Edited version of private ruling

Authorisation Number: 1011602210309

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Ruling

Subject: Invalidity segment - partial and permanent disability payment

Questions

1. Is the partial and permanent disability benefit payment an employment termination payment?

Answer: Yes

2. Is any part of the partial and permanent disability benefit payment excluded from being an employment termination payment under paragraph 82-135(i) of the ITTA 1997?

Answer: No

3. Is any part of the partial and permanent disability benefit payment an invalidity segment of the tax free component?

Answer: Yes

This ruling applies for the following period:

Year ended 30 June 2008

The scheme commenced on:

1 July 2007

Relevant facts and circumstances

Your client was employed by the employer on a full-time basis until falling ill.

Your client's employment was terminated on medical grounds after the employer considered that they were not able to resume normal work due to ill-health.

Your client received an employment termination payment from the employer within 12 months after termination of their employment.

The gross payment, including a taxable component and tax withheld amount, was made purely in relation to the termination of employment and based on age and salary.

After examining the context of medical reports provided by a number of legally qualified medical practitioners, two legally qualified medical practitioners certified that, due to the ill-health, it was unlikely that your client was able to ever be gainfully employed in a capacity for which they were reasonably qualified because of education, experience or training.

Your client was under their preservation age when receiving the payment.

There was no date prior to your client attaining age 65, on which their employment would have necessarily had to terminate.

Your client has obtained no qualifications, and not undertaken any form of employment since ceasing work with the employer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 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(i)

Income Tax Assessment Act 1997 Section 82-140

Income Tax Assessment Act 1997 Section 82-150

Income Tax Assessment Act 1997 Subsection 82-150(1)

Income Tax Assessment Act 1997 Paragraph 82-150(1)(a)

Income Tax Assessment Act 1997 Paragraph 82-150(1)(b)

Income Tax Assessment Act 1997 Paragraph 82-150(1)(c)

Income Tax Assessment Act 1997 Paragraph 82-150(1)(d)

Income Tax Assessment Act 1997 Subsection 82-150(2)

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

The lump sum payment your client received is an employment termination payment which includes an invalidity segment under section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997) as:

· the payment is made to your client because they stopped being gainfully employed;

· they stopped being gainfully employed because they suffered from ill-health;

· their employment stopped before their last retirement day; and

· two legally qualified medical practitioners have certified that, because of ill-health, it is unlikely that they can ever be gainfully employed in a capacity for which they are reasonably qualified because of education, experience or training.

The invalidity segment included in the employment termination payment is tax free.

Detailed reasoning

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

Where a person's employment is terminated because of ill-health and the person receives an employment termination payment, 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 employment termination payment.

Employment termination payment

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that:

employment termination payment has the meaning given by section 82-130.

Subsection 82-130(1) of the ITAA 1997 declares:

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.

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

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment.

Payment is received in consequence of the termination of employment

The first condition to be met is that there must be an employment termination payment that is made in consequence of the termination of employment of the taxpayer.

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.

After considering your client's medical history, the employer terminated their employment, and consequently made the payment of a disability benefit.

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

Therefore, the payment is considered to have been made in consequence of the termination of your client's employment, and the condition under subparagraph 82-130(1)(a)(i) of the ITAA 1997 is satisfied.

Payment is received no later than 12 months after termination of employment

To qualify as an employment termination payment, 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). This is referred to as the 12 month rule.

Your client received the payment within 12 months after termination of their employment, therefore the requirements of paragraph 82-130(1)(b) of the ITAA 1997 are satisfied.

Not a payment mentioned in section 82-135 of the ITAA 1997

Certain payments made on termination of employment are excluded from being an employment termination payment under section 82-135 of the ITAA 1997. These payments include any accrued annual and long service leave, the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments which do not apply to your client's payment.

However, consideration must be given as to whether the specific exemption for personal injury in paragraph 82-135(i) of the ITAA  applies, which 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 a person for or in respect of a particular injury.

In Commissioner of Taxation v. Scully (2000) 201 CLR 148; [2000] HCA 6; 2000 ATC 4111; (2000) 43 ATR 718 (Scully) the High Court, in considering former paragraph (n) of the definition of an eligible termination payment in subsection 27A(1) of the Income Tax Assessment Act 1936 (ITAA 1936) (paragraph (n)), held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

From 1 July 2007, paragraph (n) was replaced by paragraph 82-135(i) of the ITAA 1997. However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 stated, in relation to section 82-135 of the ITAA 1997, that:

Consistent with current legislation, certain payments are prevented from qualifying as employment termination payments.

As both paragraphs require that a payment must have regard to the nature of the personal injury and its affect on a person's capacity to derive income from personal exertion, it is considered appropriate to cite cases that refer to the previous legislation in respect of the current law.

