Edited version of your written advice

Authorisation Number: 1051178190647

Date of advice: 9 January 2017

Ruling

Subject: Employment termination payments

Question

Is any part of the payment made to a person (the Taxpayer) in settlement of legal proceedings brought against their former employer (the Employer), considered to be an employment termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

The Taxpayer’s employment with the Employer was terminated.

Within 12 months of the termination, the Taxpayer commenced proceedings in the Federal Circuit Court of Australia for unfair dismissal.

Subsequently, the Taxpayer and the Employer agreed to settle their dispute under a Deed of Settlement and Release (the Deed).

The terms of the Deed include the following:

● Upon receipt of the signed Deed, the Employer will pay to the Taxpayer an amount (the Gross Settlement Sum).

● Gross Settlement Sum means the sum made up of the following component sums:

a. the sum of the back payment of underpaid wages including interest;

b. compensation for loss that the Taxpayer has suffered as a result of the Employer’s contraventions related to the termination of the Taxpayer’s employment;

c. compensation for future loss including interest;

d. compensation for non-economic loss including interest;

e. penalties; and

f. miscellaneous.

The Taxpayer is under 60 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 82-10

Income Tax Assessment Act 1997 subsection 82-10(1)

Income Tax Assessment Act 1997 subsection 82-10(2)

Income Tax Assessment Act 1997 subsection 82-10(3)

Income Tax Assessment Act 1997 subsection 82-10(4)

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 subsection 82-130(1)

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

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

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 section 82-140

Income Tax Assessment Act 1997 section 82-145

Income Tax Assessment Act 1997 section 82-150

Income Tax Assessment Act 1997 section 82-155

Income Tax Rates Act 1986 Schedule 7

Superannuation Industry (Supervision) Regulations 1994 subregulation 6.01(2)

Reasons for decision

Summary

The following components of the Gross Settlement Sum are employment termination payments (ETPs) as defined in section 82-130 of the ITAA 1997 and are taxed accordingly:

a) compensation for loss that the Taxpayer has suffered as a result of the Employer’s contraventions related to the termination of the Taxpayer’s employment;

b) compensation for future loss including interest;

c) compensation for non-economic loss including interest;

d) penalties; and

e) miscellaneous.

The amount representing the back payment of underpaid wages and interest is not an ETP. This amount is ordinary income of the Taxpayer and is taxed accordingly.

Detailed reasoning

Employment termination payments

In accordance with subsection 82-130(1) of the ITAA 1997, a payment is an ETP 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.

To be an ETP, a payment must satisfy all the conditions in subsection 82-130(1) of the ITAA 1997. Failure to satisfy any one of the conditions under subsection 82-130(1) will result in the payment not being treated as an ETP.

Payment received in ‘consequence of’ the termination

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 the 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 contains references to repealed provisions, some of which may have been rewritten, the ruling still has effect 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 paragraphs 5 and 6 of TR 2003/13, the Commissioner states:

5. ... 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.

Relevantly, at paragraph 31 of TR 2003/13, the Commissioner considers payments made to settle wrongful dismissal and 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.

Based on the above, we consider that the following components of the Gross Settlement Sum were paid to the Taxpayer in consequence of the termination of their employment:

a) compensation for loss that the Taxpayer has suffered as a result of the Employer’s contraventions related to the termination of the Taxpayer’s employment;

b) compensation for future loss including interest;

c) compensation for non-economic loss including interest;

d) penalties; and

e) miscellaneous.

The above amounts represent a portion of the amount paid to the Taxpayer to settle unfair dismissal proceedings brought by them against the Employer. While the settlement of the legal proceedings is a direct cause of the payment, the proceedings were commenced by the Taxpayer as a result of the termination of their employment. That is, there was a sequence of events following the termination which had a relationship and connection which ultimately led to the payment of these amounts. In other words, but for the termination, these amounts would not be paid to the Taxpayer. Therefore, it is our view that these amounts were received by the Taxpayer in consequence of the termination of their employment.

The amount that represents the back payment of wages and interest was paid to the Taxpayer as a result of an underpayment of wages over a period of time and not as a result of the termination of their employment. This amount would have been payable to the Taxpayer whether their employment was terminated or not. As such, we do not consider that this amount was paid in consequence of the termination of the Taxpayer’s employment.

