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Ruling

Subject: Assessability of lump sum settlement payment

Questions:

1. Is payment 1 made to you under a Deed of Discharge and Release, an employment termination payment in accordance with subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes.

2. Is payment 2 made by the employer to your nominated superannuation fund an employment termination payment in accordance with subsection 82-130(1) of the ITAA 1997?

Answers: Yes

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commenced on:

1 July 2010

Relevant facts and circumstances

You are under 55 years of age.

You were employed by the employer for a number of years.

Prior to your resignation from employment, you had been absent from your work duties as a result of an injury.

You lodged an application for compensation with WorkCover in your state arising out of an alleged injury.

WorkCover rejected your application.

You appealed the WorkCover decision by way of appeal to another insurance authority (the insurance authority).

The insurance authority rejected your appeal and affirmed the WorkCover decision.

You filed a Notice of Appeal in the Industrial Magistrates Court against the insurance authority decision.

You also filed an application and supporting claim in the Federal Magistrates Court of Australia alleging breaches of general protections pursuant to the Fair Work Act 2009.

Your application filed in the Industrial Magistrates Court was heard.

You and the employer, with the assistance of the employer's representatives conducted negotiations in order to agree on the terms and conditions upon which you would resign. In the negotiations, you and the employer also participated in a mediation conducted by a Register of the Federal Magistrates Court of Australia to settle the proceedings.

You and the employer have agreed to enter into a Discharge and Release (the Settlement Agreement) to record in writing the full terms to settle the proceedings.

In accordance with the settlement agreement you were required to resign from your employment with the employer. In return, the employer within seven days of the execution of the settlement agreement agreed to pay a gross settlement payment representing:

(a) Payment 1 to you; and

(b) Payment 2 to your nominated superannuation fund.

You resigned from your employment with the employer on a specific date in the 2010-11 income year.

Relevant legislative provisions:

Income Tax Assessment Act 1936 Section 27A

Income Tax Assessment Act 1936 Subsection 27A(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 Section 82-135.

Income Tax Assessment Act 1997 Section 82-145

Income Tax Assessment Act 1997 Section 82-160

Income Tax Assessment Act 1997 Subsection 301-20(2).

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Summary

The gross payment made to you under a Discharge and Release is an employment termination payment as:

· it was made in consequence of the termination of your employment,

· the payment was made no later than 12 months after the termination of your employment, and

· the payment is not a payment which is excluded from being an employment termination payment.

Because the employment termination payment was made during your lifetime, it is a life benefit termination payment (LBTP). As a result, the entire payment is a taxable component of an LBTP, and is included in full in your assessable income for the 2010-11 income year.

However, you are entitled to a tax offset to ensure that the rate of tax on the taxable component of the payment will not exceed 30% plus Medicare levy.

Details reasoning

Employment termination payment

An employment termination payment, where the payment is made during the life of a taxpayer, is known as a life benefit termination payment (subsection 82-130(2) of the Income Tax Assessment Act 1997 (ITAA 1997)).

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 Payment 1 and Payment 2 made to you under a Discharge and Release (the settlement agreement) constitutes an employment termination payment, 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 light of these decisions, the Commissioner discusses the meaning of the 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).

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.

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).

In Reseck Justice Gibbs stated:

Within the ordinary meaning of the words a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination It is not my opinion necessary that the termination of the services should be the dominant cause of the payment.

While Justice Jacobs stated:

It was submitted that the words 'in consequence of import' a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a 'following on'.

In looking at the phrase 'in consequence of' the Full Federal Court in McIntosh considered the decision in Reseck. Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment.

Suffice it to say that 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.

Furthermore, in Le Grand v Federal Commissioner of Taxation [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39 (Le Grand), the issue before the court was whether an amount received by the applicant as a result of accepting an offer of compromise in respect of claims brought by him against his former employer, in relation to the termination of his employment was in whole, or in part, an ETP. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an ETP.

Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicant's employment and the payment to warrant the finding that the payment was made in consequence of the termination of the applicants employment. I am satisfied that the payment was an effect or result of that termination in the sense that there was a sequence of events following the termination of the employment which had a relationship and connection which ultimately led to the payment.

Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was articulated by Justice Gibbs in Reseck. Thus, for the payment to have been made in consequence of the termination of employment, the payment must follow as an effect or result of the termination of employment. As earlier stated in paragraph 6 of TR 2003/13, there must be 'a causal connection between the termination and the payment even though the termination need not be the sole or dominant cause of the payment'.

The Full Federal Court in Dibb v Federal Commissioner of Taxation [2004] FCAFC 126; (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786, 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.

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.

The essence of this analysis is that if the payment follows as an effect or a result from the termination of employment, the payment will be made in consequence of the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. The termination of the payment need not be the sole or dominate cause of the payment.

The question of whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case.

Payment 1

In the circumstance of this case, you commenced employment with the employer a number of years ago. You suffered an injury during the course of your employment with the employer. You have not worked since the beginning of the 2009-10 income year.

