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Authorisation Number: 1011752787997

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Ruling

Subject: Employment termination payment

Questions

1. Is the redemption of workers compensation income maintenance made under a redemption agreement considered to be an employment termination payment as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Is the redemption of future medical expenses made under a redemption agreement considered to be employment termination payment?

3. Is any part of the payment made under the redemption agreement exempt from capital gains tax?

Advice/Answers

1. Yes.

2. No.

3. No.

This ruling applies for the following period

For the year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

Your client, is an employee of an employer (the employer).

Your client lodged a claim for compensation with a date of injury specified some years ago. The employer accepted this claim for a closed period and your client returned to work.

During 2009-10 income year, your client submitted a further claim for compensation with the employer.

In a letter dated early 2010, the employer advised that it was determined that your client's claim for compensation was rejected and that your client may apply for review of this determination by lodging a dispute with a state tribunal.

Later in the 2009-10 income year, a dispute was lodged with a state tribunal for your client against the employer in respect of a claim for income maintenance for anxiety, depression and adjustment disorder.

An application for a redemption agreement pursuant to a state Act (the Act) was made where both parties reached an agreement 'in principle' for the resolution of the worker's claim.

Both parties submit that it is contrary to the best interests of your client from a psychological and a social perspective to continue the employment relationship. It is in the best interests of your client to finalise the employment relationship and any entitlements your client has under the Act.

An agreement (the Agreement) was made between your client and the employer under a specified section of the Act.

At a specified section of the Act it states that a liability to make weekly payments or a liability to pay compensation under another specific section of the Act may, by agreement between a worker and the Corporation be redeemed by a capital payment to the worker.

The Agreement states at a specified clause that your client had sustained at specified dates compensable disabilities.

The Agreement further states at other clauses:

· The worker undertakes to resign from their employment from the date of the Agreement waiving any rights to the notice;

· The parties have reached an Agreement for the redemption of a state's liabilities whereby the liability to make weekly payments and to pay compensation under a specified section of the Act is to be redeemed from the date of resignation pursuant to another specific section of the Act for a capital payment for a sum in respect of weekly payments and another sum in respect of compensation under the specified section of the Act.

Your client is not currently in receipt of weekly payments of compensation.

A recognised medical expert has certified that the extent of your client's incapacities resulting from the compensable disabilities, can be determined with a reasonable degree of confidence.

Your client acknowledged and agreed that your client suffered no other injuries or loss of physical, psychological, psychiatric or sensory capacity arising from your client's employment with the employer and that your client has no other claim, right or entitlement under the Act arising from your client's employment with the employer.

Both parties agreed 'in principle' that the dispute will be resolved whereby your client's 2009 claim will be accepted on the basis that the employer will pay a redemption sum in respect of weekly payments and a sum in respect of future medical and like expenses and that your client will accept the payments and resign from employment.

In a medical report dated from 2010, a medical practitioner has stated they were unable to say whether or not your client was suffering from a work related compensable condition at this time. However, they did think that your client is more than capable of performing your client's normal duties.

In a medical report dated from 2010, an independent specialist, has stated there were factors which have played a part in your client's circumstances, the first being a financial issue and secondly an inability to sell your client's home due to the economic circumstances. Further, your client is obviously unhappy about continuing to remain in the area. Should your client wish to remain and continue employment and your client's career, the specialist was sure your client would be able to do so.

Your client is over the age of 55 years.

It is anticipated that the redemption payment will be made to your client prior to 30 June 2011.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 27A(1).

Income Tax Assessment Act 1936 Paragraph (n).

Income Tax Assessment Act 1936 Subsection 160ZB(1).

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 Section 82-135.

Income Tax Assessment Act 1997 Section 83-295.

Income Tax Assessment Act 1997 Subdivision 118-A

Income Tax Assessment Act 1997 Section 118-20.

Income Tax Assessment Act 1997 Section 118-22.

Income Tax Assessment Act 1997 Section 118-37.

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Summary

The redemption sum is an employment termination payment as it is being made in consequence of the termination of your client's employment. The redemption sum being made in respect of weekly payments is a taxable component of an employment termination payment and is to be included in your client's income tax return in the income year the payment is made. This amount is not assessable under the capital gains tax (CGT) provisions as it is assessable as an employment termination payment. This amount made under the Agreement is not a payment for personal injury.

However, the sum being made in respect of future medical and like expenses in respect of your client's injury is exempt from being an employment termination payment.

