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Authorisation Number: 1011839118236

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Ruling

Subject: Employment termination payment and personal injury

Question 1

Is the proposed ex gratia payment to be made under a Heads of Agreement, considered to be an employment termination payment as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is any portion of the payment considered to be a capital payment for, or in respect of personal injury and therefore excluded from being an employment termination payment under paragraph 82-135(i) of the ITAA 1997?

Answer

Yes. The entire payment is excluded under this provision.

This ruling applies for the following period:

Year ending 30 June 2011.

The scheme commences on:

1 July 2010.

Relevant facts and circumstances

Your client, who is over age 55, is employed by the employer as a tradesman. Over two years ago your client suffered a stroke, resulting in multiple disabilities causing total and permanent incapacity for work. Your client claims that the stroke arose as a result of the employment.

Your client alleges that the stroke was caused by work related travel by air that caused or contributed to your client suffering a medical condition which in turn caused or contributed to the stroke. Your client made a claim for workers' compensation against the employer in relation to the stroke. However, the employer does not admit any liability in relation to your client's injury.

The employer made provisional payments to your client pursuant to section 50B of the Workers Rehabilitation and Compensation Act 1986 (SA) pending a determination of the workers' compensation claim. The employer disputes the causation of the stroke and intends to reject your client's workers' compensation claim.

Your client will enter into a Heads of Agreement (the Agreement) with the employer, after negotiations between the parties to resolve all current and future issues relating the disabilities resulting from the stroke. Both parties agreed to settle all issues between them relating to the claim on the terms and conditions contained in the Agreement.

The Agreement provides that your client's employment will be terminated by reason of their total and permanent incapacity for work resulting from disabilities arising from the stroke.

Under the Agreement the employee agreed to accept the payments specified in the Agreement in full and final settlement of any entitlement your client may have in respect of any claims arising out of or in the course of the employment with the employer.

The Agreement provides that the Settlement Monies to be paid to your client are as follows:

· an amount to be paid by the employer as an ex gratia payment as compensation for permanent disability impairing your client's future earning capacity in relation to disabilities arising from the stroke;

· accrued statutory entitlements; and

· a separate payment to be made towards your client's legal costs.

The Agreement contains no dissection of the ex gratia payment. Your client's solicitors state that the ex gratia payment represents an agreed settlement reached by the parties having regard to their differing contentions. The solicitors further state that the ex gratia payment represents a risk offer on the part of the employer in relation to any potential liability (which is denied).

The solicitors also state that the ex gratia payment does not include any amounts for annual leave, long service leave, superannuation benefits or salary and wages. They advise that all statutory entitlements payable to your client upon the termination of the employment will be paid to your client separately and in addition to the proposed payment.

You have advised that your client is unlikely to be able to work again due to the stroke.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Section 1-3,

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) and

Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision

Summary

The ex gratia payment is considered to be a capital payment for, or in respect of, personal injury to your client and is therefore excluded from being an employment termination payment. No part of the payment is an employment termination payment.

Detailed reasoning

Employment termination payments

Employment termination payments are payments that are made in consequence of the termination of any employment of a taxpayer.

Subsection 995-1(1) of the Income Tax Assessment Act 1997 (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 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.

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

· payments for unused annual leave or unused long service leave;

· the tax-free part of a genuine redundancy payment or an early retirement scheme payment; and

· reasonable capital payments for personal injury.

To be an employment termination payment, the amount to be received by your client must satisfy all three conditions listed above.

The first condition requires that there is a payment received by your client in consequence of the termination of his employment.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the words have been interpreted by the courts in several cases. The Commissioner has also issued Taxation Ruling TR 2003/13 (TR 2003/13) which discusses the meaning of the phrase. Paragraph 5 of TR 2003/13 states:

'...the Commissioner considers that 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.'

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 payment will be made 'in consequence of' the termination of employment'

Your client is employed by the employer as a tradesman. Over two years ago your client suffered a stroke. The stroke resulted in your client sustaining multiple disabilities causing total and permanent incapacity for work (the Disabilities). You have advised that your client is unlikely to be able to work again because of the disabilities arising from the stroke.

Your client alleges that the stroke arose because of travel by air undertaken in the course of the employment, and they made a claim for workers' compensation against the employer in relation to the stroke. However, the employer does not admit any liability in relation to your client's injury.

Although the employer made provisional workers' compensation payments to your client pending a determination of the claim, the employer disputes the causation of the stroke and intends to reject the claim.

Your client and the employer entered into negotiations to resolve all current and future issues relating the Disabilities resulting from the stroke. The parties agreed to settle these issues by entering into a Heads of Agreement (the Agreement). By entering into the Agreement, both parties agreed to settle all issues between them relating to your client's compensation claim on the terms and conditions contained in the Agreement.

The Agreement states that your client's employment will be terminated by reason of the total and permanent incapacity for work resulting from the disabilities arising from the stroke. The Agreement provides that the employer will pay an amount to your client as an ex gratia payment as compensation for permanent disability impairing your client's future earning capacity in relation to disabilities arising from the stroke. The Agreement does not provide any dissection of the payment.

The facts show that the ex gratia payment is the result of a settlement your client had reached with the employer in accordance with the provisions of the Agreement. It follows that the payment is an effect or result of the cessation of the employment.

It is clear, therefore, that the payment will be made to your client 'in consequence of the termination of employment'. Although the dominant cause of the payment was the workers' compensation claim brought by your client against the employer, there is still a causal connection between the termination and the payment. The claim, 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 is satisfied.

