Edited version of your written advice

Authorisation Number: 1051450911068

Date of advice: 9 November 2018

Ruling

Subject: Employment termination payment- settlement

Question

Is any part of the payment made to a person (the Taxpayer) assessable as 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 2018

The scheme commences on

1 July 2017

Relevant facts and circumstances

The Taxpayer commenced employment with an entity (the Employer) less than five years ago.

Less than two years ago, the Taxpayer filed a Workers Compensation claim alleging harassment by the entity’s owner (the Company Owner).

Shortly afterwards, the Taxpayer filed a separate claim (the Claim).

Subsequently, the Taxpayer filed for an Interim Restraining Order against the Company Owner.

A month later, the Taxpayer filed a claim with the Office of the Anti-Discrimination Commissioner (the Claim).

On the same day, the Taxpayer also lodged a complaint against the Employer with the Fair Work Ombudsman.

A few months later, the Taxpayer was advised by their Insurer (the Insurer) that their claim for Workers Compensation had been accepted, and that the Employer had been instructed to commence weekly payment.

A month later, the Court ordered a Restraining Order against the Company Owner.

A year later, the Taxpayer and the Employer entered into a Deed (the Deed) to settle the claims made against the Employer.

The terms of the Deed provide, in part, that:

(a) The Employer will pay to the Taxpayer a Settlement Sum providing that:

● the Taxpayer executes the Deed.

● the Taxpayer provides a letter of resignation to the Employer, effective from the date that the Deed is signed.

● The Taxpayer withdraws the Claim.

The Taxpayer received the Settlement Sum in the 2017-18 income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 995-1

Income Tax Assessment Act 1997 Section 118-A

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 118-22

Income Tax Assessment Act 1997 Section 82-130

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

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

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 Section 82-135

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

Reasons for decision

Summary

The Settlement Sum that was paid by the Employer to the Taxpayer is an ETP for the purposes of Division 82 of the ITAA 1997. Consequently, the payment is not a capital payment or a payment in respect of personal injury.

To the extent that the payment consists of a tax free component, it is not assessable income and is not exempt income.

The total amount is a taxable component of an employment termination payment and is to be included in your income tax return for the 2017-18 income year,

Detailed reasoning

Employment termination payment

A payment made to an employee is an employment termination payment if the payment satisfies all the requirements in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997) and is not specifically excluded under section 82-135.

In accordance with section 82-130 of the ITAA 1997, a payment is 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 that termination (but see subsection (4)); and

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

In consequence of 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' (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. The question of whether a payment is received in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

In the present case, to settle the Claim, the Taxpayer was required to withdraw their claim and terminate their employment with the Employer on a specified date. Following the termination, the Settlement Sum was to be paid.

Although one of the dominant causes of the payment is to settle the Claim initiate by the Taxpayer, there is a causal connection between the termination of employment and the payment of the Settlement Sum. In this case, the termination is one of the pre-conditions for the payment.

Based on the Commissioner’s views expressed in TR 2003/13, there is, in this case, a clear connection between the termination of the Taxpayer’s employment and the payment of the Settlement Sum. That is, but for the termination, the Settlement sum would not be paid to the Taxpayer.

Consequently, the payment of the Settlement Sum is ‘in consequence of’ the termination of the Taxpayer’s employment with the Employer.

The 12 month rule set out in paragraph 82-130(1)(b) of the ITAA 1997:

Paragraph 82-130(1)(b) of the ITAA 1997 specifies that the payment must be received within 12 months of the employee’s termination of employment, unless they are covered by a determination exempting them from the ‘12 month rule’.

As shown in the facts, the Taxpayer’s employment was terminated once they signed the Deed. The Settlement Sum was received by the Taxpayer a month later.

Accordingly, as the Payment was made within 12 months of the termination of your employment, the requirement in paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied.

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

The condition specified in paragraph 82-130(1)(c) of the ITAA 1997 is that an employment termination payment does not include a payment mentioned in section 82-135 of the ITAA 1997.

Section 82-135 of the ITAA 1997 lists certain payments that are not ETPs.

Relevantly, subsection 82-135(i) of the ITAA 1997 mentions a capital payment for, or in respect of, personal injury to a person so far as the payment is reasonable having regard to the nature of the personal injury and its likely effect on a person’s capacity to derive income from personal exertion.

The exclusion under paragraph 82-135(i) of the ITAA 1997 is for a payment or benefit that compensates or reimburses the taxpayer for or in respect of the particular injury. IT 2424 Income tax: compensation payments in respect of unlawful acts of discrimination states that payments for personal injury are not liable to income tax and are capital in nature. However IT 2424 also states that if dismissal is part of the settlement, then a compensation payment may qualify as a termination payment and subject to special taxation treatment. Whether a particular payment of compensation is assessable depends on the facts of each given case.

In this instance, the Settlement Sum was not paid to the Taxpayer for personal injury suffered by the Taxpayer. Rather, it was paid in order to resolve a dispute with the Employer.

Accordingly, paragraph 82-135(i) of the employment termination payment definition under section 82-135 of the ITAA 1997 does not apply to the Settlement Sum.

In view of the above and the information provided, it is clear that the Settlement Sum does not include any payment mentioned in section 82-135 of the ITAA 1997.

Therefore, the Commissioner considers that the Settlement Sum is an employment termination payment.

Taxation of employment termination payments

An ETP made may be comprised of the following components:

● the tax fee component; and

● the taxable component

Subsection 82-10(1) of the ITAA 1997, states that the ‘tax free component’ of a life benefit termination payment is not assessable income and is not exempt income.

Tax free component is defined in section 82-140 of the ITAA 1997 as so much of the ETP as consists of the following:

(a) the invalidity segment of the payment with the meaning of section 82-150 of the ITAA 1997;

(b) the pre-July 83 segment of the payment within the meaning of section 82-155 of the ITAA 1997.

Based on the information provided, it is unlikely that the Settlement Sum will consist of a tax free component. That is, the payment will consist entirely of the taxable component.

Accordingly, the entire Payment is a taxable component of an employment termination payment as defined in section 82-145 of the ITAA 1997.

Taxable component

Pursuant to section 82-10(2) of the ITAA 1997, the taxable component of a life benefit ETP is assessable income.

In accordance with section 82-145 of the ITAA 1997, the taxable component of an ETP is the amount remaining after deducting the tax free component from the total payment.

For recipients below preservation age, the taxable component of an ETP is taxed at 30% for amounts below the ETP cap amount ($200,000 for the 2017-18 income year), and at the top marginal rate for amounts above the cap (subsection 82-10(3) of the ITAA 1997).

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