Detailed reasoning

Employment termination payment

From 1 July 2007 the taxation treatment of payments made in consequence of the termination of any employment of a taxpayer changed. These payments, formerly known as eligible termination payments, are now called employment termination payments in accordance with subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997).

Section 995-1 of the ITAA 1997 states:

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

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

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 persons death, in consequence of the termination of the other persons 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.

To determine if a payment constitutes an employment termination payment, all the conditions in subsection 82-130(1) of the ITAA 1997 must be satisfied. Failure to satisfy any of the three conditions under subsection 82-130(1) will result in the payment not being considered an employment termination payment.

Even where all the conditions in subsection 82-130(1) of the ITAA 1997 have been satisfied, generally, to qualify as an employment termination payment, the payment must be received by the person within 12 months of termination (see paragraph 82-130(1)(b)). Generally, any termination payments received outside of the 12 months will be assessable at the person's marginal tax rates (section 83-295), unless the taxpayer is covered by a determination exempting them from the 12 month rule (see subsection 82-130(4)).

Payment is made in consequence of the termination of your employment

For a payment to be treated as an employment termination payment, the first condition that needs to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer (see subparagraph 82-130(1)(a)(i) of the ITAA 1997).

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Whilst the courts have divergent views on the meaning of this phrase, the Commissioner's view on the meaning and application of the in consequence of test are set out 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.

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.

While TR 2003/13 considered the meaning of the phrase 'in consequence of' in the context of the eligible termination payments, TR 2003/13 can still be relied upon as both the former provision under the Income Tax Assessment Act 1936 and the current provision under the ITAA 1997 both use the term 'in consequence of' in the same manner. As previously noted, eligible termination payments ceased to exist from 1 July 2007, being replaced by employment termination payments.

The phrase in consequence of termination of employment has been interpreted by the courts in several cases.

Of note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 (McIntosh).

Both Courts views were that for a payment to be made in consequence of the termination of employment it had to follow on as a result or effect of the termination of employment. Additionally, while it is not necessary to show that termination of employment is the sole or dominant cause, a temporal sequence alone would not be sufficient.

The Federal Court in Le Grand v Commissioner of Taxation (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 139; [2002] FCA 1258; (2002) 124 FCR 53 (Le Grand) held that an amount received for settlement of the claim for misleading and deceptive conduct did not break the casual relationship that existed between the termination of the applicant's employment and the payment of the offer of compromise. The decisions in Reseck and McIntosh were applied with Justice Goldberg stating:

I do not consider that the issue can simply be determined by seeking to identify the "occasion" for the payment. The thrust of the judgments in Reseck and McIntosh is rather to the effect that a payment is made "in consequence" of a particular circumstance when the payment follows on from, and is an effect or result, in a causal sense, of that circumstance. The passages in the judgments to which I referred earlier make this clear. They also make it clear that there need not be identified only one circumstance which gives rise to a payment before it can be said that the payment is made "in consequence" of that circumstance. The passages to which I have referred make it clear that it can be said that a payment may be made in consequence of a number of circumstances and that, for present purposes, it is not necessary that the termination of the employment be the dominant cause of the payment so long as the payment follows, in the causal sense referred to in those judgments, as an effect or result of the termination.

The Federal Court in Dibb v Commissioner of Taxation [2003] FCA 673; (2003) 53 ATR 290; [2004] ALMD 5781 has applied the above decisions in finding that the payment received by the taxpayer under a Deed of Release to settle various causes of action against the employer following the termination of employment was an ETP. These findings were confirmed by the Full Federal Court on appeal (Dibb v. Federal Commissioner of Taxation (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786; [2004] ALMD 5780; [2004] FCAFC 126).

Paragraph 31 of TR 2003/13 the Commissioner states:

It is clear from the decision in Le Grand, that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of the taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

In the Federal Court case of Federal Commissioner of Taxation v Pitcher [2005] FCA 1154; (2005) ATC 4813; (2005) 60 ATR 424 (Pitcher), Justice Ryan states, regarding whether the amount received was income or capital:

55 It was not in dispute that the weekly payments of compensation to the respondent pursuant to the SRC Act were income: FCT v Smith; Tinkler v FCT; cf FCT v Slaven.

56 The payment of the redemption payment followed on from the termination of the respondent's 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 future weekly compensation payments. It therefore constituted income according to ordinary concepts as representing the present value of that future income and a substitute therefor: see Coward v FCT (at ATR 1146; ATC 2173-2174; ALD 91) per Mathews J and Re Gillespie v FCT (2001) 49 ATR 1012; 2002 ATC 2006.

