Edited version of private advice

Authorisation Number: 1051547868232

Date of advice: 15 July 2019

Ruling

Subject: Employment termination payment - invalidity segment

Question

Is any portion of the payment received by your client exempt from tax as an invalidity segment of an employment termination payment (ETP) in accordance with section 82-150 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

Your client is under 65 years of age.

Your client commenced employment with the employer on a full time basis a number of years ago.

As a result of your client's diagnoses they could no longer continue in this role.

The employer offered your client an arrangement to retire (which your client accepted), and then ceased employment.

Your client received a PAYG payment summary - employment termination payment, however no invalidity segment was shown on the summary or in the calculation estimate.

There is no time prior to your client reaching 65 years of age, where their employment would have been terminated under the terms and conditions of their employment.

Relevant legislative provisions

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 Section 82-130

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Section 82-140

Income Tax Assessment Act 1997 Section 82-150

Income Tax Assessment Act 1997 Section 995-1

All references are to the ITAA 1997 unless otherwise indicated.

Reasons for decision

Summary

A portion of the payment received by your client includes an invalidity segment under section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997).

The taxable component of the payment is subject to the ETP cap.

Detailed reasoning

Where a person's employment is terminated because of ill-health and the person receives an ETP, part of the payment may be tax-free. This component is called an invalidity segment.

Therefore, prior to determining if the payment includes an invalidity segment, the payment must be an ETP.

ETPs are defined in section 82-130 which states:

(1) 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 the termination (but see subsection (4)); and

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

Section 82-135 provides that certain payments are not ETPs, including:

·         payment for unused annual leave or unused long service leave;

·         the tax-free part of a genuine redundancy payment or an early retirement scheme payment;

·         capital payments for personal injury.

Therefore, it can be seen that three conditions need to be satisfied in order for the payment to be treated as an ETP.

Failure to satisfy any of the three conditions will result in the payment not being considered an ETP. Any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates.

Payment is received in consequence of the termination of employment

The first condition to be met is that there must be a payment that is made 'in consequence of the termination of employment of the individual'.

In this case, it is considered that the payment was made in consequence of the termination of your client's employment. Your client was unable to continue work due to their injury and made an application for a Voluntary Medical Retirement. The employer, after taking into account medical advice, approved your client's termination of employment on the grounds that they were permanently unfit to fulfil the requirements of their substantive position.

The payment received by your client from the employer would not have been approved and paid unless your client's employment was terminated and in this case the termination was based on medical grounds.

Therefore, the payment is considered to be received 'in consequence of' the termination of your client's employment. Accordingly, the condition in subparagraph 82-130(1)(a)(i) is satisfied.

Payment is received no later than 12 months after the termination

The second condition for the payment to meet the criteria, as an ETP under paragraph 82-130(1)(b), is that the ETP was paid to the taxpayer no later than 12 months after their employment was terminated.

The facts of this case show that the payment was made within 12 months after their employment was terminated and accordingly, paragraph 82-130(1)(b) has been satisfied.

Not a payment mentioned in section 82-135

As noted earlier section 82-135 provides that certain payments, such as superannuation benefits, payments for unused annual or long service leave, or capital payments for personal injury are not ETPs.

The termination payment is the result of a calculation of your client's severance payment owed to them as a result of their termination under the arrangement accepted. It is not a payment excluded under section 82-135.

As all the conditions under section 82-130 have been met, the payment received by your client is an employment termination payment.

Invalidity segment

Subsection 82-150(1) states that:

An employment termination payment includes an invalidity segment if:

(a) the payment was made to a person because he or she stops being gainfully employed; and

(b) the person stopped being gainfully employed because he or she suffered from ill-health (whether physical or mental); and

(c) the gainful employment stopped before the person's last retirement day; and

(d) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in capacity for which he or she is reasonably qualified because of education, experience or training.

Gainful employment

Section 995-1 defines being gainfully employed as follows:

gainfully employed means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment.

Until your client became ill, your client was gainfully employed on a full-time basis with the employer.

Payment for stopping gainful employment

As stated above, the payment is considered to be a payment made on the termination of your client's employment as it satisfied the conditions under subparagraph 82-130(1)(a)(i).

The employment termination occurred because of the ill-health of the person

The requirement in paragraph 82-150(1)(b) is that the termination of employment resulted from the person's ill-health, that is, their ill-health was the immediate cause for the termination of their employment.

In this case, the facts show the termination of your client's employment occurred after the employer considered a medical report which indicated your client was unable to resume normal work due to their impairments. Therefore, it is considered that this requirement is satisfied.

The termination of employment of the employee occurred before their last retirement date in relation to the employment.

To qualify as an invalidity component, a payment must be made before the person's last retirement date.

The payment was made well before your client's retirement age of 65. Therefore, the condition in paragraph 82-150(1)(c) has been satisfied.

Certification from 2 legally qualified medical practitioners that the disability is likely to result in the person being unable to be employed in a capacity for which they are reasonable qualified

Paragraph 82-150(1)(d) requires that there must be the likelihood that the disability of the person will preclude the person from ever being employed in a role, for which they are reasonably qualified.

Based on the facts of this case, the requirements of paragraph 82-150(1)(d) has been satisfied.

Accordingly, it is considered that section 82-150 has been satisfied and a portion of your client's employment termination payment includes an invalidity segment for the purposes of subsection 82-150(1).

Tax exemption for an invalidity payment

Under section 82-140 the invalidity segment included in an employment termination payment is tax free.

The amount of the invalidity segment is worked out by applying the formula in subsection 82-150(2).

Work out the amount of the invalidity segment by applying the following formula:

Amount of *ETP x Days to retirement

Employment days + Days to retirement

Where:

days to retirement is the number of days from the day on which the person's employment was terminated to the *last retirement day.

employment days is the number of days of employment to which the payment relates.

Taxation of life benefit termination payments

As mentioned previously, whilst the taxable component of the payment is assessable income, your client is entitled to a tax offset in accordance with subsection 82-10(3).

As per subsection 82-10(4) the taxable component of the payment in your client's case is also subject to the ETP cap. The ETP cap for the 2016-17 income year was $XXX,000.

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