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Ruling

Subject: Lump sum payments

Issue 1

Question

1. Is any part of the lump sum payments of Amount A and Amount B paid by your employer assessable as an employment termination payment under subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Is any part of the lump sum payments of Amount A and Amount B paid by your employer included as an invalidity segment of an employment termination payment under subsection 82-150(1) of the ITAA 1997?

3. Is any part of the lump sum payments of Amount A and Amount B paid by your employer a transitional termination payment under subsection 82-10(1) of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A)?

1. Answer: No.

2. Answer: No.

3. Answer: No.

This ruling applies for the following period:

2010-11 income year

The scheme commences on:

1 July 2010

Issue 2

Question

Is any part of the lump sum payments of Amount A and Amount B assessable as ordinary income?

Answer: Yes.

This ruling applies for the following period:

2010-11 income year

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You commenced employment with a company affiliated with the employer several years ago and your employment was transitioned to the employer when the employer merged with another company.

On a specific date during the 2006-07 income year you commenced a leave of absence from the employer for medical reasons and shortly thereafter you commenced receiving salary continuance insurance (SCI) payments (as defined in the employer's Salary Continuance Benefit Policy amended on a specific date during the 2005-06 income year) under an SCI policy issued by a company but administered to you by the employer.

On a specific date during the 2006-07 income year you requested a private ruling for consideration of your invalidity payments to be assessed as tax free on the basis they were post 1994 invalidity payments. It was held that due to periodicity of the invalidity payments they were considered to acquire the character of salary and wages for which they were substituted and therefore would be subject to PAYG. These monthly payments have had PAYG withheld from the first payment until the last payment made under the SCI policy for the period ended 30 June 2010.

On a specific date during the 2007-08 income year you lodged an objection to the ruling. The original decision was upheld.

On a specific date during the 2009-10 income year the company terminated the SCI policy. The last monthly payment made under the SCI policy was for the month on a specific date during the 2009-10 income year and was paid on a specific date during the 2009-10 income year.

In a Claim Settlement Acceptance Form from actuaries dated on a specific date during the 2009-10 income year you accepted the offer made by the company to pay a lump sum in settlement of your claim under the SCI policy for the payment period from a specific date during the 2010-11 income year to a specific date during the 2010-11 income of Amount A.

On a specific date during the 2010-11 income year you received a gross lump sum payment of Amount A (tax was deducted from the payment). This amount was your monthly benefit under the SCI policy for the period from a specific date during the 2010-11 income year to a specific date during the 2010-11 income year (the day before your birthday).

In a letter dated on a specific date during the 2010-11 income year from your employer advised that you terminated employment on a specific date during the 2010-11 income year.

In the Deed of Settlement dated a specific date during the 2010-11 income year between you and your employer, your employer proposed to pay you an amount of Amount C in settlement of all matters between you and your employer in relation to calculation of the base figure under the SCI policy.

On a specific date during the 2010-11 income year you made application to Centrelink for a Disability Support Pension. Due to the receipt of the lump sum of Amount A on a specific date during the 2010-11 income year, there was a preclusion period applied until a specific date during the 2010-11 income. On a specific date during the 2010-11 income year you were granted the Disability Support Pension.

On a specific date during the 2010-11 income year you reviewed the SCI Policy document administered by the company.

You queried the base salary figure upon which payment to you under the SCI policy had been calculated. It was subsequently determined that there were monies due to you under the policy during the period from late 2006 to a specific date during the 2010-11 income year.

The relevant parts of the Deed were outlined to you.

Amount C paid under the Deed of Settlement consisted of an amount of shortfall and interest on the shortfall.

Your employer was aware that the receipt of the lump sum would require a partial refund to Centrelink for overpayment of the Disability Support Pension. Centrelink advised the required refund is estimated to be an amount. As a result your employer increased the lump sum by Amount D, from the agreed amount of Amount C in the Deed of Settlement dated a specific date during the 2010-11 income year to Amount B.

We have outlined the material points from an e-mail dated on a specific date during the 2010-11 income year from your employer to you.

On a specific date during the 2010-11 income year you received a further lump sum of Amount B (tax was deducted from the payment).

In a PAYG Payment Summary for the year ending 30 June 2011 dated a specific date during the 2011-12 income year from the employer stated that there was gross payments, and Lump Sum A of an amount. The gross payment included a payment of Amount A made on a specific date during the 2010-11 income year and payment of Amount B made on a specific date during the 2010-11 income year. There was tax withheld.