The Commissioner's opinion of the meaning of the words 'in consequence of the termination of employment' considered in TR 2003/13 is that a payment can be considered to be in consequence of termination where it follows from the termination, or the termination is a condition precedent to the payment.

The same view is also expressed by the Commissioner in paragraph 24 of Taxation Ruling IT 2424 and states:

A compensation payment received by way of settlement or under a determination of the Commission in respect of an unlawful act of dismissal qualifies as an eligible termination payment. Essentially, the compensation payment for unlawful dismissal, like a payment for wrongful dismissal settled or awarded under a common law action, is considered to be made "in consequence of the termination of any employment of the taxpayer". The payment falls within the definition of an eligible termination payment and is liable for income tax in accordance with the special eligible termination payment rules.

This demonstrates that while a payment may be made for a number of reasons, including out of court settlement or compensation, if the payment is connected or linked to the termination of employment it will be paid 'in consequence of the termination' for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135.

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 the facts of this case, your client is an employee of an employer (the employer).

Your client sustained compensable disabilities said to have arisen from your client's employment and lodged a claim for compensation against the employer. As a result, your client's employer offered your client a redemption payment.

An Agreement (the Agreement) was made between your client and the employer under a specified section of a state Act (the Act).

At a specified section of the Act it states that a liability to make weekly payments or a liability to pay compensation under another specific section of the Act may, by agreement between a worker and the Corporation be redeemed by a capital payment to the worker.

It is noted that, although your client may have been entitled to weekly payments under the Act, at the time of the Agreement, your client was not in receipt of any weekly payment under that Act. However, the Agreement clearly indicates that a specified amount is to be paid in respect of the employer's liability (whether past, present or future) to make weekly payments.

The Act at a specific section refers to payments made under that section as capital payments. However, if a payment is income under ordinary concepts, merely describing the payment as being capital does not, in it self, suffice to make the payment a capital payment. It is also noted that there is no requirement that a termination of employment occur in order for your client to receive a redemption payment under a specific section of the Act.

However, the Agreement, acknowledged and agreed by both your client and the employer, states that the worker undertakes to resign from their employment on and from the date of this agreement (hereinafter referred to as 'the date of resignation'), both parties waiving any rights as to the notice.

This clearly indicates that a condition of the payment of the settlement amount was that your client terminate their employment with the employer. Thus, a clear connection or link exists between the termination of employment and the making of the payment.

The fact that the dominant cause of action to which the settlement related was not the termination of employment does not alter this connection. As noted in the cases cited above, termination of employment need not be the sole or dominant cause of a payment in order for the payment to be considered 'in consequence of' the termination of employment.

Your client would not have otherwise received the payment under the Agreement except for the termination of the employment. The circumstances in which the payment was made and the terms of the Agreement clearly show that the payment is being made 'in consequence of' termination of employment and thus, is an employment termination payment.

Although the cause of the payment was the claim brought by your client against your client's former employer, there is still a causal connection between the termination and the payment. The claims, the termination and the payment are all intertwined and connected. Therefore 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 meet the criteria, as an employment termination payment is stated under paragraph 82-130(1)(b) of the ITAA 1997. The payment made under the Agreement must be received within 12 months of the taxpayer's termination of employment, unless they are covered by a determination exempting them from the 12 month rule. If the payment is received more than 12 months after termination of employment and the taxpayer is not covered by a determination exempting him from the 12 month rule, the payment will not be an employment termination payment.

As already noted in the facts, your client has agreed to terminate employment and that on the termination of employment your client will receive the redemption payment from the employer. The payment will be made within the 12 months of your client's termination of employment with the employer.

Therefore, it is considered that the payment satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997.

The final requirement under paragraph 82-130(1)(c) of the ITAA 1997 is that the payment is not a payment mentioned in section 82-135.

Exclusions under section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, 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;

· reasonable capital payments for personal injury.

Relevant to this case consideration must be given as to whether the personal injury suffered by your client is covered by the specific exemption for personal injury in 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);

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

Prior to 1 July 1997, former paragraph (n) of the definition of 'eligible termination payment' in former subsection 27A(1) of the Income Tax Assessment Act 1936 (the former paragraph (n) exclusion) applied to exclude similar payments from being eligible termination payments. The type of payment to which the former paragraph (n) exclusion applied was:

Consideration of a capital nature for, or in respect of, personal injury to the taxpayer, to the extent to which the amount or value of the consideration is, in the opinion of the Commissioner, reasonable having regard to the nature of the personal injury and its likely effect on the capacity of the taxpayer to derive income from personal exertion.

