Edited version of your written advice

Authorisation Number: 1012733847815

Ruling

Subject: lump sum payment

Question 1

Will the lump sum compensation payment be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the lump sum compensation payment meet the definition of an employment termination payment under section 82-130 of the ITAA 1997?

Answer

No

Question 3

Will the lump sum compensation payment represent capital proceeds from CGT event C2 under section 104-25 of the ITAA 1997?

Answer

Yes

Question 4

Will you be eligible for the general 50% discount under subdivision 115-A of the ITAA 1997 on the resulting capital gain?

Answer

Yes

Relevant facts and circumstances

You have been employed by a company since 19xx.

In 19xx you agreed to move from a defined benefit super scheme to an accumulation super scheme.

In consideration for changing scheme your employer provided you a guarantee it would match any shortfall between the benefit provided by the schemes.

In 20xx you were offered a redundancy.

It was calculated that there was a shortfall between the benefit provided by the accumulation scheme and what you would have had under the defined benefit scheme.

You entered into a deed of release with your employer and were paid a lump sum payment in consideration for surrendering the guarantee.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 115-25

Income Tax Assessment Act 1997 section 118-305

Reasons for decision

Compensation as ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income has been held to include income from providing personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that:

• are earned

• are expected or relied upon

• have an element of periodicity, recurrence or regularity

• replace income.

In Taxation Ruling TR 95/35 the Commissioner defines a compensation receipt, or compensation, as any amount received by a taxpayer in respect of a right to seek compensation or a cause of action, or any proceeding instituted by the taxpayer in respect of that right or cause of action, whether or not:

• in relation to any underlying asset

• arising out of court proceedings

• made up of dissected amounts.

A compensation amount normally assumes the nature of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount, then it will be regarded as a capital receipt and not ordinary income. In your instance the compensation was calculated by determining the difference in the benefit provided by accumulation fund against the benefit that you would have had if you remained in a defined benefit fund. Although this calculation had reference to your salary it cannot be said that the lump sum payment replaces income and will consequently be capital in nature.

Compensation as an employment termination payment

Section 82-130 of the ITAA 1997 defines an employment termination payment as a payment that is received by you in consequence of the termination of your employment. Taxation Ruling TR 2003/13 provides the Commissioner's view on the meaning of the phrase 'in consequence of' in relation to section 82-130.

Paragraph [5] provides:

The phrase 'in consequence of' is not defined in the ITAA 1936. However, the words have been interpreted by the courts in several cases. Whilst there are divergent views as to the correct interpretation of the phrase, 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.

A number of cases have considered the meaning of the provision as it was previously formulated in paragraph 26(d) of the Income Tax Assessment Act 1936. In McIntosh v. FC of T (1979) 25 ALR 557; (1979) 45 FLR 279; (1979) ATC 4325; (1979) 10 ATR 13, Justice Brenan in reference to the earlier decision of Reseck V. FC of T (1978) 133 CLR 45; 75 ATC 4213; (1975) 5 ATR 538 provided the following at 4328:

'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. In the Supreme Court Andrews J in McIntosh v. Federal Commissioner of Taxation [1978] Qd R 354 said:

'I think it clear that the statements of Jacobs J. refers to something more than the occurrence of events in a purely temporal progression and that it connotes a relationship between events or states of things and the payment in question to which some persons might apply the adjective causal, while others would see the link in that one or more of such events or states of things must necessarily exist or occur as precedent to the payment, so as to constitute a condition or conditions precedent, both meaning the same thing'.[78 ATC 4324 at p. 4328]

'It may not be appropriate to speak of conditions if a payment is made voluntarily, but if a payment is made to satisfy a payee's entitlement, the phrase 'in consequence of retirement' requires that the retirement be the occasion of, and a condition of, entitlement to the payment. A sufficient causal nexus between the payment and the retirement is thus established.'

In your circumstances it cannot be said that the cause of the payment is the termination of your employment. You payment was sourced out of guarantee your employee provided you in 19xx. The liability owed to you under the guarantee existed prior to your redundancy and could have been called on at any period after 19xx where there was a shortfall in the benefit between the accumulation scheme and the defined benefit scheme. Consequently the payment is not in connection with the termination of your employment and you will not be an employment termination payment.

Compensation as capital proceeds

Taxation Ruling TR 95/35 provides the Commissioner's view on the capital gains tax (CGT) consequences of a compensation receipt. It adopts a look through approach to determine if the compensation relates to an underlying asset. Paragraph 3 defines and underlying asset as:

The underlying asset is the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.

Paragraph 11 of TR 95/35 provides that if the compensation is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

In your circumstances we consider that there is no underlying asset that has been permanently damaged or disposed of. Consequently the relevant asset is the right to be compensated for the difference in benefit between the accumulation fund and the defined benefit fund. This right was created in 1997 when you signed the agreement and was surrendered when you entered into the deed of released.

Paragraph 104-25(1)(d) of the ITAA 1997 provides that CGT event C2 happens when your ownership of an intangible CGT asset ends by the asset being abandoned, surrendered or forfeited. Consequently the lump sum payment will represent capital proceeds of a CGT event C2 which occurred when you entered into the deed of release. As you have held the relevant right for a period of greater than 12 months you will be eligible for the CGT 50% general discount under Division 115 of the ITAA 1997.

Section 118-305 of the ITAA 1997 provides that a capital gain or capital loss is disregarded if you make it from a CGT event happing in relation to any of the following:

• a right to an allowance, annuity or capital amount payable out of a superannuation fund or approved deposit fund

• a right to an asset of such a fund

• a right to any part of such allowance, annuity, capital amount or asset.

In your situation the above exemption will have no application as the amount is not payable out of your superannuation fund. Further the right does no relate to a right to asset or payment from the super fund but rather the right to receive payment from your employer for the difference in the net benefit provided by an accumulation fund and defined benefit fund.

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