Edited version of your private ruling

Authorisation Number: 1012489852117

Ruling

Subject: Employment Termination Payment

Question 1

Is the settlement payment of $X, received by your client under a deed of release, an employment termination payment?

Answer

Yes.

This ruling applies for the following periods:

The year ending 30 June 2012.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Your Client had their employment with the Employer terminated during the relevant financial year.

Subsequently, an application was filed by your client in relation to the termination of their employment with their employer and other matters.

The application was resolved by way of settlement between your client and their employer.

Your client signed a Deed of Release (the Deed) with the employer.

Under the Deed, the Employer agreed to make a payment to your client in return for the discharge from all claims arising out of or in any way connected with your client's employment and the termination of their employment.

Before the end of the relevant income year, the settlement payment was transferred from your client's employer to your client's solicitor's Trust account in accordance with the Deed.

Your client is under 65 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.

Reasons for decision

Summary

The payment made in accordance with the deed is an employment termination payment. As the payment consists wholly of a taxable component, the entire payment will form part of your client's assessable income for the relevant income year.

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 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.

To determine if a payment constitutes an employment termination payment, 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 employment termination payment, 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 employment termination payment. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an employment termination payment.

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 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.

Furthermore, in paragraph 13 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.

In this case, your client made an application seeking a remedy in relation to their dismissal from their employment.

Discussions were held between your client and their Employer where an agreement was reached. The matter was settled out of court and the Deed was signed by both your client and your client's Employer.

As stated in the Deed of Release, it was agreed that the Employer would make a payment to your client.

Furthermore, under the terms of the Deed, release was given by your client discharging the employer from all claims arising out of or in any way connected with your client's employment and the termination of your client's employment.

The payment made to your client arose as a result of the termination of your client's employment with their employer. You stated in your ruling application that the payment was made to your client as an ex-gratia payment made on a commercial basis to settle a legal dispute and as such should not be included as assessable income. As the Deed states that the payment was made to release the employer from any claims connected with the employment or termination of employment, the gross payment made to your client is 'in consequence of' the termination of your client's employment with the Employer.

As the payment was made in consequence of the termination of your client's employment with your client's 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 client's employment was terminated during the relevant income year and payment was made to your client's Solicitor during the relevant income year, which is within 12 months of your client's termination. Therefore, this condition is satisfied.

Payment is not a payment mentioned under section 82-135

The payment was made to your client 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.

Taxation of employment termination payment

As the payment is an employment termination payment, the entire amount will form part of your client's assessable income during the relevant income year.

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

As your client's date of birth is after 1964, your client has not reached their preservation age of 60 years in the income year in which their employment was terminated. The 'ETP cap amount' for the relevant income year is $165,000. As the employment termination payment is below the 'ETP cap amount' for the relevant income year, this amount will be subject to concessional tax treatment, taxed at a maximum rate of 31.5% (including the Medicare levy).

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