Edited version of your written advice

Authorisation Number: 1013033881950

Date of advice: 20 June 2016

Ruling

Subject: Employment termination payment - invalidity segment

Question

Is any portion of the payments made by the Employer to Your Client exempt from tax as an invalidity segment of an employment termination payment (ETP), in accordance with section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20yy

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Your Client commenced employment with the Employer several years ago.

Your Client's contract of employment (the Contract) with the Employer during the 20xx-yy income year was for one year. The definition of 'contract year' in the contact means:

the period commencing on 1 July in one calendar year and concluding on 30 June in the next calendar during the Term.

Your Client will terminate employment with the Employer during the 20xx-yy income year.

During the 20xx-yy income year Your Client sustained a serious injury.

The Employer will pay Your Client an amount during the 20xx-yy income year. The amount comprises an amount for injury payments and an amount for the retainer.

A clause of the Contract refers to injury payments.

Another clause of the Contract advises of when an employee is entitled to injury payments.

An injury amount is paid to Your Client as specified in a clause of the Contract.

Under a clause of the contract Your Client is entitled to a retainer that is paid in monthly instalments.

The amount of the Retainer is outlined in an item of a Schedule of the Contract.

An amount of the Retainer has been paid to Your Client in monthly instalments during the 20xx-yy income year.

A medical certificate from a medical practitioner during the 20xx-yy income year advised that Your Client would not be able to continue their employment and had no choice but to retire.

A medical report from another medical practitioner during the 20xx-yy income year advised that due to Your Client's injury they are not able to continue in their employment, and would: require re-training for future gainful employment

Your Client is under 60 years of age.

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 Subparagraph 82-130(1)(a)(i).

Income Tax Assessment Act 1997 Section 82-150.

Reasons for decision

Summary

The payments that comprise an amount for injury payments and an amount for the Retainer is not an employment termination payment (ETP) under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997).

No part of the payments made to Your Client is exempt from tax as an invalidity segment of an ETP, in accordance with section 82-150 of the ITAA 1997.

The payments should be taxed as ordinary salary and wages.

Detailed reasoning

Employment termination payment

A payment is an employment termination payment (ETP) if it satisfies all the requirements in section 82-130 of the ITAA 1997 and is not specifically excluded under section 82-135 of the ITAA 1997.

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.

Section 82-135 of the ITAA 1997 provides that certain payments are not ETPs. These include (among others):

• unused annual leave or long service leave payments which are covered by Subdivision 83-A and Subdivision 83-B respectively;

• Superannuation benefits which are covered by Divisions 301-307;

• the tax-free part of a genuine redundancy payment or an early retirement scheme payment worked out under section 83-170; and

• certain capital payments for personal injury.

Paid as a 'consequence of' the termination of your employment

For a payment to be treated as an ETP, the first condition that must be met is that the payment is made in 'consequence of' the termination of employment of the taxpayer.

It should be noted that the phrase 'in consequence of the termination of your employment' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

In light of these decisions, the Commissioner discusses the meaning of the phrase in Taxation Ruling TR 2003/13 titled 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).

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) 133 CLR 45 (Reseck) and the Full Federal Court in McIntosh v. Federal Commissioner of Taxation (1979) 25 ALR 557; (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 in my opinion necessary that the termination of the services should be the dominant cause of the payment...

In the same case Jacobs J 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; (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. True it is that the payment was made not only to settle the applicant's claim for common law damages for breach of the employment agreement but also for statutory damages...

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'.

Paragraph 31 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. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

The essence of this analysis is that if the payment follows as an effect or a result of 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. The termination of the payment need not be the sole or dominate cause of the payment.

The above views were referred to, and relied upon by the AAT in Seabright v FC of T 99 ATC 2011 (Seabright), where it was held that a payment arising from a commutation of a pension that started to be paid more than 10 years earlier was made in consequence of the termination of employment.

In Seabright, the taxpayer's entitlement to the pension arose as a consequence of the termination of her employment, and the payment of the commuted amount simply changed one form of payment into another. The gap of over 10 years between the termination of employment in October 1984 and the offer to commute the pension in May 1995 did not destroy the connection between the termination of employment and the payment.

