Edited version of your written advice

Authorisation Number: 1013062294896

Date of advice: 29 July 2016

Ruling

Subject: Lump sum payment received in settlement of litigation proceedings

Question

Is the lump sum payment paid to your client by their former employer in settlement of litigation proceedings an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2015; and

Year ended 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances:

An individual (Your Client) commenced employment with an entity (the Former Employer) in the 2011-12 income year.

Your Client was to be employed by the Former Employer for approximately three years.

In the 2012-13 income year Your Client was suspended from their employment on full pay.

Your Client subsequently later resigned from their employment in the 2013-14 income year.

Your Client commenced legal proceedings against the Former Employer in the 2013-14 income year.

In the Statement of Claim to the legal proceedings Your Client claimed damages against the Former Employer for losses they alleged that they suffered by the termination of their employment. These losses were claimed to consist of: remuneration for the balance of the term of the employment contract; the loss of a chance to receive remuneration under a renewal of the contract after the expiry of the term of the contract; and damage to reputation.

Without admission of liability, Your Client and the Former Employer entered into a Deed of Release (the Deed) in the 2014-15 income year in which the Former Employer agreed to pay a settlement sum to Your Client in full and final settlement of all claims Your Client has, or may have had, against the Former Employer.

In accordance with the Deed, the Former Employer agreed to pay a settlement sum to Your Client, in several instalments, over two income years.

The Deed does not allocate any part of the payment(s) to any particular head of damage claimed by Your Client.

In accordance with the Deed each party will bear their own legal costs in connection with the Deed.

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 Paragraph 82-130(1)(b)

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

Income Tax Assessment Act 1997 Subsection 82-130(4)

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

Income Tax Assessment Act 1997 Subdivision 118-A

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 118-22

Income Tax Assessment Act 1997 Section 118-37

Reasons for decision

Summary

The entire settlement sum amount paid to Your Client by the Former Employer in settlement of litigation proceedings is an employment termination payment.

Each settlement instalment payment must be included as assessable income in the relevant year of income and subject to tax as an employment termination payment.

Detailed reasoning

Employment termination payment

A payment is an employment termination payment 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.

Paid 'in consequence' of the termination of employment

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) states, at paragraphs 5 and 6 that:

5. ...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.

6. The phrase requires 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.

While TR 2003/13 contains references to repealed provisions, some of which may have been rewritten, the ruling still has effect.

Whether payments made in respect of a taxpayer as a result of settlement of litigation arising out of the termination of the taxpayer's employment, is made 'in consequence of' the termination of employment is specifically addressed in TR 2003/13. According to paragraph 31 of TR 2003/13:

31. 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.

Your Client was advised that they were being suspended from their employment on full pay due to certain serious allegations. Sometime after their suspension, Your Client resigned, and as a result of certain alleged breaches by the Former Employer, felt they had suffered loss and damage.

Sometime after Your Client's termination of employment, Your Client commenced legal proceedings against the Former Employer.

The Proceeding commenced after Your Client's termination.

The subject of Your Client's Statement of Claim dealt with the loss of base remuneration for the remaining employment contract period, loss of future employment income through contract renewal and damage to Your Client's reputation generally.

The cause of action, whether there was a breach of contract or not, was connected to the termination. Your Client's suspension created a conflict between Your Client and their Former Employer, which led to Your Client's decision to resign and the subsequent lodgement of legal proceedings against his Former Employer, largely for, the deprivation of future employment income.

To use the language of Le Grand, the relevant question to ask is whether the payment would have been made 'but for' the termination of Your Client's employment. In this case, the Deed was entered into for the settlement of the Proceedings under which Your Client claimed damages for losses which primarily arose from termination. In other words, but for the termination of Your Client's employment, Your Client would not been entitled to claim for loss of base remuneration and loss of future employment income. As such, the sum paid to Your Client in settlement of litigation proceedings followed as an effect or result of the termination.

It is acknowledged that a claim for damage to Your Client's reputation generally was also a subject of the Claim. It is also accepted that this damage to Your Client's reputation may have primarily occurred prior to the termination, which in turn ensures that the claim for damage to reputation would not have been 'in consequence of' Your Client's termination. However, as per Dibb v FC of T (2003) ATC 4613 (Dibb's case), where there are damages claimed under a variety, or multiple heads of damage, there is no way of dissecting an un-dissected total settlement sum so that it can be apportioned amongst the several heads of damage to which it relates.

