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Ruling

Subject: Employment termination payment

Questions:

Is the settlement payment made under the Deed of Release (the Deed) an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Is the settlement payment made under the Deed assessable as ordinary income under section 6-5 of the ITAA 1997?

Answers:

Yes.

No.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts:

Your client is over 65 years of age.

Your client commenced employment with the employer a number of years ago.

Whilst on holidays, your client's employment was terminated by the employer in the beginning of the 2010-11 income year.

Your client sought compensation from the employer.

A few months after the termination of employment, your client commenced proceedings (the proceedings) in a state Court (the Court) against the employer.

In the 2011-12 income year, the matter was listed for hearing in the Court. Your client and the employer participated in a mediation conference, in an attempt to resolve the proceedings, and to settle the disputes.

The parties have agreed, without admission of liability, to settle all disputes arising out of and/or in connection with the Employment, the Termination, the Proceeding and all other claims howsoever arising, save worker's compensation claims between them in a Deed of Release (the Deed).

Under a particular subclause of the Deed, a gross amount (the payment) was agreed to be paid to your client as an employment termination payment with tax to be withheld from the payment. No break up of this payment was stipulated in the Deed. In the same subclause, the employer also made a payment to your client's legal representative, for your client's legal costs.

The payment was made in the 2011-12 income year.

Reasons for decision

Summary

The gross settlement payment made to your client under a Deed of Release is an employment termination payment.

Because the employment termination payment was made during your client lifetime, it is a life benefit termination payment (LBTP). As a result, the entire payment is a taxable component of an LBTP, and is included in full in your client's assessable income for the 2011-12 income year.

As your client has reached his preservation age, the taxable component of your client's settlement payment is taxed at 15%, plus Medicare levy. Your client is entitled to a tax offset to ensure that the rate of tax on the taxable component of the payment will not exceed 15% plus Medicare levy.

Detailed reasoning

Employment termination payment

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 Income Tax Assessment Act 1997 (ITAA 1997)).

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 causal 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.

From the facts provided your client's employment with the employer was terminated in the beginning of the 2010-11 income year. As a result of the termination of employment, your client commenced legal action against the employer within a few months after the termination of the employment.

A settlement was reached between your client and the employer under a Deed of Release (the Deed). Under the Deed, a settlement payment (the payment) was paid to your client. The payment was made to your client in the 2011-12 income year. No break up of this payment was stipulated in the Deed; however the payment under the Deed was to satisfy all claims which included a claim in relation to the termination of employment.

The payment would be considered to be made in consequence of your client's termination of employment. The payment would not have been made had there been no termination of employment. The termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the issue of paying a lump sum would not have arisen.

The payment is considered to be received by your client in consequence of the termination of employment. Therefore the requirement of subparagraph 82-130(1)(a)(i) of the ITAA 1997 is met.

Payment received more than 12 months after termination

In addition to meeting the other conditions for a payment to be an employment termination payment, paragraph 82-130(1)(b) of the ITAA 1997 specifies that the settlement sum must be received within 12 months of the employees termination of employment, unless they are covered by a determination exempting them from the 12 month rule.

As already noted in the facts, your client's employment was terminated in the beginning of the 2010-11 income year and the payment was made in the 2011-12 income year which is more than 12 months after your client's termination of employment.

Notwithstanding your client received the payment more than 12 months after the termination of employment, it is considered that the payment in this instance is exempted from the 12 month rule by the operation of paragraph 82-130(4)(a) and subsection 82-130(7) of the ITAA 1997.

Paragraph 82-130(4)(a) of the ITAA 1997 states:

Paragraph (1)(b) does not apply to you if:

You are covered by a determination under subsection (5) or (7);

Subsection 82-130(7) of the ITAA 1997 states:

The Commissioner may, by legislative instrument, determine that paragraph (1)(b) does not apply to either or both of the following, as specified in the determination:

(a) a class of payments;

(b) a class of recipients of payments.

The Employment Termination Payments (12 month rule) Legislative Instrument 2007 is a determination made under subsection 82-130(7) of the ITAA 1997, which has been registered by the Commissioner on the Federal Register of Legislative Instruments.

In accordance with paragraph 3 of the determination entitled Application, it will apply to a payment received by a person after 30 June 2007 if the payment is received:

(a) either

(i) in consequence of the termination of that persons employment, or

(ii) after another persons death, in consequence of the termination of that other persons employment; and

(a) more than 12 months after that termination; and

(b) is not a payment under section 82-135 of the Income Tax Assessment Act 1997.

Where these conditions are satisfied, the payment is referred to in the determination as a late termination payment.

In accordance with paragraph 4 of the instrument entitled Determination, paragraph 82-130(1)(b) of the ITAA 1997 will not apply to a late termination payment if the payment is received more than 12 months after the termination of a persons employment because:

(a) legal action was commenced within 12 months of the termination of employment, of which the subject is either or both:

(i) the persons entitlement to the payment;

(ii) the amount of the persons entitlement; or

(a) the payment was made by a liquidator, receiver or trustee in bankruptcy of an entity that is otherwise liable to make the payment, where that liquidator, receiver or trustee is appointed no later than 12 months after the termination of employment.

