Edited version of private advice

Authorisation Number: 1051859191837

Date of advice: 19 July 2021

Ruling

Subject: Employment termination payment

Question 1

Will the Commissioner exercise his discretion and issue a determination under paragraph 82-130(5) of the Income Tax Assessment Act 1997 1997 (ITAA 1997) that the time between the employment termination and the payment in question is reasonable, and that paragraph 82-130(1)(b) of the ITAA 1997 does not apply to you in respect of that payment?

Answer

Yes

Question 2

Is the lump sum representing the commutation of weekly entitlements to incapacity payments under the Act an ETP under section 82-130 of the ITAA 1997?

Answer

Yes

Question 3

Does any part of the lump sum represent an invalidity segment under section 82-150 of the ITAA 1997?

Answer

Yes

Relevant facts and circumstances

1.     You were employed with an employer (the Employer) until employment termination.

2.     During the time that you sustained physical, psychiatric and psychological injuries.

3.     From the date of your termination of employment you were in receipt of incapacity payments paid under an Act of Parliament (the Act).

4.     You have been unemployed since termination from the Employer.

5.     Details in relation to the Act have been supplied and they show that the Employer is liable to pay regular periodic payments to its employees who are incapacitated due to injury.

6.     A publication has also been supplied which details how the regular periodic payments were paid and that they are taxable as income related payments.

7.     You received letters from the relevant paying authority in relation the entitlement to the periodic payments.

8.     Your superannuation benefits were released on medical grounds.

9.     Details of medical certificates made in relation to you by two legally qualified medical practitioners have been provided.

10.  The relevant paying authority advised you of the lump sum payment under a section of the Act in response to your request to have the regular periodic payments commuted to a lump sum payment

11.  You received the lump sum payment.

12.  You received a PAYG payment summary (the summary) from the Employer which shows a gross payment from which tax was withheld.

13.  You are less than 55 years of age.

Relevant legislative provisions

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 Subsection 82-130(4)

Income Tax Assessment Act 1997 Subsection 82-130(5)

Income Tax Assessment Act 1997 Subsection 82-130(7)

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Subsection 82-10

Income Tax Assessment Act 1997 Section 82-150

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Question 1

Will the Commissioner exercise his ITAA 1997 that the time between the employment termination and the payment in question is reasonable, and that paragraph 82-130(1)(b) of the ITAA 1997 does not apply to you in respect of that payment?

Summary

The Commissioner has determined that the delay in payment in this case is reasonable given that it arose as a result of a determination made by the Act.

Accordingly, your request for the Commissioners determination under subsection 82-130(5) of the ITAA 1997 has been allowed, meaning that paragraph 82-130(1)(b) of the ITAA 1997 has no application in relation to the payment in question.

Detailed reasoning

Employment termination payments made on or after 1 July 2007

From 1 July 2007 the taxation treatment of payments made in consequence of the termination of any employment of the taxpayer has changed. These payments were formerly known as eligible termination payments. Now, these payments are treated as employment termination payments (ETP) where they are made within 12 months of the termination of the taxpayer's employment and they are not specifically excluded under section 82-135 of the ITAA 1997.

ETPs do not include payments for unused annual leave or unused long service leave; or the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

To qualify as an ETP, the payment must be received within 12 months of the taxpayer's termination of employment. Payments received outside 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.

ETPs made on or after 1 July 2007 will not be able to be rolled-over into a complying superannuation fund, complying approved deposit fund (ADF) or to a retirement savings account (RSA) provider.

To determine if the payment in your case constitutes an ETP, the conditions in section 82-130(1)(b) of the ITAA 1997 will need to be satisfied.

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

To qualify as an ETP, the payment must be received no later than 12 months after the termination of the taxpayer's employment (paragraph 82-130(1)(b) of the ITAA 1997). Also as noted previously, payments received more than 12 months after the termination of the employment do not qualify as ETPs and will be taxed as ordinary income at marginal tax rates under the terms of section 83-295 of the ITAA 1997.