In Dibb's case, Mr Dibb commenced legal action against his former employer in relation to the termination of his service agreement, alleging there was a breach of his service agreement, breach of the fiduciary duty of trust and confidence, breach of the Trade Practices Act 1974 (Cth) and that his former employer and their lawyers conspired to terminate his employment without 'proper cause or warning'. Mr Dibb sought damages for amounts due under the service agreement to the date of termination that were unpaid, future economic loss, physical and mental injury and diminution of amenities, injury to employment reputation, exemplary damages, interest and costs. The parties agreed to settle the claim, entering into a deed of release for the payment of a settlement sum to Mr Dibb. Heerey J held that at 4617, the payment under the deed of release was made in consequence of the termination of Mr Dibb's employment with his former employer.

…The various causes of action, whether breach of contract, conspiracy, breach of fiduciary duty or contravention of the Trade Practices Act were … "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.

The payment of the settlement sum under the Deed was therefore made 'in consequence of' the termination of Your Client's employment. 'In consequence of the termination' requires that termination be a cause, but not necessarily a dominant cause of a payment. There is a causal connection between the termination and the payment of the settlement sum. The termination, the legal proceedings and the payment are intertwined.

Payment must be received no later than 12 months after termination

As it has been determined that the settlement sum was received in consequence of Your Client's termination of employment, paragraph 82-130(1)(b) of the ITAA 1997 of the definition of employment termination payment also requires that the amount is paid to Your Client within 12 months of their termination.

In this case, the settlement instalments were not paid within 12 months of Your Client's termination. Accordingly, paragraph 82-130(1)(b) of the ITAA 1997 is not satisfied.

However, subsection 82-130(4) of the ITAA 1997, provides an exemption from the application of paragraph 82-130(1)(b) of the ITAA 1997, (the 12 month rule), if:

• you are covered by a determination under subsection (5) or (7); or

• the payment is a genuine redundancy payment or an early retirement scheme payment.

Your Client is covered by a legislative instrument under subsection 82-130(7), being SPR 2007/1 Employment Termination Payments (12 months rule) Determination 2007. According to this determination, if legal action was commenced within 12 months of the termination of employment in relation to the entitlement to or the amount of the payment, paragraph 82-130(1)(b) of the ITAA 1997 does not apply.

Accordingly, as legal action was commenced by Your Client within 12 months of their termination, an exemption from the application of paragraph 82-130(1)(b) of the ITAA 1997 applies in this case.

Paragraph 82-130(1)(c) of the ITAA 1997 regarding the definition of employment termination payment also requires that the payment in question is not a payment mentioned in section 82-135 of the ITAA 1997.

Exclusions under section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 provides that certain payments are not employer termination payments. This includes (among others):

• unused annual leave and unused long service leave payments; and

• 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).

In this case, the settlement sum is not a payment that falls within any of the exceptions in section 82-135.

Therefore, the settlement sum paid to Your Client by their Former Employer in settlement of litigation proceedings is an employment termination payment in accordance with section 82-130 of the ITAA 1997.

Capital gains tax

The general capital gains tax (CGT) exemptions provisions are found in subdivision 118-A of the ITAA 1997. Included amongst them is an anti-overlap provision, section 118-20 of the ITAA 1997, which ensures that an amount cannot be assessable under both the CGT provisions and non-CGT provisions. The effect of the anti-overlap provision is to reduce the amount of any assessable capital gain by any amount which is also assessable under non-CGT provisions and by amounts which are exempt income.

According to section 118-22 of the ITAA 1997:

In applying section 118-20, treat a * superannuation lump sum or an * employment termination payment that you receive as being included in your assessable income.

In this case, as the settlement sum is an employment termination payment under section 82-130 of the ITAA 1997 that must be included as assessable income under section 82-10 of the ITAA 1997 (a non-CGT provision), any capital gain made is to be reduced under section 118-20 of the ITAA 1997 by the amount assessable under section 82-10 of the ITAA 1997. This prevents any possible overlap in relation to the taxation of the amount.

The fact that the payment may also be assessable as a capital gain does not change the fact that it is assessable under another provision of the ITAA 1997.

Accordingly, each of the instalment settlement sums are excluded from the capital gains tax provisions and as explained above, included in Your Client's assessable income in the relevant income year and subject to tax as employment termination payments.

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