You lodged an application for compensation with WorkCover. The decision was unfavourable to you. You subsequently lodged appeals with an insurance authority. The insurance authority rejected your appeal. You further lodged appeals with the Industrial Magistrates Court and Federal Magistrates Court of Australia.

As a result of the above actions, an agreement was reached between yourself and your employer to settle all claims by you against the employer on the terms contained in a Discharge and Release (the settlement agreement).

In accordance with the settlement agreement you were required to resign from your employment with the employer. In return, the employer within seven days of the execution of the settlement agreement agreed to pay a gross settlement payment representing:

(a) Payment 1 to you; and

(b) Payment 2 to your nominated superannuation fund.

It is clear from the facts provided that you were required to resign in order to be entitled to the settlement payment. Had you not resigned from your employment with the employer the settlement payment would never have been made. Accordingly, the settlement agreement, the termination of employment and the settlement payment are all intertwined and connected.

Consequently, Payment 1 is considered to be received by you in consequence of the termination of your employment.

Payment 2

The question also arises as to whether part of the settlement payment for Payment 2 to your nominated superannuation fund is an employment termination payment.

Section 80-20 of the ITAA 1997 deals with employment termination payments that are made for your benefit or at your direction or request. Subsection 80-20(2) of the ITAA 1997 states:

A payment is treated as being made to you, or received by you, if it is made:

(a) for your benefit; or

(b) to another person or to an entity at your direction or request.

Based on the above, an employment termination payment does not necessarily have to be paid direct to the taxpayer. This provision contemplates the situation where all or part of the payment may be made to a person or an entity other than the taxpayer but for the taxpayer's benefit, or at the direction or request of the taxpayer.

In this case, the settlement agreement directed that Payment 2 be paid directly to your nominated superannuation fund. Hence the sum of Payment 2 provided for your benefit and is treated as being received by you, even though this amount was paid directly to your nominated superannuation fund. For the reasons discussed above concerning your settlement payment of Payment 1, the Commissioner considers Payment 2 forms part of the total employment termination payment.

Consequently, Payment 2 is a payment made (whether voluntarily, by agreement or by compulsion of law) during your lifetime to a superannuation fund for your benefit in accordance with paragraph 80-20(2)(a) of the ITAA 1997. Therefore, the payment is an employment termination payment.

Thus the whole amount of the settlement sum is an employment termination payment within the meaning of subsection 82-130(1) of the ITAA 1997.

The Settlement Sum constitutes a life benefit termination payment

Both subsections 82-130(1) and 82-130(2) of the ITAA 1997, provide that where an employment termination payment is made during the life of a taxpayer, the payment is known as a life benefit termination payment.

In particular, subsection 82-130(2) of the ITAA 1997 states:

82-130(2) A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies

Because the settlement payment is an employment termination payment to which subparagraph 82-130(1)(a)(i) of the ITAA 1997 applies, the settlement payment constitutes a life benefit termination payment (LBTP) within the meaning of subsection 82-130(2) of the ITAA 1997.

However, to be an LBTP the settlement payment must also satisfy the remaining conditions in subsection 82-130(1) of the ITAA 1997.

The payment is received no later than 12 months after termination

The second condition is stated under paragraph 82-130(1)(b) of the ITAA 1997. The settlement sum must be received within 12 months of the employee's termination of employment, unless the payment is covered by a determination exempting them from the 12 month rule.

Your employment was terminated on a specific date and the settlement payment was made the same day. As such it was made within 12 months after the termination of your employment with the employer. Therefore, the requirement under subparagraph 82-130(1)(b) of the ITAA 1997 has been met.

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 settlement payment.

However, consideration must be given as to whether the specific exemption for personal injury in paragraph 82-135(i) of the ITAA 1997 (payments that are not employment termination payments) applies. This subsection states that employment termination payments do 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);

This exclusion is for a payment or benefit that compensates or reimburses a person for or in respect of the 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) has been 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 these phrases.

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.

In the full Federal Court case Dibb v. Commissioner of Taxation (2004) 207 ALR 151; 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126 (Dibb's Case), while considering whether any part of a settlement payment was in respect of personal injury, Justices Spender, Dowsett and Allsop accepted the argument of Justice Heerey in Dibb v. Federal Commissioner of Taxation 2003 ATC 4613; (2003) 53 ATR 290; [2004] ALMD 5781; [2003] FCA 673 (Dibb), saying:

45. As to this matter, the reasons of the primary Judge were as follows [ATC at 4618]:

32. Before the Commissioner on the objection hearing were two medical certificates dated respectively 21 July 1997 and 19 December 2002 from Dr Jim Ryan of Wishart, Queensland. In the first of these reports Dr Ryan stated:

'This is to certify that I have been treating Mr Dibb for Anxiety/Depression since September 1996. This I believe has come about I believe as a result of losing his job. Currently he takes anti depressant medication with a gradually increasing dosage. He received a medical certificate excusing him from Jury Duty partly because of his serious condition.'

