Edited version of private advice

Authorisation Number: 1051178368089

Date of advice: 09 January 2017

Ruling

Subject: employment termination payments

Question

Is a lump sum payment (the Settlement Sum) received by a person (the Taxpayer) in settlement of all claims and issues concerning the Taxpayer's employment with their former employer (the Employer) an employment termination payment (ETP) in accordance with section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following period:

Income year ending 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The Taxpayer suffered injuries in the course of their employment with the Employer.

As a consequence of their injuries, the Taxpayer received weekly payments of income support from an insurance company (the Insurer), on behalf of Return to Work South Australia.

Several months later, the Insurer determined to discontinue the weekly payments which were paid to the Taxpayer in consequence of the injuries they suffered.

The Taxpayer disputed the Insurer's decision to discontinue weekly payments by filing an application in the South Australian Employment Tribunal (the Tribunal).

The Taxpayer and the Employer agreed to resolve all claims and issues concerning the Taxpayer's employment under a Settlement Agreement (the Agreement).

In accordance with the Agreement:

• The Taxpayer will resign effective a specified date.
• Within 14 days of executing the Agreement, the Employer will pay to the Employee the Settlement Sum.
• Upon payment of the Settlement Sum, the Taxpayer forever releases and discharges the Employer from all claims against the Employer.

The Agreement will be executed when the Commissioner makes this private ruling.

The Taxpayer was born before 1 July 1960.

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 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 Settlement Sum to be paid to the Taxpayer in settlement of all claims and issues concerning the Taxpayer's employment with the Employer will be an ETP as defined in section 82-130 of the ITAA 1997.

Detailed reasoning

Employment termination payments

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

1. it is received by you:
   1. in consequence of the termination of your employment; or
   2. after another person's death, in consequence of the termination of the other person's employment; and
2. it is received no later than 12 months after that termination (but see subsection (4)); and
3. it is not a payment mentioned in section 82-135.

Paid 'in consequence of' the termination of employment

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Whilst the courts have divergent views on the meaning of this 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'.

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. 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.

In this case, the payment of the Settlement Sum is conditional on the termination of the Taxpayer's employment on the agreed date. That is, but for the termination, the payment will not be made. Therefore, it is considered that the payment will be made in consequence of the termination of the Taxpayer's employment.

Payment is received no later than 12 months after termination

In this case, it was agreed that the Taxpayer's employment would terminate effective a specified date and that Settlement Sum would be paid within 14 days of the Agreement being executed by the Taxpayer.

As the Agreement is to be executed when the Commissioner makes this ruling, the Settlement Sum will be paid within 12 months after the termination date. Therefore, this condition will be satisfied.

Payment is not a payment mentioned under section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 lists certain payments that are not ETPs, none of which apply in this case.

As the payment of the Settlement Sum is not excluded from being an ETP, this condition is satisfied.

Consequently, the Settlement Sum will be an ETP as defined in section 82-130 of the ITAA 1997.

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 meaningof 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 section 82-155 are met hence; the Settlement Sum does not consist of a tax free component. That is, the payment consists entirely of the taxable component.

In accordance with subsection 82-10(2) of the ITAA 1997, the taxable component of an ETP is assessable income. 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:

1. if you are your *preservation age or older on the last day of the income year in which you receive the payment-15%; or
2. 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:

1. the 'ETP cap amount' reduced by the amount of any earlier ETPs received in the same income year, or
2. the lessor of:
   1. the ETP cap amount (reduced by the amount of any earlier ETPs received in the income year); and
   2. 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 before 1 July 1960, is 55 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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