You are over 60 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Subsection 82-130(1)

Income Tax Assessment Act Subparagraph 82-130(1)(a)(i)

Income Tax Assessment Act 1997 subsection 82-130(2

Income Tax Assessment Act 1997 Subsection 82-150(1)

Income Tax Assessment Act 1997 Section 995-1

Income Tax (Transitional Provisions) Act 1997 Section 82-10

Reasons for decision

Issue 1 Question

Reasons for decision

Summary of decision

The lump sum payments of Amount A and Amount B paid by your employer are not assessable as employment termination payments under section 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997).

The lump sum payments of Amount A and Amount B paid by your employer do not include an invalidity segment of an employment termination payment under subsection 82-150(1) of the ITAA 1997.

The lump sum payments of Amount A and Amount B paid by your employer are not transitional termination payments under subsection 82-10(1) of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A).

Detailed reasoning

Employment termination payment

From 1 July 2007, payments made in consequence of the termination of a taxpayers employment are known as employment termination payments. Prior to 1 July 2007, these payments were known as eligible termination payments.

Section 995-1 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.

Therefore, it can be seen that 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 the conditions will result in the payment not being considered an employment termination payment.

Payment is made in consequence of the termination of employment

The first condition to be met is that the payment is received by the person in consequence of the termination of their 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 which discusses the meaning of the phrase.

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.

Also in paragraph 5 of TR 2003/13 the Commissioner notes that the Courts have considered the meaning of the words in consequence of in several cases.

Of note are the decisions made by the Full Bench of 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, in the same case, 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. In doing so the Full Federal Court emphasised that a payment may be in consequence of the termination of employment even though the termination is not the dominant cause of the payment.

In particular, 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.

Thus, 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 phrase in consequence of and the decisions in Reseck and McIntosh were considered more recently by the Federal Court 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).

In Le Grand, a settlement payment in relation to legal proceedings involving a wrongful dismissal claim, together with a claim for misleading and deceptive conduct, was held to be an eligible termination payment. Justice Goldberg, the presiding judge, considered that the settlement of the misleading and deceptive conduct component of the claim did not break the casual relationship that existed between the settlement payment and the termination of the taxpayer's employment.

In making his decision, Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicants 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.

The approach taken in Le Grand was also adopted in Dibb v Commissioner of Taxation (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126, where the Full Federal Court held that a payment received under a deed of release following the settlement of legal proceedings against the taxpayer's former employer was an eligible termination payment. The Court considered that there was a clear chain of causation between the payment and the termination. That is, the subject matter of the litigation was clearly interwoven and intertwined with the termination.

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 noted in both paragraphs 6 and 28 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'.

Therefore 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. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135 of the ITAA 1997.

Lump sum payment of Amount A

From the facts of the case you commenced employment with a company affiliated with the employer several years ago and your employment was transitioned to the employer when the employer merged with another company. On a specific date during the 2006-07 income year you commenced a leave of absence from the employer for medical reasons and shortly thereafter you commenced receiving salary continuance insurance (SCI) payments under an SCI policy issued by a company but administered to you by the employer.

On a specific date during the 2009-10 income year you received a lump sum in settlement of your claim under the SCI policy for the payment period from a specific date during the 2009-10 income year to a specific date during the 2009-10 income year of Amount A.

Your employment was terminated on a specific date during the 2009-10 income year.

The payment of Amount A was made on a specific date during the 2009-10 income year which was made prior to your termination of employment on a specific date during the 2009-10 income year. The payment was in settlement of your claim under the SCI policy for the payment period from a specific date during the 2009-10 income year to a specific date during the 2009-10 income year and not as a result of the termination of employment. The termination of employment and the payment are not all intertwined and connected. There is no causal connection between the termination and the payment.

Therefore as the payment is not considered to be made in consequence of the termination of employment, the requirement under subparagraph 82-130(1)(a) of the ITAA 1997 will not be met.

As mentioned above, all the conditions under section 82-130 of the ITAA 1997 must be met before the payment is considered to be an employment termination payment. As one of the conditions under section 82-130 of the ITAA 1997 has not been met, it is not necessary to discuss whether the other conditions have been met. Therefore the payment of Amount A is not an employment termination payment.

We will now discuss the payment of Amount B paid on a specific date during the 2009-10 income year.

