Edited version of your private ruling

Authorisation Number: 1011944962013

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject : Invalidity

Question

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

Answer

Yes.

This ruling applies for the following period:

2008-09 income year.

The scheme commences on:

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Your client is under preservation age when the payment was made.

Your client commenced working for the Employer several years ago.

Your client was a member of a complying superannuation scheme.

During the course of employment, your client was exposed to significantly life threatening traumatic incidents. Your client reported off sick in early 2008 and was subsequently treated through various rehabilitation methods and therapies for an illness.

Your client returned to work on restricted duties in mid-2008. Subsequently, your client appeared to have suffered from illness and in mid-2008, was certified unfit for all duties by their treating doctor.

A medical panel, in conjunction with a government medical office's recommendation, has recommended your client be medically discharged from the Employer. This was accepted by the Employer and your client's last day of service was in mid-2009.

A letter from the Employer advised your client that a payment had been approved as a partial and permanent disability benefit.

Further, the letter advised that this payment was calculated in accordance with a Schedule of an award (the Award).

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

Your client has not been in any employment since the termination of employment with the Employer.

You have provided copies of two medical certificates. In relation to your client's injuries, both certificates state in part that the taxpayer is unable to engage in work consistent with their training, education and experience due to medical condition.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 1-3.

Income Tax Assessment Act 1997 Subsection 82-10(1).

Income Tax Assessment Act 1997 Subsection 82-10(2).

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 Subsection 27A(1).

Income Tax Assessment Act 1936 Section 27G.

Reasons for decision

Summary

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

Detailed reasoning

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). Subsection 82-130(1) declares:

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 termination; 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:

· 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.

Therefore, it can be seen that three conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. Any termination payments received more than 12 months after the termination of employment will be taxed as ordinary income at marginal tax rates.

Payment received in consequence of the termination of employment

The first condition to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer.

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

Retirement on medical grounds was recommended by a medical panel to the Employer who approved your client's termination of employment and the payment of a partial and permanent disability benefit under the Award.

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

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

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

The second condition for the payment to meet the criteria is that the employment termination payment was paid to the taxpayer no later than 12 months after your client's employment was terminated.

The facts of this case show that your client's payment was received within 12 months of the termination and therefore satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997.

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

As noted earlier section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments. These include:

· superannuation benefits;

· 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.

The payment is the result of a calculation of a partial and permanent disability benefit under the Award. It 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.

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

Paragraph 82-135(i) of the ITAA 1997 states that an employment termination payment does 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 '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, the former paragraph (n) exclusion 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 which, as enacted, inserted section 82-135 of the ITAA 1997, states that:

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

Paragraph 82-135(i) of the ITAA 1997 represents a rewrite of the former paragraph (n) exclusion. Despite the fact that the wording of the legislation has changed from 'consideration of a capital nature' to 'capital payment', the meaning of the legislation has not changed.

In this regard, 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;

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

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 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 a capital payment for, or in respect of, personal injury, the payment must actually be for personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

As advised in a letter from the Employer the payment was calculated in accordance with the Award. Payments under the Award are made where an employee has suffered a partial and permanent disability (PPD) as a result of an on-duty injury and their employment is subsequently terminated.

A Schedule of the Award determines the amount to be paid as a lump sum under the Award. The amount is calculated by reference to the age and salary of the employee at the time of the injury.

Consequently, the level of incapacity is irrelevant as to the amount received under the Award. For example, an employee who is 20% incapacitated will receive the same amount as an employee who is 80% incapacitated provided they are at the same salary level and age at the date of injury.

The only criterion is that the employee has suffered a PPD and cannot be redeployed elsewhere by the Employer.

The lump sum payments are consideration for, or in respect of the employee's termination of employment and the employee's rights under the Award and not consideration for, or in respect of the employee's injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss to the employee. In other words, the payment is to compensate the employee for the loss of their employment as a result of the injury sustained rather than to compensate for the injury itself and any subsequent loss of earning capacity.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the lump sum payment being made under the Award.

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

As all the conditions under subsection 82-130(1) of the ITAA 1997 have been met, the payment will be an employment termination payment.

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.

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 becoming ill, your client was employed on a full-time basis with the Employer. In mid 2009 your client's employment with the Employer was terminated after a medical panel considered your client was unfit for the substantive requirements of their position due to your client's disabilities and recommended your client's medical discharge.