In this case legal action was commenced within 12 months of your client's termination of employment. Accordingly, it is considered that the conditions for the payment to be viewed as a late termination payment are satisfied. The payment is exempt from the 12 month rule found in paragraph 82-130(1)(b) of the ITAA 1997. Therefore the requirement of paragraph 82-130(1)(b) of the ITAA 1997 is met.

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.

In this case, the facts provided show that the payment did not include any of the payments mentioned in section 82-135 of the ITAA 1997 which would preclude any part of the payment from being an employment termination payment.

Consequently, it is considered that the payment is not of a type mentioned in section 82-135 of the ITAA 1997. As the payment is not a payment mentioned in section 82-135, the requirement of subparagraph 82-130(1)(c) of the ITAA 1997 is met.

As all the conditions under subsection 82-130(1) of the ITAA 1997 have been satisfied, the settlement payment paid in the 2011-12 income year under the Deed is an employment termination payment.

Ordinary income v statutory income

Section 6-5 of the ITAA 1997 provides that the assessable income of a person includes income according to ordinary concepts (ordinary income) and section 6-10 of the ITAA 1997 also includes statutory income in a person's assessable income.

A person's assessable income therefore may include both ordinary income and statutory income.

Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business.

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

· are earned;

· are expected;

· are relied upon; and

· have an element of periodicity, recurrence or regularity.

Statutory income includes employment termination payments through the operation of subdivision 82-A of the ITAA 1997.

Taxation Ruling IT 2424 discusses compensation payments in respect of unlawful acts of discrimination. At paragraph 24 it states: 

A compensation payment received by way of settlement or under a determination of the Commission in respect of an unlawful act of dismissal qualifies as an eligible termination payment. Essentially, the compensation payment for unlawful dismissal, like a payment for wrongful dismissal settled or awarded under a common law action, is considered to be made in consequence of the termination of any employment of the taxpayer.

In this case, the settlement payment received under the Deed by your client was not income from rendering personal services, income from property or income from carrying on a business. The payment is a one-off payment and thus it does not have an element of recurrence or regularity. Therefore, the payment received under the Deed does not have the characteristics of ordinary income and is capital in nature. However, it is an employment termination payment as the payment was paid in consequence of the termination of your client's employment. The payment is therefore considered to be a capital payment but is assessable as statutory income under section 82-10 of the ITAA 1997. Although the employment termination payment is included in assessable income, the payment still retains its character as a capital receipt.

Capital Gains Tax

The general exemptions provisions from capital gains tax (CGT) are found in subdivision 118-A of the ITAA 1997. Included amongst them is an anti-overlap provision, section 118-20, which ensures that an amount cannot be assessable under both the CGT provisions and non CGT provisions. The effect of the provision is to reduce the amount of any assessable capital gain by any amount which is also assessable under non CGT provisions and by amounts which are exempt income.

Section 118-22 is a related section, which recognises that a CGT event could give rise to an employment termination payment as well as a capital gain. It says that where part of an employment termination payment is assessable under a non CGT provision, then, for the purposes of giving effect to section 118-20, the whole of that employment termination payment is treated as if it had been assessable under the non CGT provision.

Section 118-37 contains an exemption, from CGT, for an amount received as compensation or damages for any wrong or injury suffered in a person's occupation.

In AAT Case 20/97 a taxpayer negotiated a settlement with their former employer after lodging an application with the Queensland Industrial Relations Commission for wrongful dismissal. In considering the application of the predecessor provision of section 118-37 to the payment Senior Member Dwyer stated:

I accept Mr Gibb's submission that if a payment is caught, as I am satisfied it is, by s 27A(1), there is no advantage to the applicant in the fact that it would have been exempt by virtue of s 160ZB(1), if it were not so caught. Further, I agree that because of the difference in the terminology s 160ZB(1) provides a wider exemption from capital gains tax than the exclusion from taxable income of that part of an eligible termination payment which is "consideration of a capital nature for, or in respect of, personal injury to the taxpayer": s 27A(1)(n). For that reason the Ruling dealing with s 160ZB(1) is not relevant to the construction of the term "consideration for or in respect of personal injury" in para 27A(1)(n).'

Accordingly, even though the payment is exempt from being taxed as a capital gain it is assessable as an employment termination payment under section 82-130 of the ITAA 1997.

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

An employment termination payment made after 1 July 2007 will be comprised 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.

Your client commenced employment with the employer after 1 July 1983. Therefore, there will not be any pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997.

As the payment is not made because your client ceased being gainfully employed as a result of suffering from ill-health, there is no invalidity segment for the purposes of section 82-150 of the ITAA 1997.

As the employment termination payment contains neither a pre-July 83 segment nor an invalidity segment, there is no tax free component as defined in section 82-140 of the ITAA 1997. Rather the entire employment termination payment is a taxable component as defined in section 82-145 of the ITAA 1997.

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

In this case, your client was over preservation age on the last day of the income year in which the payment was made. As your client was over preservation age, the entire payment is taxed at a maximum rate of 15%.

A tax offset will apply to ensure the amount of tax is not greater than 15% plus Medicare levy in accordance of subsection 301-20(2) of the ITAA 1997.