Lump sum payment of Amount B

From the facts of the case, you received salary continuance insurance payments under an SCI. On a specific date during the 2009-10 income year you reviewed the SCI Policy document administered by a company. You queried the base salary figure upon which payment to you under the SCI policy had been calculated. It was subsequently determined that there were monies due to you under the company policy during the period from late 2006 to on a specific date during the 2009-10 income year.

In a Deed of Settlement dated on a specific date during the 2009-10 income year between you and your employer, your employer proposed to pay you an amount of Amount C in settlement of all matters between you and your employer in relation to calculation of the base figure under the SCI policy. In an e-mail from your employer to you dated on a specific date during the 2009-10 income year, your employer advised that they will increase the payment from an amount of Amount C to Amount B to take into account reimbursement to Centrelink due to the payment of a lump sum .

The payment under the Deed of Settlement was made in settlement of all matters between you and your employer in relation to calculation of the base figure under the SCI policy and was not made in consequence of the termination of your employment. The termination of employment and the payment are not all intertwined and connected. There is no causal connection between the termination and the payment.

Therefore as the payment is not considered to be made in consequence of the termination of employment, the requirement under subparagraph 82-130(1)(a) of the ITAA 1997 will not be met.

As mentioned above, all the conditions under section 82-130 of the ITAA 1997 must be met before the payment is considered to be an employment termination payment. As one of the conditions under section 82-130 of the ITAA 1997 has not been met, it is not necessary to discuss whether the other conditions have been met. Therefore the payment of Amount B is not an employment termination payment.

Invalidity segment of employment termination payment

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.

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.

All the conditions under subsection 82-150(1) must be met before an employment termination payment contains an invalidity segment.

Prior to determining if a payment includes an invalidity segment, the payment must be an employment termination payment. As mentioned above we have determined that the payments of Amount A and Amount B are not employment termination payments. As the payments are not employment termination payments, they do not meet the first condition of subsection 82-150(1) of the ITAA 1997.

As mentioned above, all the conditions under subsection 82-150(1) of the ITAA 1997 must be met before the payment includes an invalid segment. As one of the conditions under subsection 82-150(1) of the ITAA 1997 has not been met, it is not necessary to discuss whether the other conditions have been met. Therefore the payments of Amount A and Amount B do not have an invalidity segment under subsection 82-150(1) of the ITAA 1997.

Transitional termination payment

Employment termination payments cannot be rolled over into a complying superannuation fund, unless the payment qualifies as a transitional termination payment under section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA).

Subsection 82-10(1) of the IT(TP)A states that:

This Division applies in relation to a life benefit termination payment received by you on or after 1 July 2007 if:

(a) the payment is received by you because you are entitled to it under a written contract, a law of the Commonwealth, a State, a Territory or another country, an instrument under such a law or a workplace agreement within the meaning of the Workplace Relations Act 1996; and

(b) the entitlement is provided for under that contract, law, instrument or agreement as in force just before 10 May 2006.

Furthermore, at subsection 82-10(3) of the IT(TP)A it states:

This Division applies in relation to a life benefit termination payment only to the extent that the contract, law or agreement as in force just before 10 May 2006 specifies the amount of the payment, or a way to work out a specific amount of the payment.

Prior to determining if a payment is a transitional termination payment, the payment must be a life termination payment. Under subsection 82-130(2) of the ITAA 1997 a life termination benefit is as follows:

A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies.

A payment is an employment termination payment to which subparagraph (1)(a)(i) applies if it is received by the taxpayer in consequence of the termination of the taxpayer's employment.

As mentioned above the payments of Amount A and Amount B are not employment termination payments. As the payments are not employment termination payments the payments are not transitional termination payments as they do not meet the first condition of subsection 82-10(1) of the IT(TP)A.

As mentioned above, all the conditions under subsection 82-10(1) of the IT(TP)A must be met before the payment is considered a transitional termination payment. As one of the conditions under subsection 82-10(1) of the IT(TP)A has not been met, it is not necessary to discuss whether the other conditions have been met. Therefore the payments of Amount A and Amount B are not transitional termination payments under subsection 82-10(1) of the IT(TP)A.

Issue 2 Question

Reasons for decision

Summary

The lump salary continuance payments are assessable income in the year of receipt. The lump sum amounts related to your monthly income replacement benefits under the group salary continuance policy. As the lump sum relates to the replacement of assessable income amounts, the lump sum is also regarded as ordinary assessable income.

