR 2003/13, the facts presented demonstrate a connection or a link exists between the termination of your employment and the payment. You would not otherwise have received the payment except for the termination of your employment.

Consequently, the Payment is considered to be an employment termination payment in accordance with subparagraph 82-130(1)(a)(i) of the ITAA 1997 and is assessable as an employment termination payment to the extent that it is not specifically excluded under section 82-135 of the ITAA 1997.

Exclusions under section 82-135 of the ITAA 1997

The condition specified in paragraph 82-130(1)(c) of the ITAA 1997 is that an employment termination payment does not include a payment mentioned in section 82-135 of the ITAA 1997.

Section 82-135 of the ITAA 1997 includes payments such as pensions, foreign termination payments, unused annual leave and unused long service leave and the tax free part of genuine redundancy payments or early retirement scheme payments as well as other types of payments which are not considered to be employment termination payments.

In your case, consideration has been given to whether the Payment is covered by the specific exemption for personal injury in paragraph 82-135(i) of the ITAA 1997 (payments that are not employment termination payments) which states:

(i) 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);

The exclusion under paragraph 82-135(i) of the ITAA 1997 is for a payment or benefit that compensates or reimburses the taxpayer for or in respect of the particular injury.

In your case it is noted that your representative stated that you accepted the Payment in regard to likely future medical costs associated with your claim and the potential loss of future income you may incur as a result of you not having the capacity to work while your injury was treated.

Though you may apply the Payment for the above stated purposes, the facts show the Payment was not paid to you for personal injury, or the likely effect a personal injury would have on your capacity to earn income from personal exertion, as:

(a) the parties agreed to the orders made by a conciliation officer which confirmed the rejection of your claims to injuries;

(b) the Payment was made in accordance with the Agreement;

(c) the Employer stated in a letter that the:

(i) Payment was paid on a commercial risk basis to resolve the dispute; and

(ii) the Payment figure was arrived at by the Employer after taking into consideration the costs associated with further proceedings.

Accordingly, paragraph 82-135(i) of the employment termination payment definition under section 82-135 of the ITAA 1997 does not apply to the Payment.

In view of the above and the information provided, it is clear that the Payment does not include any payment mentioned in section 82-135 of the ITAA 1997.

The 12 month rule set out in paragraph 82-130(1)(b) of the ITAA 1997:

In addition to meeting the other conditions for a payment to be an employment termination payment, 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 relevant income year and the Payment was made to you in the same income year.

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.

Conclusion:

Despite the Employer's statement that the Payment was not paid by way of an employment termination payment, the Commissioner concludes that the lump sum payment is an employment termination payment as it satisfies all of the relevant provisions as shown above.

Tax treatment:

An employment termination payment may comprise 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.

The period of employment to which the Payment relates occurred wholly after 1 July 1983 as you were not employed with the Employer prior to 1 July 1983. Hence, the Payment will not have a pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997.

Therefore, as the Payment contains neither a pre-July 83 segment nor an invalidity segment within the meaning of section 82-150 of the ITAA 1997, the Payment has no tax free component.

Accordingly, the entire Payment is a taxable component of an employment termination payment as defined in section 82-145 of the ITAA 1997.

The taxable component, which represents assessable income to be included in your relevant income tax return, is subject to tax

In your case as you had already attained your preservation age when the Payment was made, the Payment is taxed at a rate not exceeding 15% plus Medicare Levy where it does not exceed the ETP cap of $175,000 for the relevant income year.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).