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Edited version of your written advice

Authorisation Number: 1051300636376

Date of advice: 7 November 2017

Ruling

Subject: Eligible termination payment

Question

Has your PAYG Payment Summary – Employment Termination Payment (ETP) dated early 2017 been issued with the correct ETP code of “O”?

Answer

Yes

This ruling applies for the following periods:

Income year ended 30 June 201Z

The scheme commences on:

1 July 201Y

Relevant facts and circumstances

You commenced employment with the Employer on a date in 201X.

During your employment you state that in the last XX months of your tenure, you were subjected to harassment from staff and certain officials of the Employer.

On a date in 201Y you met with a Chief Representative of the Employer. They indicated it would be best if you resigned.

You were asked to suggest a figure for the compensation settlement amount. At a later date the Chief Representative of the Employer offered a ‘compensation’ settlement.

You were informed that a Discharge Deed would be developed to outline the responsibilities of both parties and the ‘compensation’ to be paid. You were given a timeframe in which to decide whether to accept. You stated an amount was fair compensation for the harassment to which you had been subjected.

Subsequently the Deed was executed on a date in 201Y and the information accompanied your request has been included under the heading Recitals, clause D it states:

Under the heading 3 Payment and Benefits it states:

Heading 4 Release from claims further states in part:

On a date in 201Y a payment was made to your bank account which you then disputed with the Chief Representative who advised that your ‘release from the Employer was not a bona fide redundancy and therefore subject to a whole of income cap’.

On a date in early 201Z your legal representative wrote to the Employer and disputed the payment and tax treatment of the received amount. A reply to this letter was received from a law firm acting on behalf of the Employer on a date in early 201Z disputing incorrect taxing of the payment. They also reject that the ex-gratia payment was compensation on the basis that it was for general damages and the Employer does not admit any of the allegations made by you and the settlement terms agreed to were without any admission of liability.

You state that your case has similarities with An employee v Federal Commissioner of Taxation (2010) ATR 999; [2010] AATA 912 and that the ex-gratia payment was in fact compensation for the harassment you received by the Employer.

You are under 60 years of age.

Relevant legislative provisions

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

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(2)

Income Tax Assessment Act 1997 Subsection 82-135(i)

Income Tax Assessment Act 1997 Section 995-1

Income Tax (Transitional Provisions) Act 1997 Section 82-10

Reasons for decision

Summary

The payment made to you under the terms of the Deed is considered to be an ex-gratia payment and therefore an employment termination payment (ETP).

The payment is not considered to be compensation for harassment and therefore is not exempt from being an ETP.

The total amount is thus considered a taxable component and is to be included in your income tax return for the 201Y-ZZ income year as per the PAYG payment summary – ETP issued by the Employer with ETP code ‘O’.

Detailed reasoning

Employment termination payment

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that:

employment termination payment has the meaning given by section 82-130 of the ITAA 1997.

Subsection 82-130(1) of the ITAA 1997 states that:

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 that termination (but see subsection (4)); and

    (c) it is not a payment mentioned in section 82-135.

    Subsection 82-130(2) of the ITAA 1997 states:

A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies.

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

To determine if the total payment less the unused leave amount constitutes an ETP, all the conditions in section 82-130 of the ITAA 1997 must be satisfied.

Failure to satisfy any of the three conditions will result in the payment not being considered an ETP. Furthermore, any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule.

Essentially, section 82-130 of the ITAA 1997 states that for a payment to be a life benefit termination payment, it must be an employment termination payment made to the taxpayer in consequence of the termination of their employment.

Payment is made in consequence of the termination of your employment

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 Taxation Ruling TR 2003/13 the Commissioner has considered the meaning of the phrase ‘in consequence of’.

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) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 (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 my opinion necessary that the termination of the services should be the dominant cause of the payment.

While Justice Jacobs 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; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39 (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.

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'.

The Full Federal Court in Dibb v Federal Commissioner of Taxation [2004] FCAFC 126; (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786, has applied the above decisions in finding that the payment received by the taxpayer under a Deed of Release to settle various causes of action against the employer following the termination of employment was an ETP.

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 from 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. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135 of the ITAA 1997.

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 the facts of this case, you were employed by the Employer from a date in 201X until your resignation on a date in 201Y.