Detailed reasoning

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the income year.

Salary and wages are regarded as ordinary income.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82).

Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

Payments under a salary continuance policy are paid to substitute salary and wages and are regarded as assessable income.

The issue of whether the redemption or conversion of an entitlement to periodic payments to a lump sum affects assessability was considered in Coward v. FC of T 99 ATC 2166; (1999) 41 ATR 1138. In that case Mathews J found that payments made to replace income take on the character of the payment they replace and that the method of payment does not alter the character of the payment. Mathews J held that as the weekly compensation payments made to the appellant until he turned 65 were paid for loss of earnings and thus constituted income, a lump sum representing redemption of those future weekly payments was also income. That is, a lump sum payment takes on the character of the payment it replaces.

This is consistent with the approach taken by the Commissioner in Taxation Determination TD 93/3 which deals with the partial commutation of periodic payments to a lump sum. As outlined in paragraph 4 of TD 93/3, such a commutation would result in the lump sum remaining assessable, as its effect was simply to pay in advance the future weekly payments.

Therefore, where future regular payments are ordinary income and commuted to a lump sum, the lump sum payment also retains the character of being ordinary income and would be assessable in the income year in which the payment was received.

Taxation Determination TD 93/58 explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable income if the payment is compensation for loss of income.

In your case, your former employer's group salary continuance (income protection) policy with the Company provided for the replacement of income in certain circumstances. The periodic monthly payments that you received in relation to this policy were to replace lost earnings (salary). The purpose of the payments was a substitute for the income which you would otherwise have earned.

When you received the lump sum payment of Amount A, this represented your future monthly benefits under the group salary continuance policy. The payment was calculated as the amount which would be expected to provide the monthly salary continuance payments otherwise payable to you from a specific date during the 2010-11 income year to a specific date during the 2010-11 income year.

This lump sum payment was in satisfaction of an entitlement to income. The fact that the payment of the monthly benefits was made as a lump sum does not change the revenue character of the receipt as it was essentially designed to provide you with an income replacement. Consequently, the lump sum payment retains its character of income and is assessable under section 6-5 of the ITAA 1997.

Similarly, the shortfall amount and associated interest totalling Amount C relate to the correct amount of your monthly benefits under the policy. As these amounts are revenue in nature and replace an amount of ordinary income, this lump sum retains its revenue character and is also assessable under section 6-5 of the ITAA 1997. Although some of the payment accrued in earlier years, the lump sum is assessable income in the year of receipt.

The balance of your second lump sum, totalling Amount D relates to amounts that are either repaid to Centrelink or relate to an amount not paid by Centrelink. Such an amount is still designed to be an income replacement and therefore is regarded as assessable income.

However, where an amount is repaid to Centrelink, Centrelink generally issues an amended payment summary showing the reduced amount of assessable income. The Centrelink amount declared on your tax return should be this reduced amount.

In your case, you received two lump sums under the SCI policy for your loss of salary. The total payments are regarded as ordinary assessable income and are assessable under subsection 6-5(2) of the ITAA 1997.

Other income - lump sum in arrears tax offset

Individuals who receive certain income in a lump sum payment containing an amount that accrued in earlier income years may be entitled to a lump sum in arrears tax offset under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936).The tax offset is intended to overcome the problem of the lump sum attracting more tax in the year of receipt than would have been payable if the payment had been taxed in each of the years in which it accrued.

Eligible income is defined in subsection 159ZR(1) of the ITAA 1936 to include income by way of compensation or sickness or accident pay that is: 

· in respect of an incapacity for work

· calculated at a weekly or other periodical rate; and

· is not a payment made under an insurance policy to the policy owner.

The lump sum payment you received qualifies as eligible income.

To be eligible for the tax offset, the amount of the eligible lump sum that accrued before the year of receipt must not be less than 10% of the 'normal taxable income' of the year of receipt. 

Please note, that your exact entitlement, if any, to a tax offset can not be calculated until you lodge your 2010-11 income tax return.

When you lodge your income year tax return, you should show your assessable lump sum payment in arrears amount of Amount C as 'other income'. Please also attach additional information to show the amount of the payment in arrears for each income year involved.

Please note the remaining amounts of Amount A and Amount D should be included as salary and wages on your tax return.