Edited version of your written advice

Authorisation Number: 1051484982015

Date of advice: 13 March 2019

Ruling

Subject: Employment termination payment- settlement

Question

Are the payments paid to your client assessable as an employment termination payments 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

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Relevant facts and circumstances

Your client was born in the 195X year.

Your client commenced employment with the Employer in a consultancy capacity in 200X.

Your client’s consultancy work with the Employer was through another company where your client was the sole director, employee and shareholder of this company.

In 20XX the Employer recognised your client as an employee.

A Deed of Settlement, Termination and Release (the Settlement) was executed in 20XXbetween your client, the Employer and your consultancy company.

The Settlement states that your client’s employment with the Employer would be for five months and would end in the 20XX-XX income year.

A Contract of Employment (the Contract) was also signed in 20XX between your client and the Employer.

The Contract states that your client is an employee and in the position of General Manager with a commencement and cessation date of five months.

The Settlement acknowledges your client’s past consultancy work and states that your client ought to have been treated as an employee of the Employer from mid- 20XX.

You provided the ATO with a copy of the Settlement Document as well as the Contract of Employment documents. This described the settlement sums and termination.

A Termination Pay Calculation- Payslip Summary was provided which confirmed that a lump sum payment was paid to your client by the Employer in the 20XX-XX income year.

A Payslip was provided which confirmed that an amount was paid to your client by the Employer in the 20XX-XX income year.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 27A(1).

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 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 Section 82-135

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

Detailed reasoning

Summary

The Settlement Sum paid by the Employer to your client is an Employment Termination Payment (ETP) for the purposes of Division 82 of the Income Tax Assessment Act 1997 (ITAA 1997).

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

The taxable component of the payment is assessable income and must be declared in your client’s income tax return for the relevant income year.

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, there was a dispute between your client and the Employer regarding your client’s employment. The Settlement Agreement and Employment Contract was a result of this dispute.

In relation to your client’s matter you have provided both the Settlement and the Contract which is signed by the parties. Under the Settlement your client was paid an amount (the Payment). As part of the Settlement your client was acknowledged as an employee as well as your client’s period of employment being determined with the settlement amount being payable on your client’s cessation date which was determined as a date in 20XX. Under the Contract your client was paid the Payment which was determined as a bonus upon meeting KPI’s and was payable on a date in 20XX, which was also your client’s cessation of employment.

The Courts have held that amounts arising from actions that are connected with the termination of employment are payments made in relation to the taxpayer in consequence of the termination of their employment. Therefore there is a causal connection between the termination of your client’s employment and the Payments.

Given the nature of the dispute, the Settlement, the Contract, the termination of employment and the Payments, it is considered they are all intertwined and connected.

Based on the Commissioner's views expressed in TR 2003/13, the facts presented demonstrate a connection or a link exists between the termination of your employment and the payments. Your client would not otherwise have received the payment except for the termination of their employment.

Consequently, the Payments are considered to be an employment termination payment in accordance with subparagraph 82-130(1)(a)(i) of the ITAA 1997 and is assessable as an employment termination payment to the extent that it is not specifically excluded under section 82-135 of the ITAA 1997.

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, being XX XXXX 20XX. The Settlement Sum was received by the Taxpayer on XX XXXX 20XX.

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.

Exclusions 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 includes payments such as pensions, foreign termination payments, unused annual leave and unused long service leave and the tax free part of genuine redundancy payments or early retirement scheme payments. As well as other types of payments which are not considered to be employment termination payments.

The Settlement payment was related to the parties agreeing to settle all matters regarding the provision and termination of consultancy services. Accordingly, paragraph 82-135(i) of the employment termination payment definition under section 82-135 of the ITAA 1997 does not apply to the Payment.

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

The Commissioner concludes that thee lump sum payments are an employment termination payment as it satisfies all of the relevant provisions as shown above.

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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