However, by virtue of paragraph 82-130(4)(a) of the ITAA 1997, the 12 month rule prescribed in paragraph 82-130(1)(b) of the ITAA 1997 will not apply to you if they are covered by a determination made by the Commissioner under either subsection 82-130(5) or subsection 82-130(7) of the ITAA 1997.

82-130(7)

The Employment Termination Payments (12 months rule) Determination 2007 (SPR 2007/1) is a legislative instrument made by the Commissioner of Taxation pursuant to subsection 82-130(7) of the ITAA 1997. This instrument applies to ETPs received after 30 June 2007.

This instrument makes a payment received more than 12 months after termination of persons employment an ETP, if the delay in the payment was due to the commencement of legal action concerning either or both:

(a) the persons entitlement to the payment;

(b) the amount of the persons entitlement

and the legal action was commenced within 12 months of the termination of employment.

According to SPR 2007/1 Explanatory Statement, the legal action is intended to cover any Court, Tribunal, and other procedures of a judicial or quasi-judicial nature which may result in the payment in consequence of the termination of a person's employment.

In this case, based on the information provided, no legal action/proceedings were involved with your payment therefore subsection 82-130(7) of the ITAA 1997 has no application in your case.

82-130(5)

The Commissioner may determine, in writing, that paragraph (1)(b) does not apply to you if the Commissioner considers the time between the employment termination and the payment to be reasonable, having regard to the following:

(a) the circumstances of the employment termination, including any dispute in relation to the termination;

(b) the circumstances of the payment;

(c) the circumstances of the person making the payment;

(d) any other relevant circumstances.

Under section 118 of the Act, as the facts show, compensation is payable to an employee who is incapacitated for work as a result of an injury. The circumstances of employment termination in your case are provided in the facts of the case.

You received correspondence from the Employer whereby you were advised that a determination had been made under the Act that you were entitled to receive incapacity payments where you have been incapacitated for work.

Under the Act, current or former employees of the Employer may be entitled to commute their weekly incapacity payments to a lump sum. As noted there are additional conditions to be satisfied under the Act, those additional conditions require the person to be either engaged in work, be in receipt of a pension under a super fund or have received a lump sum under a super fund.

In your case the early release of your preserved benefit on medical grounds was received by you as a lump sum thereby satisfying the requirement in the Act.

In a letter from the Employer you were notified that your request that your incapacity payments be redeemed was successful and that you had met the provisions under the Act. You were further advised the Employer had ceased your weekly compensation payments and you would receive the lump sum payment plus weekly payments already accrued within the current fortnightly pay period.

The Employer, who made the payment, did so under the Act. This along with the fact that the gross weekly amounts were less than the legislative threshold indicate that there was no agreement between the parties involved to merely postpone the payment. This also supports your claim for the Commissioner's discretion under subsection 82-130(5) of the ITAA 1997.

We are satisfied that although your lump sum you received is in effect the redemption of regular incapacity payments made to you by the Employer, the facts provide at least some support for your contention that the Commissioner should exercise his discretion under subsection 82-130(5).

Having regard to all of the above, both individually and together, the Commissioner has determined that the delay in payment in this case is reasonable given that it arose as a result of a determination made by the Employer under the Act.

Accordingly, your request for the Commissioners determination under subsection 82-130(5) of the ITAA 1997 has been allowed, meaning that paragraph 82-130(1)(b) of the ITAA 1997 has no application in relation to the payment in question.

Question 2

Is the lump sum representing the commutation of weekly entitlements to incapacity payments under the Act an ETP under section 82-130 of the ITAA 1997?

Summary

The lump sum payment that you received is an ETP under section 82-130 of the ITAA 1997.

Detailed reasoning

Employment termination payment

It is noted that the circumstances relating to the commutation of your weekly incapacity payments to a lump sum are similar to those in FC of T v Pitcher FCA 1154; (2005) ATC 4813; (2005) 60 ATR 424 (Pitcher).

In Pitcher's Case, Ryan J held that the commutation of weekly payments to a lump sum, which were made pursuant to section 30 of the Safety, Rehabilitation and Compensation Act 1988 (SRCA), was an ETP.