33. In the second certificate Dr Ryan stated:

'This is to certify that I am treating this (patient/man) for dermatitis, hypertension, gastrointestinal disorder and depression.'

34. Counsel for the Commissioner accepted that, in an appropriate case, a single payment made in consequence of the termination of employment of a taxpayer may be apportioned amongst several heads to which it relates. One of those heads could be consideration in respect to personal injury within the meaning of s 27A(1)(n). To that extent the payment may be treated as not being an ETP.

35. 'Personal injury' encompasses injury or disease of a physical or psychological nature. However it would not extend to anguish, distress or embarrassment of the kind traditionally taken into account in assessing damages for defamation:
FC of T v Scully 2000 ATC 4111 at 4119 [28]; (2000) 201 CLR 148 at [28],
Graham v Robinson [1992] VR 279.
However, even accepting that some of the complaints of damage the applicant raised in the Federal Court proceeding consisted of anxiety and depression and thus personal injury', the Commissioner was correct in concluding there was no way of dissecting the total settlement sum to include an amount for such a payment:
McLaurin v FC of T (1961) 12 ATD 273; (1960-1961) 104 CLR 381.

46. The last sentence of [35] of the primary Judge's reasons contains a premise with which we agree. The occasion for apportionment pursuant to par 27A(1)(n) only arises if there can be said to be ''consideration of a capital nature for, or in respect of, personal injury to the taxpayer...''. Here, it is impossible to say whether there was or was not personal injury. AVCO denied it. The section does not provide for ''consideration... of, or in respect of, allegations of personal injury.'' As can be seen from the description of the allegations in the Federal Court proceedings and the terms of the deed, there was no agreement between the parties that Mr Dibb had suffered personal injury. It was submitted on his behalf (as it had to be) that the respondent was obliged to sit, in effect, as a tribunal to decide whether he suffered personal injury and if so, the amount of a reasonable payment therefore. We disagree. The respondent was correct, as was his Honour, in concluding that it was impossible to identify any part of the total sum of $788,544 as consideration for, or in respect of personal 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 your particular case, it is clear from the settlement agreement the settlement payment was made to you in respect of:

· your agreement to the termination of your employment; and

· your agreement not to institute any further proceedings in respects of your allegations, and

· is not consideration for, or in respect of any injury you suffered.

The settlement payment was not calculated by reference to the nature and extent of any personal injury, or your loss of income producing capacity. This is also supported by the settlement agreement that you can continue with your claim for compensation lodged with WorkCover relating to your injury.

Therefore, for the purposes of paragraph 82-135(i) of the ITAA 1997 the settlement payment could not be said to be in respect of personal injury.

Hence, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the settlement payment made to you.

Accordingly, the settlement payment is not a type that paragraph 82-135(i) of the ITAA 1997 would exclude from being an employment termination payment.

The Payment is an employment termination payment and a life benefit termination payment (LBTP)

As all the requirements in subsection 82-130(1) of the ITAA 1997 have been satisfied, the payment made by the employer under the settlement agreement is an employment termination payment in accordance with subsection 82-130(1) of the ITAA 1997.

Tax Treatment of the payment as a LBTP:

An LBTP made after 1 July 2007 is comprised of the following components:

· Tax-free component - this includes the pre-July 83 segment of the payment (if any) and/or the invalidity segment (if any); and

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

In your case, as the period of employment to which the LBTP relates commenced after 1 July 1983, the LBTP does not have a pre-July 83 segment.

In addition, as the LBTP was not made because you ceased being gainfully employed as a result of suffering from ill-health, there is also no invalidity segment for the purposes of section 82-150 of the ITAA 1997.

Consequently the LBTP you received contains no tax-free component as defined in section 82-140 of the ITAA 1997. Rather the entire LBTP is a taxable component as defined in section 82-145 of the ITAA 1997. According the entire LBTP is included in your assessable income for the 2010-11 income year.

The taxable component is subject to tax, depending on the person's age when the settlement payment is received.

As you are under 55 years of age, where the payment does not exceed the employment termination payment cap amount ($160,000) that is specified for the 2010-11 income year under section 82-160 of the ITAA 1997, the payment will be taxed at a maximum rate of 30% plus Medicare levy.

A tax offset will apply to ensure the amount of tax is not greater than 30% plus Medicare levy in accordance of subsection 301-20(2) of the ITAA 1997.

It should be noted, however, that your employment termination payment cap amount is reduced by the amount of any other life benefit termination payments you receive:

· in the same income year; and

· in respect of the same employment termination.

If any amount of your employment termination payment is in excess of your employment termination payment cap amount, it will be taxed at the top marginal tax rate plus Medicare levy.

Employment termination payments cannot be rolled over into a complying superannuation fund, complying approved deposit fund (ADF) or to a retirement savings account (RSA) provider. Accordingly, the Payment 2 amount to your nominated superannuation fund is a non-concessional contribution (i.e. your own personal contribution).