Edited version of private ruling

Authorisation Number: 1011720835124

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Ruling

Subject: Invalidity segment

Question:

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

Advice/Answers:

Yes.

This ruling applies for the following period:

1 July 2007 to 30 June 2008

The scheme commenced on:

1 July 2007

Relevant facts:

Your client is under 55 years of age.

After completion of secondary education your client worked in a clerical capacity for various employers.

More than twenty years ago your client commenced working for the employer.

Your client was a member of the employer's superannuation scheme.

Your client suffered an injury and consequently attended rehabilitation, counselling and evaluation procedures. However your client was unable to complete the rehabilitation due to the illness.

Your client was medically assessed by the employer and subsequently your client's employment was terminated.

A letter from the employer advised your client that a payment had been approved as a disability benefit. Further, the letter advised that this payment was calculated in accordance with an award (the Award).

A payment summary was issued by the employer showing the details of the payment.

A letter from the employer advised that your client had been overpaid salary/allowance from which PAYG tax had been deducted. The net amount was repaid by your client

A revised payment summary shows the amended details of the payment.

There were no pre existing employer or award arrangements that would have terminated your client's employment prior to their 65^th birthday.

You client has not been in any employment since the termination of employment with the employer.

You have provided copies of two medical certificates. In relation to your client's injuries, both certificates state that your client is suffering from a medical condition which in the medical practitioners' opinions is likely to result in your client being unable ever to be employed in a capacity for which your client is reasonably qualified by education, training or experience.

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 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 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 82-145

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

Income Tax Assessment Act 1936 Section 27A

Income Tax Assessment Act 1936 Section 27G

Reasons for decision

Summary

The employment termination payment received by your client includes an invalidity segment.

Detailed reasoning

Invalidity segment

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

Employment termination payments are defined in section 82-130 of the ITAA 1997.

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. Any termination payments received more than 12 months after the termination of employment will be taxed as ordinary income at marginal tax rates.

Payment 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 taxpayer.

It is considered that the payment received by your client from the employer, was made in consequence of the termination of employment. Your client was unable to continue work due to injury and consequently was medically discharged by the employer.

Retirement on medical grounds was approved by the employer and so was the payment of a disability benefit under the Award.

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

Therefore, the condition under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

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

The second condition for the payment to meet the criteria, as an employment termination payment is stated under paragraph 82-130(1)(b) of the ITAA 1997, is that the employment termination payment was paid to the taxpayer no later than 12 months after their employment was terminated.

The employment termination payment was received within 12 months of the termination and therefore satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997.

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

The payment of the disability benefit is the result of a calculation of a disability benefit under the Award. It is a distinct payment for illness suffered at work and is unconnected with payments for your client's other entitlements on termination of employment.

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 leave and long service leave and 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 employment termination payment.

However, consideration must be given as to whether the payment represents a reasonable capital payment for personal injury. If it does, then the payment will not be an employment termination payment under paragraph 82-135(i) of the ITAA 1997 (payments that are not employment termination payments). 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 the particular injury.

From 1 July 2007, paragraph 82-135(i) of the ITAA 1997 has replaced paragraph (n) of the definition of an eligible termination payment in subsection 27(1) of the Income Tax Assessment Act 1936 (ITAA 1936) (paragraph (n). 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.

In accordance with section 1-3 of the ITAA 1997, sections in the ITAA 1936 which have been rewritten in the ITAA 1997 will have the same meaning where it is expressing the same idea, even if the words used are different. It is therefore appropriate to cite cases that refer to the previous legislation.

In Commissioner of Taxation v. Scully (2000) 201 CLR 148; [2000] HCA 6; 2000 ATC 4111; (2000) 169 ALR 459; (2000) 74 ALJR 504; (2000) 43 ATR 718 (Scully) the High Court, in considering former paragraph (n), held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

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, the 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, a payment made in accordance with the Award as a result of an on-duty injury. The amount paid as a lump sum in accordance with the Award is based on the age and salary of the employee.

Consequently, the level of incapacity is irrelevant as to the amount received under the Award. The only criterion is that the employee has suffered a disability and cannot be redeployed elsewhere with the employer.

The lump sum payment is consideration for, or in respect of the employee's termination of employment and the employee's rights under the Award and not consideration for, or in respect of the employee's injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss to the employee. In other words, the payment is to compensate the employee 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 being made under the Award.

Therefore your client's payment is not of a type paragraph 82-130(1)(c) of the ITAA 1997 would exclude.

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.

Until your client became ill your client was employed on a full-time basis as an employee 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.

Employment termination occurred because of ill-health

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 taxpayer's employment.

In this case, the facts show the termination of employment occurred after your client's discharge from employment. This indicates your client was unable to resume normal work due to your client's disability. Therefore, it is considered that this requirement is satisfied.

Termination of employment occurred before last retirement date

The third condition for a payment to qualify as an invalidity component is that it was made before the taxpayer's last retirement date.

The payment was made when your client was under the normal retirement age of 65. Therefore, the condition of paragraph 82-150(1)(c) of the ITAA 1997 has 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.

In respect of this requirement, it must be demonstrated that the disability at the time of termination was such that:

...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.

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.

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, section 27G of the 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 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 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, would not now satisfy the condition in paragraph 82-150(1)(d) of the ITAA 1997, which is the rewritten provision for section 27G of the ITAA 1936.

However, the use of the term 'appropriate employment' in the EM suggested the intention that the term 'reasonably qualified' be interpreted as meaning neither over nor under qualified to any significant extent.

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

Two legally qualified medical practitioners, have certified, in two medical certificates, that your client is suffering from a medical condition as a result of which, in their opinion, it is unlikely that your client can ever be employed in any capacity for which your client is reasonably qualified because of education, experience and training.

It is also noted that prior to working with the employer your client performed clerical duties after completion of secondary education, and that your client has not worked since leaving their employ.

Therefore, as two medical practitioners have provided certificates that attest to your client being unable to ever be employed in a capacity for which your client is 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.

Components of an employment termination 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 comprises 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.

Calculation of invalidity segment

As your client has satisfied the requirements for the payment of an invalidity segment, 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:

Amount of employment termination payment	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.

Therefore, the amount calculated is the invalidity segment included in the employment termination payment which is tax free. The remaining (that is, the total payment less the tax free amount) is a taxable component to be included in your client's income tax return for the 2007-08 income year. As this amount is over the 2007-08 income year employment termination payment cap of $140,000, and your client has not yet reached preservation age, $140,000 will be taxed at no more than 30% plus Medicare levy. The remainder will be taxed at the top marginal rate of 45% plus Medicare levy.

Please note that you are only entitled to one employment termination payment cap in relation to either the 2007-08 income year or the termination of your employment with the employer.