The '12 month rule'

The second condition for the payment to qualify as an employment termination payment is stated in paragraph 82-130(1)(b) of the ITAA 1997. The payment must be received within 12 months after the termination of your client's employment, unless your client is covered by a determination exempting them from the 12 month rule.

In this case, it is accepted that the employer will make the payment to your client within 12 months after the termination of the employment. Therefore, the payment will also satisfy the second requirement under 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 of the ITAA 1997.

Payments excluded from being employment termination payments

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 superannuation benefits, any accrued annual and long service leave payments, the tax-free part of a genuine redundancy payment or an early retirement scheme payment, and reasonable capital payments for personal injury.

The proposed ex gratia payment is the result of a settlement your client had reached with the employer according to the terms and conditions of the Agreement. The payment is not a superannuation benefit, a payment for unused annual leave or unused long service leave, nor is it the tax-free part of a genuine redundancy payment or an early retirement scheme payment. In this light, it is noted that the Agreement provides for the payment of your client's accrued statutory entitlements upon the termination separately and in addition to the payment.

However, consideration must be given as to whether paragraph 82-135(i) of the ITAA 1997 will exclude the payment from being an employment termination payment.

Reasonable capital payments for personal injury

Paragraph 82-135(i) 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);…

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 an 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 former paragraph (n) exclusion stated:

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 former paragraph (n) has been replaced by paragraph 82-135(i) of the ITAA 1997. Whilst the wording of the new provision differs slightly from the wording contained in the former paragraph (n) exclusion, the operation of the new provision remains the same.

This is illustrated by the following statement made in the Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Act 2007 (No. 9 of 2007) in relation to section 82-135 of the ITAA 1997:

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

Further, section 1-3 of the ITAA 1997 states:

1. This Act contains provisions of the Income Tax Assessment Act 1936 in a rewritten form.

2. If:

(a) that Act expressed an idea in a particular form of words; and

(b) this Act appears to have expressed the same idea in a different form of words in order to use a clearer or simpler style;

(c) the ideas are not to be taken to be different just because different forms of words were used.

It is therefore appropriate to cite cases that refer to the previous legislation.

In considering whether the ex gratia payment will fall within the exclusion set out in paragraph 82-135(i) of the ITAA 1997, we must determine if your client has a 'personal injury', and what the ex gratia payment will actually be paid for.

Does your client have a personal injury?

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

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

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

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

· property injury - damage to a person's property.

Notwithstanding it may be said all three types of injury may be personal, it is considered only the first type (that is, behavioural injury) falls within the meaning of the term personal injury as used in the former paragraph (n) exclusion. Therefore for an amount to be excluded from being an employment termination payment under paragraph 82-135(i), the payment must be for a behavioural type personal injury.

As noted previously, over two years ago your client suffered a stroke which resulted in your client sustaining multiple disabilities causing total and permanent incapacity for work. It is quite clear that your client suffered a physical injury.

The Agreement provides for the ex gratia payment to be made as compensation for the physical injury your client suffered as a result of the stroke. It is clear from the Agreement that the payment will be made to your client to compensate them for the particular injury arising from the stroke. As such, the payment will be made in respect of your client's behavioural type personal injury.

What will the ex gratia payment be paid for?

In Commissioner of Taxation (Cth) v. Scully (2000) 201 CLR 148; [2000] HCA 6; (2000) 2000 ATC 4111; (2000) 43 ATR 718 (Scully) the High Court, in considering the former paragraph (n) exclusion, held that the 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 be excluded from being an employment termination payment under paragraph 82-135(i), in addition to the payment being made for personal injury, the payment must also be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In this case, the Heads of Agreement evidencing the terms of the agreement your client and the employer had reached to settle the claim for workers' compensation, involved the payment of the amounts referred to in the Agreement as the Settlement Monies, in return for your client discontinuing all legal proceedings against the employer, and releasing the employer from all claims and liability in relation to the employment, the stroke and the workers' compensation claim.

As noted previously, the Agreement provides for the payment of an amount to your client as an ex gratia payment as compensation for permanent disability impairing your client's future earning capacity in relation to disabilities arising from the stroke.

The Agreement does not provide any dissection of the ex gratia payment.

However your client's solicitors state that the ex gratia payment was calculated as a capital payment to be made in respect of the personal injury your client sustained and which is considered reasonable having regard to the nature of the injury and the effect on their capacity to derive income from personal exertion (i.e. total and permanent incapacity for work). On the facts provided, and in light of the express terms of the Agreement, the Commissioner agrees with this statement.

As noted above, the ex gratia payment will be made to your client for, or in respect of, the personal injury. Given the express terms of the Agreement, it is clear that the payment will also be made to compensate your client for the permanent disabilities impairing your client's future earning capacity that your client sustained as a result of the stroke.

It is evident that the ex gratia payment was calculated by reference to the nature and extent of your client's injury and likely loss to your client arising from the injury. Hence the payment is a capital payment for, or in respect of, personal injury to your client.

The payment is a payment mentioned in section 82-135 of the ITAA 1997

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 operates to exclude the entire amount of the ex gratia payment from being an employment termination payment. Therefore the final requirement under paragraph 82-130(1)(c) is not satisfied, because the payment is a payment mentioned in section 82-135.

Conclusion

In this case, paragraph 82-135(i) of the ITAA 1997 clearly applies to the ex gratia payment provided for in the Agreement. Therefore, the requirement in paragraph 82-130(1)(c) of the ITAA 1997 is not satisfied. Consequently, no part of the payment is considered to be an employment termination payment, because the payment is specifically excluded under section 82-135 of the ITAA 1997.