Edited version of private advice

Authorisation Number: 1012628234217

Ruling

Subject: Employment termination payment - 12 month rule

Question

Will the Commissioner determine under subsection 82-130(5) of the Income Tax Assessment Act 1997 that paragraph 82-130(1)(b) [the 12 month rule] does not apply to a payment?

Answer

Yes.

This ruling applies for the following periods:

2013-14 income year

The scheme commences on:

1 July 2013.

Relevant facts and circumstances

The Employee was employed by the Employer.

The Employee resigned at the beginning of the 2012-13 income year and agreed to an offer (the Agreement) made by the Employer. The Agreement was documented in a letter from the Employer to the Employee, and outlines a number of arrangements pertaining to the resignation.

The Employee immediately disputed that the Agreement was not adhered to by the Employer. The Employee informed the Employer of her intention to commence legal proceedings.

In the following month, the Employee sought to engage mediators to resolve the dispute with the Employer.

In the following month, the Employee commenced mediation with the Employer.

Approximately 12 months after engaging mediation, a settlement was reached between the Employee and the Employer.

A PAYG payment summary shows that a payment was made to the Employee from the Employer.

Relevant legislative provisions

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 Subparagraph 82-130(1)(a)(i)

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

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

Income Tax Assessment Act 1997 Paragraph 82-130(4)(a)

Income Tax Assessment Act 1997 Subsection 82-130(7)

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

The gross payment made to the Employee is an employment termination payment. Because the employment termination payment was made during the former employee's lifetime, it is a life benefit termination payment (LBTP). As a result, the entire payment is a taxable component of an LBTP, and is included in full in the former employee's assessable income for the 2013-14 income year.

Detailed reasoning

Employment termination payment

An employment termination payment, where the payment is made during the life of a taxpayer, is known as a life benefit termination payment (subsection 82-130(2) of the Income Tax Assessment Act 1997 (ITAA 1997)).

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states:

employment termination payment has the meaning given by section 82-130.

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.

Therefore, it can be seen that a number of conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of the conditions will result in the payment not being considered an employment termination payment.

Payment is made in consequence of the termination of employment

The first condition to be met is that the payment is received by the person 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 which discusses the meaning of the phrase.

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.

Also in paragraph 5 of TR 2003/13 the Commissioner notes that the Courts have considered the meaning of the words in consequence of in several cases.

Of note are the decisions made by the Full Bench of 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, in the same case, 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. In doing so the Full Federal Court emphasised that a payment may be in consequence of the termination of employment even though the termination is not the dominant cause of the payment.

In particular, 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.

Thus, 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.

The phrase in consequence of and the decisions in Reseck and McIntosh were considered more recently by the Federal Court 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).

In Le Grand, a settlement payment in relation to legal proceedings involving a wrongful dismissal claim, together with a claim for misleading and deceptive conduct, was held to be an eligible termination payment. Justice Goldberg, the presiding judge, considered that the settlement of the misleading and deceptive conduct component of the claim did not break the casual relationship that existed between the settlement payment and the termination of the taxpayer's employment.

In making his decision, 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.

The approach taken in Le Grand was also adopted in Dibb v Commissioner of Taxation (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126, where the Full Federal Court held that a payment received under a deed of release following the settlement of legal proceedings against the taxpayer's former employer was an eligible termination payment. The Court considered that there was a clear chain of causation between the payment and the termination. That is, the subject matter of the litigation was clearly interwoven and intertwined with the termination.

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 noted in both paragraphs 6 and 28 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.

From the facts provided, the Employee's employment was terminated and the Employee signed an offer (the Agreement) made by the Employer in relation to the termination of employment. However, the Employee disputed that the Agreement was not adhered to by the Employer and mediation between the two parties commenced within three months of termination.

Over 12 months later, as a result of mediation, a settlement was reached between the Employee and the Employer that a payment was to be paid to the Employee.

The payment would be considered to be made in consequence of the Employee's termination of employment. The payment would not have been made had there been no termination of employment. The termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the issue of paying a lump sum would not have arisen.

The lump sum payment is considered to be received by the Employee in consequence of the termination of employment. Therefore the requirement of subparagraph 82-130(1)(a)(i) of the ITAA 1997 will be met.