In the Deed executed on a date in 201Y, it was agreed between both parties of the cessation of your employment with the Employer and a settlement of all claims whatsoever arising out of, and in connection with, your employment and resignation.

The Employer agreed to pay you a gross sum less tax withheld subject to the terms and conditions under the Deed. The Deed stated this amount was as follows:

It is clear from the facts provided that the termination payment component being made to you is made as ‘in consequence of the termination of employment’. The termination and the payment are all intertwined and connected and the payment would not have been made but for the termination of employment. Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

The payment is received no later than 12 months after termination

The second condition for the payment to meet the criteria as an employment termination payment is that the payment must be received within 12 months of the termination of employment (paragraph 82-130(1)(b) of the ITAA 1997).

In your case, this condition has been satisfied as you ceased employment in 201Y and the ex-gratia payment was made to you in 201Y.

In view of the above, the final requirement for the payment to be an ETP is that the payment is not a payment mentioned in section 82-135 of the ITAA 1997.

Exclusions from being an employment termination payment

Certain payments made on termination of employment are excluded from being an employment termination payment under section 82-135 of the ITAA 1997.

In this case, consideration must be given as to whether the harassment claimed is covered by the specific exemption for personal injury in paragraph 82-135(i) of the ITAA 1997 (payments that are not employment termination payments).

Paragraph 82-135(i) states that employment termination payments do not include:

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);

This exclusion is for a payment or benefit that compensates or reimburses a person for or in respect of the particular injury.

In Commissioner of Taxation (Cth) v. Scully (Scully) the High Court, in considering former paragraph (n) of the definition of an eligible termination payment (ETP) in former subsection 27A(1) of the ITAA 1936 (former paragraph (n)),held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In considering the meaning of personal injury for the purposes of the former paragraph (n) exclusion, the Administrative Appeals Tribunal (AAT) has cited the decision by the Victorian Supreme Court in Graham v Robinson (Graham v. Robinson), in AAT Case 11,722, McMahon v Commissioner of Taxation (Cth) (McMahon) and, more recently, in Re Applicant and Federal Commissioner of Taxation, and held that personal injury does not extend beyond physical injury or mental illness.

The Victorian Supreme Court had to decide if emotional hurt (that is, hurt, distress, public scandal, hatred, odium, ridicule and contempt) was a personal injury in its decision in Graham v. Robinson, where Justice Smith stated at 281:

In the absence of express authority, I have come to the conclusion that the expression personal injury does not extend beyond physical injury and mental illness to include emotional hurt. I am encouraged to this view by the fact that the law has rejected grief or sorrow as a form of injury which can be relied on to mount a claim in negligence: Mount Isa Mines Ltd. v. Pusey (1970) 125 CLR 383, at p. 394 and Jaensch v. Coffey (1984) 155 CLR 549, at p. 587. It is true that damages are awarded for pain and suffering in the typical personal injury case. They are awarded, however, where pain and suffering flow from and are connected with physical or mental injury and may therefore be said to be damages in respect of personal injury.

Flowing from these decisions, it can be said that there are three types of injury a person can receive:

Notwithstanding it may be said all three types of injury may be personal, it is considered only the first type (that is, behavioural injury) falls within the meaning of the term personal injury as used in the paragraph (n) exclusion.

The decision in Graham v. Robinson was applied in McMahon in relation to a payment for alleged damage to a taxpayers reputation. In McMahon, a critical performance appraisal of McMahon and other comments were published in the media. Subsequent to this, McMahon’s employment was terminated and it was agreed to pay him certain amounts including an amount for the alleged damage to his reputation. Senior Member Block stated:

The tribunal also notes the stipulation in the concluding portion of s27A(1)(n) of the ITAA 1936 that the amount of consideration for personal injury is to be regarded as an ETP only to the extent that it is reasonable having regard to the nature of the injury and the taxpayers capacity to derive income from personal exertion. The tribunal considers that the inclusion by the legislature of the words from personal exertion tends to confirm that the section is intended to exclude from the definition of ETP payments in respect of injuries to the person, where such injuries being physical injuries or mental illnesses which have an assessable and identifiable impact on the capacity of the taxpayer to earn income. The tribunal considers in summary that an injury to person is distinguishable from an injury to a person’s reputation.

