Edited version of private advice

Authorisation Number: 1051873518138

Date of advice: 2 August 2021

Ruling

Subject: Lump sum payments

Question 1

Will the Settlement payment which included $X (pain and suffering) made to you by the employer, be considered to be an employment termination payment (ETP) as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the Settlement payment which included $X (pain and suffering) be included in your assessable income under section 6-5 of the ITAA 1997?

Answer

No.

Question 3

Is the receipt of $X included in your assessable income under section 6-5 of the ITAA 1997?

Answer

No.

Question 4

Is the receipt of the $X included in your assessable income under section 15-2 of the ITAA 1997?

Answer

Yes

Question 5

Is the receipt of the $X included in your assessable income under section 15-2 of the ITAA 1997?

Answer

Yes.

Question 6

Is any capital gain made on the receipt of the $X reduced to $nil?

Answer

Yes.

Question 7

Is any capital gain made on the receipt of the $X reduced to $nil?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You lodged several complaints in relation to conduct and compliance issues that affected you personally with the employer in relation to your claims of intimidation, harassment, threats and/or inappropriate behaviour.

The employer did not take any disciplinary action in relation to these matters and your health was impacted, with you experiencing regular headaches, bloody nose, sleeplessness, heightened feelings of stress and anxiety, depression and physical illness.

Your employment ended due to you being made redundant and you were paid amount/s in relation to your redundancy.

A Statement of Claim was filed in the Federal Court of Australia (file number XXXXXXXX)

The Court Proceedings were finalised once the Deed was executed and they ended.

The employer issued a PAYG payment summary for the income year ending 30 June 20XX which included the following information:

•         Period of payment - 1 July 20XX to 1 July 20XX

•         Gross payments - $X, Type S.

The employer issued a Pay As You Go payment summary - employment termination payment for the income year ending 30 June 20XX which included the following information:

•         Date of payment

•         Total tax withheld

•         Taxable component

•         Eligible termination payment (ETP) code - S.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 15-2

Income Tax Assessment Act 1997 Section 82-130

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

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 (c)

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

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

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Detailed reasoning

In relation to the $X portion of the payment, for this payment received from your employer to be considered an ETP, it must satisfy the definition of an ETP set out in subsection 82-130(1) 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 termination (except for situations mentioned in subsection (4)); and

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

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

Paragraph 82-130(1)(c) states that any payments listed in section 82-135 of the ITAA 1997 are not classified as ETPs.

Section 82-135 of the ITAA 1997 lists examples of payments which are not ETPs.

Based on the nature of the injuries you suffered when working with the employer, we must give consideration to whether or not any part of the lump sum you will receive contains a reasonable capital payment for personal injury as per paragraph 82-135(i) of the ITAA 1997.

Paragraph 82-135(i) of the ITAA 1997 states that an employment termination payment does 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);

Payments that fall within this exclusion are payments or benefits that compensate or reimburse the person for or in respect of the particular injury.

In considering whether the payment of $X for pain and suffering falls within the exclusion set out in paragraph 82-135(i), consideration must turn to whether you had a 'personal injury', what this payment was actually paid for and whether the payment is reasonable having regard to the nature of the personal injury and its likely effect on one's capacity to derive income from personal exertion.

Personal injury

The term 'personal injury' is not defined in the income tax legislation. However, the term has been interpreted by the Administrative Appeals Tribunal (AAT) in several cases.

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

a)    behavioural injury - one that involves physical injury (internal and/or external) and/or mental injury that is clearly discernible to a qualified medical practitioner;

b)    non-behavioural injury - hurt, distress, anxiety, et cetera., that flows from the death of, or serious injury to, a relative or close friend; wrongful dismissal; defamation; et cetera. This type of injury may have legal remedies under the law of torts (for example, defamation, slander), statute (for example, sexual harassment, discrimination), or contract (for example, employment, professional negligence); and

c)    property injury - damage to a person's property.

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.

In view of the above, paragraph 82-135(i) operates to exclude the entire amount of $X from being an ETP. Therefore, the requirement under paragraph 82-130(1)(c) is not satisfied.

Consequently, no part of the payment of $X is considered to be an ETP, because the payment is specifically excluded under section 82-135.

There is an order to be followed when considering the potential application of remuneration related provisions in relation to received payments as follows:

•         Termination payments (Divisions 80 to 83 of the ITAA 1997)

•         Ordinary income (Section 6-5 of the ITAA 1997)

•         Other remuneration benefits (Section 15-2 of the ITAA 1997)

•         Capital gains tax (Parts 3-1 and 3-3 of the ITAA 1997).

As the Payment is not viewed as being ETP, we have considered how the Settlement Payments will be treated for taxation purposes by you under the other provisions listed above as follows:

Ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Salary and wages, including sick pay, holiday pay, back pay and long service leave, are the main forms of employment income and are assessable as ordinary income under section 6-5 of the ITAA 1997.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

•         are earned

•         are expected

•         are relied upon, and

•         have an element of periodicity, recurrence or regularity.

A compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount, then it will be regarded as a capital receipt and not ordinary income. Lump sum damages, or lump sum out of court settlements representing compensation for losses of an income nature only will be assessable income in accordance with the ordinary principle.

Accordingly, the Settlement Payments are not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.

Statutory income

Amounts that are not ordinary income but are included in your assessable income by another provision are called statutory income as outlined in section 6-10 of the ITAA 1997.

The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997 and included in this list is section 15-2 of the ITAA 1997 and capital gains at section 102-5 of the ITAA 1997 discussed below.

Section 15-2 of ITAA 1997 includes as assessable income of the taxpayer all allowances, gratuities, compensation, benefits, bonuses and premiums provided in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by the taxpayer.

In practical terms, section 15-2 of the ITAA 1997 will generally only apply to receipts that are of a capital nature as section 6-5 of the ITAA 1997 would apply in preference to revenue receipts.

Payments of a capital nature will be assessable under section 15-2 of the ITAA 1997 if there is a relationship between the payment and the taxpayer's employment.

Section 15-2 of the ITAA 1997 has the equivalent meaning of the former paragraph 26(e) of the Income Tax Assessment Act 1936 (ITAA 1936). Cases concerning section 26(e) of the ITAA 1936 will continue to be relevant in considering the application of section 15-2 of the ITAA 1997.

The phrase 'in respect of' in relation to the employment of an employee is defined in subsection 136(1) of the Fringe Benefits Tax Assessment Act (FBTAA) to include 'by reason of, by virtue of, for or in relation directly or indirectly to, that employment'.

In J & G Knowles & Associates Pty Ltd v Commissioner of Taxation [2000] 44 ATR 22, the Full Federal Court considered the judgements in Smith v. FCT (1987) 164 CLR 513; 19 ATR 274; 87 ATC 4883 and Federal Commissioner of Taxation v. Rowe (1995) 60 FCR 99; 31 ATR 392; 95 ATC 4691 before concluding that it is not sufficient for the purposes of the FBTAA to conclude that there is a causal connection between the benefit and the employment.

At paragraph 26 the Court said:

Whatever question is to be asked, it must be remembered that what must be established is whether there is a sufficient or material, rather than a, causal connection or relationship between the benefit and the employment.

At paragraphs 28 and 29, the Court said:

While the width of the definition of 'fringe benefit' was designed to capture benefits that, in truth, were other than remuneration, the stated purpose suggests that asking whether the benefit is a product or incident of the employment will be helpful. If it is not then the benefit is likely to be extraneous to the employment and will not bear FBT, notwithstanding that the employment might have been a causal factor in the provision of the benefit. In particular, the fact that a benefit is provided to a director because it was authorised by that director will not, of itself, be sufficient to characterise the benefit as one which is "in respect of" the employment. Without more, it is not a product of incident of that office.

To put the matter another way, although the process of characterising the benefit provided in a particular case can involve questions of fact and degree, it is not sufficient for the purposes of the FBTAA merely to enquire whether there is some causal connection between the benefit and the employment.

In relation to paragraph 26(e) of the ITAA 1936, the leading case is FC of T v Dixon (1952) 86 CLR 540: 10 ATD 82 (Dixon case). In that case, it was held that weekly instalments to make up the difference between the rate of civil pay of an employee on enlistment and the rate of his defence force pay was in the nature of income, and therefore assessable. However, all the members of the High Court agreed that the payments were not allowed, given or granted to the employee in respect of, or for, or in relation directly or indirectly to any employment of or services rendered by him within the meaning of paragraph 26(e) of the ITAA 1936.In a joint judgment Dixon CJ and Williams J held at CLR 553 and 554 that:

A direct relation may be regarded as one where the employment is proximate cause of the payment, [whereas] an indirect relation is one where the employment is a cause less proximate, or, indeed, only one contributory cause.

The closer the benefit or gain is to the workplace or employment, the more likely it is to be ordinary income. In Federal Commissioner of Taxation v. Smith (1986) 86 ATC 4463 (Smith case), a taxpayer received a payment for completing a management certificate course. Once the court accepted that the payment would not have been made if the relationship of employer and employee had not existed, it was impossible to deny that employment was not a contributory cause of the payment. The payment was therefore causally connected to the taxpayer's employment by the bank and was assessable under paragraph 26(e) of the ITAA 1936.

The fact that a payment would not have been received but for the existence of a current or past employment relationship or services having been rendered is relevant but not determinative. In the Dixon case payments made by the taxpayer's former employer were held to be ordinary income. In their judgment Dixon CJ and Williams J considered the following:

It does not seem to matter whether these employers are regarded as his former employers, as his future employers or as the other party to a suspended employment. In the definition of "income from personal exertion" the expression "allowances and gratuities received in the capacity of employee or in relation to any services rendered", while it does not appear to us to include, as a matter of meaning, allowances and gratuities received by an employee after he has ceased to render any services and after his employment has completely terminated, nevertheless does seem to indicate that no contractual right to the allowance or payment need exist. Indeed, it is clear that if payments are really incidental to an employment, it is unimportant whether they come from the employer or from somebody else and are obtained as of right or merely as a recognized incident of the employment or work.