Payment received more than 12 months after termination

The second requirement under section 82-130 of ITAA 1997 is that the payment be made within 12 months of the termination of employment. However, subsection 82 130(4) of the ITAA 1997 provides that the 12 month rule does not apply if a determination under subsection (5) or (7) is made.

Subsection 82-130(7) provides that the Commissioner may determine, by legislative instrument that the 12 month rule will not apply to a class of payments or a class or recipient. The Commissioner has issued legislative determination SPR 2007/1 which states that the 12 month rule will not apply where legal action commenced within 12 months of the termination or the payment was made by a liquidator, receiver, receiver/manager or trustee in bankruptcy provided they were appointed within 12 months of the termination. These circumstances do not apply to the Employee's situation as legal action did not take place.

However, the Commissioner may also make a determination on a case by case basis pursuant to subsection 82-130(5) of ITAA 1197.

Subsection 82-130(5) of the ITAA 1997 states:

The Commissioner may determine, in writing, that paragraph (1)(b) does not apply to you if the Commissioner considers the time between the employment termination and the payment to be reasonable, having regard to the following:

(a) the circumstances of the employment termination, including any dispute in relation to the termination;

(b) the circumstances of the payment;

(c) the circumstances of the person making the payment;

(d) any other relevant circumstances.

Paragraph 4.19 of the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Act 2007 states that the 12 month rule exists to prevent abuse of the tax concessions offered for these payments by using a series of payments over a number of income years. The provisions dealing with the Commissioners ability to issue a determination are provided to allow flexibility where delays in payments are reasonable and not constructed with the intention of delivering a tax advantage.

From the facts provided, the Employee's employment was terminated at the beginning of the 2012-13 income year. A dispute on the termination of employment resulted in discussions between the Employer and the Employee. Mediation between the two parties commenced within three months of termination and concluded approximately 12 months later.

As a result of mediation, a settlement was reached between the Employee and the Employer that a payment was to be paid to the Employee. As a result, the payment was not made within 12 months of the date of termination of employment.

Based on the fact that:

_ steps were taken by the Employee shortly after the termination of employment to determine the correctness of the offer made by the Employer by way of seeking external mediators; and

_ the Employee had limited control over the speed to which a resolution to the mediation and subsequent payment could be made;

the Commissioner determines that the time taken between the termination of the Employee's employment and the payment is deemed reasonable.

Therefore the 12 month rule will not apply to the payment made to the Employee from the Employer.

Employment termination exclusions

Section 82-132 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; and

• reasonable capital payments for personal injury.

In this case, the facts provided 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 employment termination payment.

Consequently, it is considered that the payment is not of a type mentioned in section 82-135 of the ITAA 1997. As the payment is not a payment mentioned in section 82-135, the requirement of subparagraph 82-130(1)(c) of the ITAA 1997 is met.

Conclusion

As all of the conditions have been satisfied, the lump sum payment made to the Employee will be treated as an employment termination payment and must be included in her tax return for the 2013-14 income year.

Tax Treatment of the payment as a Life Benefit Termination Payment (LBTP):

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

• Tax free component this includes the pre-July 83 segment (if any) and/or the invalidity segment (if any); and

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

The tax free component is not assessable income and is not exempt income.

The taxable component is included, in full, as assessable income.

If the Employee commenced employment with the Employer after 1 July 1983 then there will not be any pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997.

As the payment is not made because the former employee ceased being gainfully employed as a result of suffering from ill-health, there is no invalidity segment for the purposes of section 82-150 of the ITAA 1997.

If the employment termination payment contains neither a pre-July 83 segment nor an invalidity segment, there is no tax free component as defined in section 82-140 of the ITAA 1997. Rather the entire employment termination payment will be a taxable component as defined in section 82-145 of the ITAA 1997.

The taxable component is subject to tax, depending on the person's age when the payment is received.

If the Employee is over the preservation age or older on the last day of the income year in which the former employee receive the payment. The payment will be taxed at 15% plus Medicare levy.

If the Employee is under the preservation age the entire amount will be taxed at 30% plus Medicare levy.

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