From 1 July 2007 the former paragraph (n) exclusion has been replaced by paragraph 82-135(i) of the ITAA 1997 which, as can be seen, is essentially a rewrite of the former paragraph (n) exclusion. 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 light of this, court decisions dealing with the operation of the former paragraph (n) exclusion can be cited with authority in respect of the operation of paragraph 82-135(i) of the ITAA 1997.

In Commissioner of Taxation v. Scully [2000] HCA 6; (2000) 2000 ATC 4111; (2000) 169 ALR 459; (2000) 43 ATR 718; (2000) 74 ALJR 504; (2000) 201 CLR 148 (Scully) the Full Bench of the High Court considered whether a payment made by a superannuation fund as a result of the taxpayer's termination of employment because of invalidity was:

· 'consideration'; and

· consideration 'for, or in respect of, personal injury'.

It was held that the payment was 'consideration' within the broad sense of that term. However, the payment was not 'consideration for or in respect of personal injury to the taxpayer' which would fall within the former paragraph (n) exclusion. The clauses of the trust deed which calculated the payment made no attempt to place a monetary value on the taxpayer's injury, nor was it the purpose of superannuation schemes to compensate for 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 be excluded from being an employment termination payment under 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, an amount is being made to your client in respect of the employer's liability (whether past, present or future) to make weekly payments and is not being made in respect of your client's injury. Therefore this amount is not excluded from being an employment termination payment under paragraph 82-135(i) of the ITAA 1997.

As the payment is not excluded from being an employment termination payment it constitutes an employment termination payment, as all the conditions in subsection 82-130(1) of the ITAA 1997 will be satisfied.

However, an amount is being made to compensate your client for medical and other expenses in relation to any compensable disabilities suffered by your client arising from your client's employment. Thus, although this payment may not necessarily be made for your client's injury, it is considered that it will be made in respect of your client's injury.

Accordingly, the sum being made in respect of future medical and like expenses in respect of your client's injury is excluded from being an employment termination payment under paragraph 82-135(i) of the ITAA 1997.

Capital gains tax provisions

The general exemptions provisions (from CGT) are found in Subdivision 118-A of the ITAA 1997. Included amongst them is an anti-overlap provision, Income Tax Assessment Act 1997, which ensures that an amount cannot be assessable under both the CGT provisions and non-CGT provisions. The effect of the provision is to reduce the amount of any assessable capital gain by any amount which is also assessable under non-CGT provisions or by amounts which are exempt income under non-CGT provisions.

Section 118-22 of the ITAA 1997 is a related section, which recognises that a CGT event could give rise to an employment termination payment as well as a capital gain. It ensures that, for the purposes of section 118-20 only, the whole of the payment is included as assessable income.

The combined effect of these two sections is that where a capital payment is assessable under a non-CGT provision (in this case as an employment termination payment) then it is treated as being assessable under that non-CGT provision.

Therefore an employment termination payment is excluded from being taxed as a capital gain.

A payment may be disregarded as a capital gain by the operation of section 118-37 of the ITAA 1997 (which replaced former subsection 160ZB(1) of the Income Tax Assessment Act 1936 for the 1998-99 and later income years).

In this regard it is relevant to note the following comment made by Senior Member Dwyer of the Administrative Appeals Tribunal (AAT) in AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258 at paragraph 31:

I accept Mr Gibb's submission that if the payment is caught, as I am satisfied it is, by s 27A(1), there is no advantage to the applicant in the fact that it would have been exempt by virtue of s 160ZB(1), if it were not so caught. …

In this case, the sum being made in respect of weekly payments is to be included as assessable income because it is an employment termination payment as defined under subsection 82-130(1) of the ITAA 1997 and is to be disregarded as a capital gain under sections 118-20 and 118-22. The fact that the payment may also be disregarded as a capital gain under section 118-37 does not change the fact that it is assessable as an employment termination payment.

Conclusion

The sum being made in respect of weekly payments to be made to your client in the 2010-11 income year is a taxable component of an employment termination payment therefore this amount is to be included in your client's assessable income for the 2010-11 income year.

Accordingly, no part of the payment being made in respect of weekly payments is assessable under the CGT provisions because it is included in your client's assessable income as an employment termination payment.

The payment made in respect of future medical and like expenses in respect of your client's injury to be made to your client in the 2010-11 income year is excluded from being an employment termination payment under paragraph 82-135(i) of the ITAA 1997.