Lump sum damages or out-of-court settlements may be a compromise of a claim made up of several elements, some being revenue and others being capital in nature. If the gross amount is not specifically allocated to the various items making up the claim and it cannot be dissected into its component parts, the compensation (which would be taxable if received in respect of a particular part of the claim) is of a capital nature (McLaurin v FCT (1961) 104 CLR 381 and Allsop v FCT (1965) 113 CLR 341).

In Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts, the Commissioner states that whether a lump sum or other compensation payment is assessable in the hands of the recipient depends on whether it is a receipt of a capital or income nature. This in turn depends upon consideration of all the circumstances surrounding the payment. It is the character of the receipt in the hands of the recipient that must be determined.

Paragraph 21 of TR 95/35 states that if compensation is received by a taxpayer in a lump sum paid in settlement of a number of claims, including a personal injury claim, and its individual components cannot be determined or reasonably estimated, no part of the compensation can be quantified as relating to the personal injury of the taxpayer. Accordingly, the exemption under subsection 160ZB(1) of the ITAA 1936 does not apply to any part of the compensation.

In the case of Purvis v. FC of T [2013] AATA 58 (Purvis' case), the AAT considered the tax consequences of a pilot receiving a lump sum insurance payment for the loss of licence. Although the loss of licence came about as a result of illness or injury, the Tribunal found that the payment did not relate directly to compensation or damages within paragraph 118-37(1)(a) of the ITAA 1997. The amount was calculated without regard to the nature of the personal injury suffered, save that the personal injury had to result in the loss of licence.

•         loss of opportunity to participate in a Bonus Plan to receive a discretionary bonus up to 25% of your base salary

•         loss of opportunity to participate in a Bonus Plan to receive a discretionary bonus over future years until you had secured alternative employment at an equivalent rate of pay

•         loss of opportunity to receive cash and stock/option entitlements under long-term incentive plans; and

•         pain, suffering, stress, anxiety, humiliation and dislocation of life.

Based on the information provided, and applying the principles contained in TR 95/35 and the cases above to the facts of your situation, it is viewed that the Settlement Payments directly relate to your former employment with the employer. The Proceedings would not have eventuated but for your employment with the employer, and the Deed would not have occurred but for your claims made in the Proceedings in relation to your period as an employee with the employer.

As outlined above we do not have sufficient information to be able to dissect the Settlement Payments to account for any capital or revenue components, so the whole of the payments included in the Settlement Payments will be capital in nature.

Therefore, it is viewed that the Settlement Payments consisting of the amounts of $x and $1x are assessable under section 15-2 of the ITAA 1997 as they are of a capital nature and there is a relationship between the payments and your employment with the employer.

Capital gains tax

The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own.

Under subsection 108-5(1) of the ITAA 1997, a CGT asset is:

•         any kind of property; or

•         a legal or equitable right that is not property.

Depending on the circumstances, the receipt of compensation amounts may give rise to one of the following CGT events such as CGT event C2 which occurs if a taxpayer's ownership of an intangible CGT asset ends because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited.

Paragraph 11 of TR 95/35 outlines that if the compensation is not received in relation to any underlying asset, then the compensation relates to the disposal of a right to seek compensation.

A settlement or compensation payment may be paid as a result of giving up your right to seek compensation and this right is an intangible CGT asset.

Where the disposal of an asset gives rise to both a capital gain and an assessable amount under another provision, the capital gain is reduced by the amount assessable under the other provision under section 118-20 of the ITAA 1997.

Section 118-37 of the ITAA 1997 provides for capital gains or capital losses to be disregarded where they arise from CGT events relating directly to either of the following categories of compensation payments contained in paragraph 118-37(1)(a) of the ITAA 1997:

a)    compensation or damages the taxpayer receives for:

                        i.        any wrong or injury the taxpayer suffers in their occupation, or

                      ii.        any wrong, injury or illness the taxpayer or their relative suffers personally

The capital gain is reduced to $nil under subsection 118-20(2) of the ITAA 1997 because it does not exceed the amount included in your assessable income under section 15-2.

We have not considered whether you are eligible to disregard any capital gain under section 118-37 of the ITAA 1997 arising as a result of entering the Deed because the amount of the capital gain is $nil (after section 118-20 has applied).

Conclusion

The Settlement Payments consisting of $X and $X are:

•         not assessable under section 6-5 of the ITAA 1997; and

•         are assessable under section 15-2 of the ITAA 1997.

Any capital gain arising in relation to entering the Deed will be reduced to nil in accordance with section 118-20 of the ITAA 1997.

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