As stated above, a payment will be an ETP only if all the conditions in subsection 82-130(1) of the ITAA 1997 have been met. As one of the conditions under subsection 82-130(1) of the ITAA 1997 has not been met, the amount of back payment of wages and interest is not an ETP as defined in subsection 82-130(1) of the ITAA 1997.

The amount of back payment of wages and interest is ordinary assessable income and is taxed accordingly.

Payment received within 12 months of termination

The Taxpayer’s employment was terminated and payment was made to the Taxpayer more than 12 months after the termination. Therefore, the condition in paragraph 82-130(1)(b) of the ITAA 1997 is not met.

However, subsection 82-130(4) of the ITAA 1997, as far as relevant, provides that paragraph 82-130(1)(b) of the ITAA 1997 does not apply if a person is covered by a determination under subsection 82-130(7) of the ITAA 1997.

In accordance with subsection 82-130(7) of the ITAA 1997, the Commissioner may, by legislative instrument, determine that paragraph 82-130(1)(b) of the ITAA 1997 does not apply to either or both:

(a) a class of payments;

(b) a class of recipients of payments.

To that effect, the Commissioner has issued a legislative instrument SPR 2007-1 - Employment Termination Payments (12 month rule) (SPR 2007-1) which extends the definition of ETP to include certain payments that are received more than 12 months after the termination of a person's employment if the delay in the payment was due to the commencement of legal action concerning either or both:

(a) the person's entitlement to the payment;

(b) the amount of the person's entitlement.

The legal action must have commenced within 12 months of the termination of a person's employment. Legal action is intended to cover any Court, Tribunal and other proceedings of a judicial or quasi-judicial nature which may result in the payment of an amount in consequence of the termination of a person's employment.

In this case, SPR 2007-1 applies to the payment because the legal proceedings concerning their entitlement to the payment commenced less than 12 months after the termination. Accordingly, the payment is exempt from the 12 month rule in paragraph 82-130(1)(b) of the ITAA 1997.

Further, the settlement sum received by the Taxpayer is not a payment excluded from being an ETP under section 82-135 of the ITAA 1997.

In view of the above, all the amounts of the Gross Settlement Sum, except the amount of back payment of underpaid wages and interest are ETPs as defined in section 82-130 of the ITAA 1997 and are taxed accordingly.

Taxation of ETPs

An ETP may be made up of two components: the ‘tax-free component’ and the ‘taxable component’.

In accordance with subsection 82-10(1) of the ITAA 1997, the tax free component of an ETP is not assessable income and is not exempt income. That is, it is tax-free.

Section 82-140 of the ITAA 1997 states that the tax free component of an ETP consists of the invalidity segment of the payment and the pre-July 83 segment of the payment.

In accordance with section 82-145 of the ITAA 1997, the taxable component of an ETP is the amount of the payment less the tax free component.

The meaning of invalidity segment of an ETP is found in section 82-150 of the ITAA 1997; and the meaning of pre-July 83 segment is found in section 82-155 of the ITAA 1997. In this case, neither the conditions in section 82-150 nor the conditions in 82-155 are met, therefore, the payment received by the Taxpayer does not consist of a tax free component. That is, the payment consists entirely of the taxable component.

The taxable component of an ETP is assessable income in accordance with subsection 82-10(2) of the ITAA 1997. However, subsection 82-10(3) of the ITAA 1997 provides that a tax offset applies to ensure that the rate of income tax on the amount mentioned in subsection 82-10 (4) of the ITAA 1997 does not exceed:

(a) if you are your *preservation age or older on the last day of the income year in which you receive the payment-15%; or

(b) otherwise-30%.

*To find definitions of asterisked terms, see the Dictionary, starting at section 995-1

Subsections 82-10(4) and (5) of the ITAA 1997 outline how the relevant amount is worked out. According to these subsections, the amount is either:

a. the ‘ETP cap amount’ reduced by the amount of any earlier ETPs received in the same income year, or

b. the lessor of:

i. the ETP cap amount (reduced by the amount of any earlier ETPs received in the income year); and

ii. the ‘whole-of-income cap amount’ (being $180,000 minus other taxable income earned throughout the income year).

In accordance with Schedule 7 of the Income Tax Rates Act 1986, any part of the taxable component that exceeds the ETP cap amount (the ‘employment termination remainder’) is taxed at the top marginal rate.

Preservation age is defined in subregulation 6.01(2) of the Superannuation Industry (Supervision) Regulations 1994 and, for a person born after 30 June 1964, is 60 years.

ATO view documents

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’.

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