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Ruling

Subject: Invalidity Segment

Issue

Question

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

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

Advice/Answers

Yes

Yes

This ruling applies for the following period

Year ending 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

1. You are under 60 years of age.

2. After completion of your secondary education you worked in a position with another employer.

3. Over 10 years ago you commenced working for the employer.

4. You were a member of the employer's Superannuation Scheme.

5. You were referred to a medical practitioner due to your illness. You did not attend rehabilitation or counselling as your medical practitioner advised against this.

6. You applied for a medical discharge which was accepted by your employer.

7. Your employment was terminated.

8. A letter from the employer advised you that a payment had been approved as a partial and permanent disability benefit.

9. This letter also confirms that the payment is based on your age and years of service and not on the severity and nature of your injury.

10. A payment summary shows the details of your employment termination payment.

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

12. You have not been in any employment since the termination of your employment

13. You have provided copies of two medical certificates. Both certificates state that you are suffering from a medical condition which is likely to result in you being unable ever to be employed in a capacity for which you are reasonably qualified by education, training or experience.

Assumptions

None

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 of decision

The payment received is an employment termination payment.

The employment termination payment includes a tax free 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 Income Tax Assessment Act 1997 (ITAA 1997).

A number of conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of these 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 you, was made in consequence of the termination of your employment. You were unable to continue work due to your injury and consequently were medically discharged.

Retirement on medical grounds was approved along with the payment of a partial and permanent disability benefit.

The payment received by you would not have been approved and paid unless your 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 facts of this case show that the payment was received within 12 months of the termination of your employment. As a result it 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 is the result of a calculation of a permanent disability benefit under the Award. It is a distinct payment for illness suffered at work and is unconnected with payments for your 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 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 part of 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 paragraph 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 was made to you as a result of an injury. The amount was paid as a lump sum.

The facts show that the level of incapacity is irrelevant as to the amount received under the Award. The lump sum payments are consideration for, or in respect of the termination of employment and not consideration for, or in respect of the injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss. In other words, the payment is to compensate for the loss of 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 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 you became ill you were employed on a full-time basis.

Payment for stopping gainful employment

As stated above, the payment is considered to be a payment made on the termination of your 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 the employer considered your injuries. This indicates you were unable to resume normal work due to your 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 you were well before the normal retirement age of 65. Therefore, the condition of paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied.

Certification from 2 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.

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 satisfy the condition in paragraph 82-150(1)(d) of the ITAA 1997.

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.

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 you are suffering from a medical condition as a result of which, in their opinion, it is unlikely that you can ever be employed in any capacity for which you are reasonably qualified because of education, experience and training.

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

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 you have satisfied the requirements for the payment of an invalidity segment, an element of the employment termination payment received 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 amount less the tax free amount is a taxable component to be included in your income tax return for the 2010-11 income year.

The amount of the taxable component below the 2010-11 income year employment termination payment cap will be taxed at no more than 30% plus Medicare levy, as you have not yet reached your preservation age.