For the Reasons set out previously (and bearing in mind that the decision in Graham v. Robinson is binding on the tribunal), the reputation payment was not made in respect of personal injury within s27A(1)(n) of the ITAA 1936; accordingly the reputation payment was correctly assessable as an ETP.

To reiterate, for an amount to be excluded from the definition of an ETP by virtue of paragraph (n), there must be a behavioural type personal injury.

From 1 July 2007, paragraph (n) has been replaced by subsection 82-135(i) of the ITAA 1997. However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 stated, in relation to section 82-135 of the ITAA 1997, that:

consistent with current legislation, certain payments are prevented from qualifying as employment termination payments.

It is therefore appropriate to cite cases that refer to the previous legislation.

The payment in Scully was held not to be in respect of personal injury. Acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stated in their joint decision:

In our opinion, the payment in this case cannot be characterised as consideration... in respect of, personal injury. The fact that the payment is not calculated by reference to the nature and extent of the injury or likely loss to the respondent and the fact that the other benefits are similar to that for total and permanent disablement point inevitably to the conclusion that the payment was consideration... for, or in respect of the respondent's termination of employment and her rights under the Trust Deed and was not consideration... for, or in respect of her injury.

Accordingly, for an amount to meet the definition in subsection 82-135(i) of the ITAA 1997, the payment must be for personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In your case, the Employer entirely rejects that any of the ex-gratia payment should be categorised as compensation and not taxed, on the basis that it is for general damages.

Under the terms of the Deed, the Employer agreed, without admission of liability, to make an ex-gratia payment to you and you agreed to release the employer from all claims and liability arising out of or in connection with the employment and the cessation of your employment.

It follows, even if the harassment claimed by you amount to ‘personal injury’, there is no evidence to indicate that any part of the payment was calculated with regard to the nature and extent of your injury.

The ex-gratia payment is a single un-dissected lump sum payment which bears no relation to a capital payment for, or in respect of, personal injury to you.

Further, there is nothing to indicate that any part of the settlement sum has been calculated with regard to your likely loss of income producing capacity. Rather, the payment was simply made in full resolution of claims arising from or in relation to the dispute, the employment, the termination and any act or omission of the Employer during your employment.

Accordingly, it is considered that the ex-gratia payment was made to settle all matters and claims arising out of, or in connection with, your employment and for the cessation of your employment. The payment was not made in respect of any harassment.

In view of the above, paragraph 82-130(1)(c) of the ITAA 1997 is satisfied as the exclusion under paragraph 82-135(i) does not apply to the ex-gratia payment.

Consequently, the ex-gratia payment satisfies all the requirements in section 82-130 of the ITAA 1997 to be considered an ETP.

Tax treatment of an employment termination payment

The ex-gratia payment amount is an ETP as defined under subsection 82-130(1) of the ITAA 1997.

ETPs can comprise of two different components:

You only withhold tax from the taxable component.

Depending on the type of ETP, the concessional tax treatment may be limited to the smaller of:

The top rate of tax applies to amounts paid in excess of these caps.

The ETP payment summary has an ETP code that is used to describe the type of ETP and which cap has been applied to it. In your case the correct ‘O’ code has been used.

As your ex-gratia payment is not an excluded payment, we therefore need to apply the smallest of the ETP cap and the whole-of-income cap.

The following steps are used to work out smaller of the ETP cap and whole-of-income cap.

Therefore, the amount up to the whole-of-income cap is taxed at 17% and the amount above the whole-of-income cap is taxed at 47%

In respect to you stating your case having similarities with An employee v Federal Commissioner of Taxation (2010) ATR 999; [2010] AATA 912, the decision made was that the objection decision was affirmed. Therefore in that case it was ruled that the payment was considered an ETP within s82-130 of the ITAA 1997 and Division 82 made the taxable component of the payment assessable income, and nothing in s118-37 could undo that fact.

In any event, and for reasons similar to those just expressed in relation to s82-135, it is not possible to characterise the payment as “compensation or damages you receive for any wrong or injury you suffer in your occupation” or as “compensation or damages you receive for any wrong, injury or illness you or your relative suffers personally.

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