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Ruling

Subject: Assessability of lump sum payment

Questions and answers:

1. Is the settlement payment you received from your former employer assessable as ordinary income?

No.

2. Is the payment received under a settlement agreement an employment termination payment under subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

3. Is the settlement payment you received from your former employer assessable as statutory income?

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You commenced employment with your former employer.

Your employment was terminated several years later.

Approximately 6 months after your employment was terminated you lodged a complaint via a Statement of Claim with the relevant state authority alleging that you were subject to unlawful termination, bullying and harassment and other unlawful discrimination in the course of your employment.

The authority referred the complaint for conciliation.

You were subsequently advised by the authority that unsuccessful attempts had been made to conciliate the complaint.

The authority then received written notice from you requiring the complaint be referred to a tribunal for hearing.

Just over 1 year after your employment had been terminated you and your former employer signed a settlement agreement (the Settlement Agreement) to settle the complaint. Part of the Settlement Agreement states:

Release

6. The Complainant agrees, in consideration of the matters set out in paragraph 4 above, to release and forever discharge the Respondent (including all officers and employees) for all claims or demands, whether current or future, arising from the Complainant's employment with the Respondent (save with the exception of any claim for personal injury arising under the Accident Compensation Act 1985).

Under the settlement agreement your former employer agreed to pay you a lump sum by a stated date.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 6-10
Income Tax Assessment Act 1997 Section 10-5
Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Please note that all references are to the Income Tax Assessment Act 1997 (ITAA 1997).

To determine the assessability of the lump sum payment you have received, we need to consider Division 6, and Division 82.

Division 6 - Assessable income and exempt income

Section 6-5 - ordinary income

Section 6-5 advises that your assessable income includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services (such as salary and wages), income from property (such as rental income) and income from carrying on a business.

Other characteristics of income that have evolved from case law include proceeds that:

· are earned;

· are expected;

· are relied upon; and

· have an element of periodicity, recurrence or regularity.

The lump sum you received was not earned by you as it does not relate to services performed. The payment is also a one off payment and it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the agreement to settle your complaint rather than from a relationship to personal services performed.

The lump sum you received is not included in your assessable income under section 6-5.

Section 6-10 - statutory income

Section 6-10 discusses statutory income amounts which are not ordinary income but are included in your assessable income by other legislative provisions.

Section 10-5 contains a list of those other provisions and included in this list is section 82-10 which deals employment termination payments.
Division 82 - Employment termination payment

Section 995-1 states that:

employment termination payment has the meaning given by section 82-130 of the ITAA 1997.

Subsection 82-130(1) states that:

A payment is an employment termination payment if:

· it is received by you:

· in consequence of the termination of your employment; or

· after another person's death, in consequence of the termination of the other person's employment; and

· it is received no later than 12 months after that termination (but see subsection (4)); and

· it is not a payment mentioned in section 82-135.

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 ITAA 1997).

To determine if the payment you received under a settlement agreement (the Settlement Agreement) between you and your former employer is 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.

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 titled 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 in 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 applicant's 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. True it is that the payment was made not only to settle the applicant's claim for common law damages for breach of the employment agreement but also for statutory damages...

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 of 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.

In this case, you commenced employment with your former employer.

That employment was terminated several years later.

Within 6 months of being terminated you lodged a complaint with the relevant state authority alleging that you were subject to unlawful termination, bullying and harassment and other unlawful discrimination in the course of your employment.

The authority referred the complaint for conciliation.

You were subsequently advised by the authority that unsuccessful attempts have been made to conciliate the complaint.

The authority then received written notice from you requiring the complaint be referred to a tribunal for hearing.

Just over 1 year after your termination you and your former employer signed a settlement agreement (the Settlement Agreement) to settle the complaint. A part of the Settlement Agreement states:

Release

6. The Complainant agrees, in consideration of the matters set out in paragraph 4 above, to release and forever discharge the Respondent (including all officers and employees) for all claims or demands, whether current or future, arising from the Complainant's employment with the Respondent (save with the exception of any claim for personal injury arising under the Accident Compensation Act 1985).

Under the settlement agreement your former employer agreed to pay you a lump sum by a stated date.

Consequently, it is clear that the lump sum was made in consequence of the termination of your employment. The termination of employment and the payments are all intertwined and connected.

Because the payment is considered to be received by you in consequence of the termination of your employment, the requirement under subparagraph 82-130(1)(a) of the ITAA 1997 has been met.

The payment is received no later than 12 months after termination

Paragraph 82-130(1)(b) of the ITAA 1997 requires that the payment must be received no later than 12 months after the termination of employment.

However, paragraph 82-130(4)(a) of the ITAA 1997 states that the 12 month rule prescribed in paragraph 82-130(1)(b) of the ITAA 1997 will not apply if a person is covered by a determination made by the Commissioner under subsection 82-130(7) of the ITAA 1997.

The Employment Termination Payments (12 month rule) Legislative Instrument 2007 is a legislative instrument made by the Commissioner of Taxation pursuant to subsection 82-130(7) of the ITAA 1997. This instrument applies to employment termination payments received after 30 June 2007.

This instrument states that a payment received more than 12 months after termination of persons employment will be an employment termination payment if the delay in the payment was due to the commencement of legal action concerning either or both:

· the persons entitlement to the payment;

· the amount of the persons entitlement;

and the legal action was commenced within 12 months of the termination of employment.

As noted above, the payment was made just over than 12 months after the termination of your employment. However, you commenced legal action within 12 months of the termination of your employment. Therefore, the payment is exempt from the 12 month rule found in paragraph 82-130(1)(b) of the ITAA 1997.

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

Section 82-135 of the ITAA 1997 lists payments that are not employment termination payments. These include (among others):

· superannuation benefits;

· unused annual leave or long service leave payments;

· foreign termination payments covered under Subdivision 83-D of the ITAA 1997; and

· the tax free part of a genuine redundancy payment or an early retirement scheme payment.

The lump sum payment is not a payment that would be excluded from being an employment termination payment.

Tax Treatment of the payment as a Life Benefit Termination Payment (LBTP):

An employment termination payment will comprise of the following components:

· Tax free component - this includes the pre-July 83 segment (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 is not assessable income and is not exempt income. The taxable component is included, in full, as assessable income.

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

Where a taxpayer is under their preservation age, the taxable component of the LBTP is taxed at 30% plus Medicare levy for amounts below the employment termination payment cap of $160,000 for the 2010-11 income year, and at the top marginal rate for the amount above this cap.

The taxable components of all LBTPs received in an income year, or in respect of the same termination of employment, are counted towards this cap. Any tax-free amounts are not counted towards the cap.

According to your preservation age the payment is subject to tax of 30% plus the 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.

Conclusion:

The lump sum is not assessable as ordinary income under Division 6.

The lump sum received under a settlement agreement received by you is an employment termination payment as:

o the payment has been made in consequence of the termination of your employment; and

o the payment is exempt from the 12 month rule; and

o no part of the payment is a payment that would be excluded from being an employment termination payment.

As the payment is an employment termination payment it is assessable as statutory income under Division 6.