In arriving at this decision, Senior Member Pascoe stated:

...The question is whether the payment, however it came about, could be said to have followed on termination of the applicant's employment...in 1984. In my view it could. The payment of the commuted amount was simply to change one form of payment, a pension, into another, a lump sum. The entitlement to the pension arose as a consequence of termination of employment in 1984. Termination was a prerequisite to payment of the pension which, in turn, was a prerequisite to the right to receive a lump sum in lieu of the pension. The gap of more than ten years between the two events does not, in my view, destroy the connection between termination of employment and the payment. They remain inextricably linked. The statement by Toohey J in McIntosh's case that "a short period of one month might be thought to strengthen" the connection does not, in my view, necessarily suggest that the longer the period the weaker the connection. If the termination of employment can be seen as either a cause or an antecedent of the payment of the lump sum it can be said that the payment is made in consequence of that termination (Emphasis added).

The Commissioner does not accept that a payment will be made in consequence of termination simply because the termination of employment was antecedent to the payment. There must be a causal connection between the termination and the payment. In Seabright the termination was a cause of the payment of the commuted lump sum amount and the causal connection was sufficient for a finding that the payment was made in consequence of the termination of employment. The facts in Seabright show that but for the termination of employment the taxpayer would not have received the commuted lump sum payment (paragraph 39 of TR 2003/13).

Accordingly, it must be demonstrated that, but for the termination of employment, the payment would not have been made.

The question of whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case.

In this case Your Client was employed with the Employer under a one year contract during the 20xx-yy income year. Your Client sustained a serious injury during the 20xx-yy income year. Under Your Client's Contract of Employment (the Contract), Your Client is entitled to injury payments and payments for a retainer.

Your Client is entitled to injury payments under a clause of the Contract. The injury payments were paid to Your Client during the 20xx-yy income year as specified in a clause of the Contract. A total amount of injury payment has been made to Your Client during the 20xx-yy income year.

Your Client is entitled to a retainer in the Contract under a clause in the Contract. Under an item of a Schedule of the Contract, Your Client is entitled to the Retainer paid in monthly instalments. An amount of the Retainer has been paid to Your Client in monthly instalments during the 20xx-yy income year.

Applying the principles expressed in Reseck, McIntosh and Seabright's case, the injury payments and the monthly instalment payments of the Retainer made by the Employer to Your Client is not considered to be made in consequence of the termination of employment. The payments did not follow on as an effect or result of Your Client's termination of employment. There was no causal nexus between the termination and payment. Your Client was not required to terminate employment with the Employer before the injury payments and monthly instalments of the Retainer were made to Your Client as Your Client was entitled to the injury payments under a clause of the Contract and the Retainer under a clause of the Contract. Your Client was still employed by the Employer when the payments were made. The termination and the payment are not intertwined because Your Client was entitled to the payments under the Contract and was not required to terminate employment with the Employer to receive those payments.

From the above discussion, the payment did not follow on as an effect or result of the Employee's termination of employment. Your Client is still currently employed under a contract of employment that terminates during the 20xx-yy income year. It cannot be said that the payment would not have been made but for the termination of employment. The payment is not considered to be made in consequence of the termination of employment. Therefore the condition in subparagraph 82-130(1)(a)(i) of the ITAA 1997 is not met.

As noted above all the requirements in section 82-130 of the ITAA 1997 must be met before the payment is considered to be an ETP. As one of the conditions under subsection 82-150(1) of the ITAA 1997 is not met, it is not necessary to discuss the other conditions in the subsection.

As one condition under section 82-130 of the ITAA 1997 has not been met the payment is not considered to be an ETP.

Invalidity Segment of ETP

Under subsection 82-150 of the ITAA 1997 where a person's employment is terminated because of ill-health and the person receives an employment termination payment part of the payment may be tax free. This component is called an invalidity segment (subsection 82-150(1) of the ITAA 1997).

In relation to whether any part of the Payment includes an invalidity segment it must satisfy subsection 82-150(1) of the ITAA 1997 which states:

An employment termination payment includes an invalidity segment if:

(a) the payment was made to a person because he or she stops being gainfully employed; and

(b) the person stopped being gainfully employed because he or she suffered from ill-health (whether physical or mental); and

(c) the gainful employment stopped before the person's last retirement day; and

(d) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in capacity for which he or she is reasonably qualified because of education, experience or training.

In this case, as the payments are not ETPs, no part of the payments will contain an invalidity segment under subsection 82-130(1) of the ITAA 1997.

The payments should instead be taxed as ordinary salary and wages income.

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