Under normal conditions of employment your client would have retired at age 65. Your client was under preservation age at the time of the termination of their employment. Therefore the conditions in paragraphs 82-150(1)(a), (b) and (c) of the ITAA 1997 have 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

As noted above, paragraph 82-150(1)(d) of the ITAA 1997 requires that two legally qualified medical practitioners certify that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

Prior to 1 July 1994, it had only been necessary for the termination of employment to occur because the taxpayer was physically or mentally incapacitated and therefore unable to engage in that employment. It did not require there be incapacity to engage in any employment. However, amendments made to the section that applied prior to 1 July 2007, section 27G of the ITAA 1936, by the Taxation Laws Amendment (Superannuation) Act 1992 require the incapacity to prevent the taxpayer ever being able to undertake any employment for which the taxpayer is reasonably qualified.

The EM to the Taxation Laws Amendment (Superannuation) Bill 1992 confirms this. In explaining the test for invalidity, the EM stated the following:

To clarify the test for incapacity and to place the onus of determining invalidity on legally qualified medical practitioners, from 1 July 1994 the incapacity of the person will have to be certified by two medical practitioners.

…the invalidity payment concession is extended only to people who are unable to undertake any form of employment for which they are reasonably qualified. A person who is unable to continue his or her current employment, but is able to undertake other appropriate employment, will not have access to the concession.

Therefore, a person who is unable to continue to perform the duties of his or her current employment, but is able to undertake other appropriate employment for which they are reasonably qualified, would now not satisfy the condition in paragraph 82-150(1)(d) of the ITAA 1997, which is the rewritten provision for section 27G of the ITAA 1936.

The EM does not elaborate further. 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.

It is clear from reading the provision that the onus for determining invalidity (ill-health) is ascribed to the two legally qualified medical practitioners. Fulfilling that responsibility would involve, not only a medical opinion as to the taxpayer's physical and mental capabilities but also consideration as to what constitutes appropriate employment, based upon the taxpayer's education, training and experience.

Even if a taxpayer's employment is terminated by reason of disability, this does not mean that the second part of test for invalidity is satisfied. The two parts are independent. The fact that the medical practitioners have to determine invalidity does not mean that the medical practitioners have to determine the reason for termination.

A person's employment can be terminated because of disability, irrespective of whether two medical practitioners form an opinion as to whether the disability will prevent the taxpayer from ever being able to be employed in a capacity for which the taxpayer is reasonably qualified because of education, training or experience.

Further, the requirement that the disability is likely to result in the taxpayer being unable ever to be employed in a capacity for which he or she is reasonably qualified extends to full-time employment, part-time or casual employment. A person who is not able to work full-time but can work part-time or casual in any employment for which the taxpayer is reasonably qualified because of education, experience or training, will not receive the concessional component.

In your client's case, two legally qualified medical practitioners have certified that as a result of the injury your client will never be able to be gainfully employed in any capacity for which your client is reasonably qualified because of education, training or experience.

It is also noted that prior to being employed by the Employer your client engaged in a trade and then worked in an industry analogous to that of the Employer.

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

Components of an employment termination payment

An employment termination payment made after 1 July 2007 comprises the following components:

· Tax free component this includes the pre-July 83 component (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.

The tax-free component of an employment termination payment is not assessable income and is not exempt income (subsection 82-10(1) of the ITAA 1997). However, the taxable component is assessable income (subsection 82-10(2)) and subject to tax, depending on the person's age when the payment is received.

Calculation of invalidity segment

As noted above, the invalidity segment of an employment termination payment is included in the tax-free component (section 82-140 of the ITAA 1997). As a consequence, the invalidity segment is not assessable income and is not exempt income.

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 x ______Days to retirement_______________

Termination Payment 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.

The amount calculated as per the formula above is the invalidity segment which, as noted earlier, forms part of the tax-free component of the employment termination payment.

As your client's employment commenced after 30 June 1983 there will not be any pre-July 83 segment.

Tax treatment of taxable component

The remainder of the payment (the payment less the tax-free component) is a taxable component of the employment termination payment as defined in section 82-145 of the ITAA 1997. This component is to be included in your client's tax return for the 2008-09 income year.

For recipients below preservation age, the taxable component of an employment termination payment is:

· for amounts below the employment termination payments cap ($145,000 for the 2008-09 income year) - taxed at a maximum rate of 30% plus Medicare levy (and Medicare levy surcharge, if applicable); and

· for amounts above the cap - at the top marginal rate plus Medicare Levy (and Medicare levy surcharge, if applicable).

Preservation age is the age at which a person can access their superannuation benefits generally on retirement. For persons born after 30 June 1960, their preservation age will be between 55 and 60. This is because the preservation age will gradually increase from 55 to 60 between 2015 and 2025. In your client's case, your client is under preservation age on the last day of the income year in which the payment was made.