Unlike Pitcher's Case, which considered whether a lump sum payment was an ETP within the meaning of section 27A of the Income Tax Assessment Act 1936 (ITAA 1936), it must be determined in your case whether the lump sum payment you received is an 'employment termination payment' (as from 1 July 2007, the taxation treatment of payments made in consequence of the termination of any employment of the taxpayer, formerly known as eligible termination payments (ETPs), changed).

Section 995-1 of the 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.

To determine if the lump sum (the payment) paid to you constitutes an ETP, all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

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

Paid as a consequence of the termination of 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 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) 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.

In your case, you were medically terminated from employment due to medical injuries sustained by you during your employment.

Subsequently you commenced to receive incapacity payments under the Act. Incapacity payments are payments for economic loss due to the inability to work because of injury or disease that has been accepted as service related under the Act.

Under the Act, as the facts show, compensation is payable to an employee who is incapacitated for work as a result of an injury.

Further, these compensation payments, incapacity payments, are made to the employee for each week after the date of retirement during which the employee is incapacitated.

In view of the above it is clear that the weekly incapacity payments made to you, notwithstanding that they are of an income nature, were in consequence of a termination of employment.

In relation to the lump sum payment you received, which was made in accordance with the Act and represents the redemption of the regular incapacity payments to a lump sum, it is considered that there is a nexus between that payment and the termination of your employment.

The incapacity payments were the result of a sequence of events that followed the termination of your employment on medical grounds and they were connected with the lump sum paid by way of redemption. The redemption by a lump sum of future entitlements was the final payment made to you in consequence of the termination of your employment.

It follows, therefore, that the amount was made in consequence of the termination of your employment. Consequently, 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 be an employment termination payment under paragraph 82-130(1)(b) of the ITAA 1997 is that the employment termination payment is paid to the taxpayer no later than 12 months after the taxpayer's employment was terminated. However, in certain circumstances, where the payment is made outside 12 months there is an exemption from the 12 month rule under subsection 82-130(4) of the ITAA 1997.

The Commissioner has made a determination under subsection 82-130(5) of the ITAA 1997, meaning that paragraph 82-130(1)(b) of the ITAA 1997 has no application in relation to the payment in question.

Exclusions under section 82-135 of the ITAA 1997

Paragraph 82-130(c) of the ITAA 1997 specifies that one of the conditions for a payment to be an employment termination payment is that it is not to be one of the types of payments mentioned in section 82-135 of the ITAA 1997 (payments that are not employment termination payments).

Section 82-135 of the ITAA 1997 includes payments such as pensions, foreign termination payments, unused annual leave and unused long service leave, a capital payment for personal injury and the tax-free part of genuine redundancy payments or early retirement scheme payments.

In your case consideration must be given as to whether the personal injury suffered by you is covered by the specific exemption for personal injury in subsection 82-135(i) of the ITAA 1997. This subsection states that employment termination payments do not include:

(i) 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 the taxpayer for or in respect of a particular injury.

In Pitcher's case, the taxpayer was compulsorily retired from the Employer on medical grounds and was in receipt of weekly compensation payments which were redeemed and the taxpayer received a lump sum.

In Pitcher it was confirmed that the weekly payments of compensation paid to the taxpayer pursuant to the SRC Act were income. Further, it was stated by Justice Ryan:

The payment of the redemption payment followed on from the termination of the respondents employment and was paid to the respondent pursuant to s 30 of the [SRC] Act as a lump sum in substitution for the right to receive weekly compensation payments. It therefore constituted income according to ordinary concepts as representing the present value of that future income and a substitute therefore;

In view of the above and the similarities between your case and Pitcher it is considered that the lump sum payment paid you was not in relation to an injury but represents a substitution for the right to receive weekly compensation payments, payments which are of an income nature.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the lump sum payment.

Therefore, the payment meets all the conditions in section 82-130 of the ITAA 1997 and is an ETP.

Question 3

Does any part of the lump sum represent an invalidity segment under section 82-150 of the ITAA 1997?

