Edited version of your private ruling

Authorisation Number: 1012111465526

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: Employment termination payment - 12 month rule

Question

Is the ex-gratia payment to be made to a former employee an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts and circumstances

The former employee commenced employment with the employer in the 2009-10 income year.

The former employee resigned in the 2010-11 income year and was paid all accrued leave entitlements.

The former employee disputed the reasons that led to their termination of employment. The former employee commenced legal action against the employer for unfair dismissal within a month of the termination of employment.

In the 2011-12 income year, a settlement was reached and a gross amount was agreed to be paid to the former employee as an ex-gratia payment.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 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 Subparagraph 82-130(1)(a)(i)

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 Paragraph 82-130(4)(a)

Income Tax Assessment Act 1997 Subsection 82-130(7)

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary

The gross payment to be made to the ex-employee is an employment termination payment as:

· it was made in consequence of the termination of the employee's employment,

· the payment is exempt from the 12 month rule, and

· the payment is not a payment which is excluded from being an employment termination payment.

Because the employment termination payment was made during the former employee's 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 the former employee's assessable income for the 2011-12 income year.

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

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

(b) 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 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.

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, the former employee's employment with the employer was terminated in the 2010-11 income year. As a result of the termination of employment, the former employee commenced legal action against the employer within a month after the termination of employment1.

A settlement was reached between the former employee and the employer that an amount was to be paid to the former employee as an ex-gratia payment.

The ex-gratia payment would be considered to be made in consequence of the former employee'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 lump sum payment is considered to be received by the former employee in consequence of the termination of employment. Therefore the requirement of subparagraph 82-130(1)(a)(i) of the ITAA 1997 will be 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, the payment was received by the former employee more than 12 months after the former employee's termination of employment.

Notwithstanding the former employee received the payment more than 12 months after their 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 the former employee'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 amount to be made is an employment termination payment.

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.

The former employee commenced employment with the employer in the 2009-2010 income year, 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 the former employee 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.

If the former employee is over the preservation age on the last day of the income year in which the former employee receive the payment. The payment will be taxed at 15 per cent (%) plus Medicare levy.

If the former employee is under the preservation age the entire amount will be taxed at 30% plus Medicare levy.