The payment in Scully was held not to be in respect of personal injury. Acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stated in their joint decision:

In our opinion, the payment in this case cannot be characterised as consideration... in respect of, personal injury. The fact that the payment is not calculated by reference to the nature and extent of the injury or likely loss to the respondent and the fact that the other benefits are similar to that for total and permanent disablement point inevitably to the conclusion that the payment was consideration... for, or in respect of the respondent's termination of employment and her rights under the Trust Deed and was not consideration... for, or in respect of her injury.

From the foregoing it is apparent that for an amount to meet the definition of consideration in paragraph 82-135(i) of the ITAA 1997, a payment must be for personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In this case, your client received a payment made in relation to the termination of their employment. The amount paid as a lump sum is based on their age and salary.

Therefore, the level of incapacity is irrelevant as to the amount your client received. The only criterion is that they suffered a disability, cannot be redeployed elsewhere with the employer, and as a result, their employment was terminated.

The payment is consideration for, or in respect of your client's termination of employment and their rights and not consideration for, or in respect of their injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss. In other words, the payment is to compensate your client for the loss of their employment as a result of the injury sustained rather than to compensate for the injury itself and any subsequent loss of earning capacity.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the lump sum payment, and no amount is excluded from being an employment termination payment.

Therefore your client's payment is not a payment mentioned in section 82-135 of the ITAA 1997.

As all the conditions in section 82-130 of the ITAA 1997 have been satisfied, the payment your client received is 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.

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.

Until becoming ill, your client was employed by the employer on a full-time basis.

Your client's employment was terminated on medical grounds after the employer considered that they were not able to resume normal work due to ill-health.

Under normal conditions of employment your client would have retired at age 65. Your client was under the preservation age at the time their employment was terminated.

Therefore the conditions in paragraphs 82-150(1)(a), (b) and (c) of the ITAA 1997 have been satisfied.

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

As noted above, paragraph 82-150(1)(d) of the ITAA 1997 requires that two legally qualified medical practitioners certify that, because of the ill-health, 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.

Prior to 1 July 1994, it had only been necessary for the termination of employment to occur because the taxpayer was physically or mentally incapacitated and therefore unable to engage in that employment. It did not require there be incapacity to engage in any employment. However, amendments made to the section that applied prior to 1 July 2007, former section 27G of ITAA 1936, by the Taxation Laws Amendment (Superannuation) Act 1992 require the incapacity to prevent the taxpayer ever being able to undertake any employment for which the taxpayer is reasonably qualified.

The Explanatory Memorandum (EM) to the Taxation Laws Amendment (Superannuation) Bill 1992 confirms this. In explaining the test for invalidity, the EM stated the following:

To clarify the test for incapacity and to place the onus of determining invalidity on legally qualified medical practitioners, from 1 July 1994 the incapacity of the person will have to be certified by two medical practitioners.

The relevant test is also to be modified so that the invalidity payment concession is extended only to people who are unable to undertake any form of employment for which they are reasonably qualified. A person who is unable to continue his or her current employment, but is able to undertake other appropriate employment, will not have access to the concession.

Therefore, a person, who is unable to continue to perform the duties of his or her current employment, but is able to undertake other appropriate employment for which they are reasonably qualified because of education, experience or training, would not now satisfy the condition in paragraph 82-150(1)(d) of the ITAA 1997, which is the rewritten provision for former section 27G of the ITAA 1936.

The EM does not elaborate further. However, the use of the term appropriate employment in the EM suggests the intention that the term reasonably qualified be interpreted as meaning neither over nor under qualified to any significant extent.

It is clear from reading the provision that the onus for determining invalidity (ill-health) is ascribed to the two legally qualified medical practitioners. Fulfilling that responsibility would involve, not only a medical opinion as to the taxpayer's physical and mental capabilities but also consideration as to what constitutes appropriate employment, based upon the taxpayer's education, training and experience.

Even if a taxpayer's employment is terminated by reason of disability, this does not mean that the second part of test for invalidity is satisfied. The two parts are independent. The fact that the medical practitioners have to determine invalidity does not mean that the medical practitioners have to determine the reason for termination.

A person's employment can be terminated because of disability, irrespective of whether two medical practitioners form an opinion as to whether the disability will prevent the taxpayer from ever being able to be employed in a capacity for which the taxpayer is reasonably qualified because of education, training and experience.

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 client's case, two legally qualified medical practitioners certified that, because of the ill-health, it was unlikely that your client would ever be able to be gainfully employed in a capacity for which they were reasonably qualified because of education, experience or training.

It is also noted that, your client has obtained no qualifications, and not undertaken any form of employment since their discharge from the employer.

As two medical practitioners have provided certificates that attest to your client being unable to ever be employed in any capacity for which they are reasonably qualified because of education, training or experience, it is considered that the final condition of subsection 82-150(1) of the ITAA 1997 has been satisfied.

Tax exemption for an invalidity segment

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

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