Summary

The payment is an ETP which includes an invalidity segment under section 82-150 of the ITAA 1997 as:

• the payment is made to you because you stopped being gainfully employed;
• you stopped being gainfully employed because you suffered from ill-health;
• your employment stopped before your last retirement day; and
• 2 legally qualified medical practitioners have certified that, because of ill-health, it is unlikely that you can ever be gainfully employed in a capacity for which you are reasonably qualified because of education, experience or training.

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.

From 1 July 2007, the taxation treatment of payments made in consequence of the termination of any employment of a taxpayer has changed. Payments, formerly known as eligible termination payments, are now called employment termination payments.

As determined above, the lump sum payment satisfies all the requirements in section 82-130 of the ITAA for it to be considered an employment termination payment.

Invalidity segment

Subsection 82-150(1) of the ITAA 1997 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 of the ITAA 1997 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.

You were an employee of the Employer until your termination on medical grounds. It was during this period that you sustained the injuries which resulted in your termination from the Employer.

Payment for stopping gainful employment

The payment was made to you because your employment as a member of the Employer was terminated on medical grounds.

Your retirement on medical grounds was made by the Employer under the Actbecause you were medically unfit. The subsequent incapacity payment received by you from the Employer would not have been approved and paid unless your employment with the Employer was terminated.

Accordingly, this requirement has been satisfied.

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

The requirement under paragraph 82-150(1)(b) of the ITAA 1997 is that the termination of employment resulted from the taxpayer's ill health, that is, the ill health was the immediate cause for the termination of the taxpayers employment.

In this case, the facts show the termination of employment occurred after a decision was handed down by the Employer which stated that you were to be terminated from the Employer under the Act, including unfitness because of mental incapacity. You were subsequently medically terminated.

This indicates that you were unable to resume your normal work duties due to your medical incapacity. Therefore, it is considered that this requirement has been satisfied.

The termination of employment of the taxpayer occurred before the last retirement date in relation to the employment

The third condition for a payment to qualify as an invalidity segment is that the termination of employment occurs before the taxpayer's last retirement day.

The term 'last retirement day' is defined in section 995-1of the ITAA 1997 as follows:

last retirement day means:

(a) if an individual's employment or office would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be); or.

(b) in any other case - the day on which he or she would turn 65.

Your last day of service with the Employer was before the normal retirement age of 65.

Therefore, the condition set out under paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied.

Certification from 2 legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed

In respect of this requirement, it must be demonstrated that the disability was such that It is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

Therefore, paragraph 82-150(1)(d) of the ITAA 1997 requires that there must be the likelihood that the disability of the taxpayer will preclude the taxpayer from ever being employed in a role, for which the taxpayer is reasonably qualified.

Further, the requirement that the disability is likely to result in the taxpayer being unable ever to be employed in a capacity for which he or she is reasonably qualified extends to full-time employment, part-time or casual employment. A person who is not able to work full-time but can work part-time or casual in any employment for which the taxpayer is reasonably qualified will not receive the concessional component.

In your case, two qualified medical practitioners have certified in two separate medical certificates that you are suffering from a medical condition which in their opinion states that you are unable to return to work on a long term indefinite basis.

Therefore, after examining the contents of the medical reports provided it is considered that the two reports satisfy the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997.

Tax exemption for an invalidity payment

Under section 82-140 of the ITAA 1997 the invalidity segment included in an employment termination payment is tax free.

An employment termination payment made after 1 July 2007 may be comprised of the following components:

•        Tax free component this includes the invalidity segment or pre-July 83 component (if any); and

•        Taxable component the amount remaining after deducting the tax free component from the total payment.

Conclusion

As you have satisfied the requirements for the payment of an invalidity payment, an element of the employment termination payment received from the Employer will be tax free.

The amount of the invalidity segment is worked out by applying the formula in subsection 82-150(2) of the ITAA 1997:

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

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.

Therefore, the amount is the invalidity segment included in the employment termination payment which is tax free. The remaining amount is a taxable component to be included in your income tax return.

As your employment commenced after 30 June 1983 there will not be any pre-July 83 segment.

Conclusion

You have satisfied all of the above conditions. Therefore your assessment will include the ETP and a tax free invalidity component.

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