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Subject: Compensation payment - lump sum - Deed of Settlement

Question 1: Is the payment you received under a deed of settlement an employment termination payment under subsection 82-130(1) of the Income Tax Assessment Act 1997?

Answer:

No.

Question 2: Is a lump sum payment made in respect of compensation, assessable income?

Answer:

No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

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.

You were an employee of a government department.

You resigned from the department in late 200X.

In early 200Y, you made a claim seeking compensation for detriment caused by defective administration.

The claim was for the treatment for a period of more than six months the department caused the defective administration in a number of ways including:

· failure to stop unnecessary interference by a senior officer in your duties and responsibilities as an officer in charge

· inappropriately causing charges of a trivial nature to be brought against you

· the failure to properly administer your hearing, and

· the posting from one place to another.

You asserted that you had suffered loss by reason of the defective administration on the part of the department.

By virtue of the Deed dated early 2011, you received a compensation payment of a specified amount under a specified compensation scheme.

The payment included reimbursement of legal fees.

You have provided a copy of documentation to support your application and these documents are to be read with and forms part of your application for the purpose of this ruling.

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 Section 82-135.

Income Tax Assessment Act 1997 Subsection 82-135(e).

Income Tax Assessment Act 1997 Section 995-1.

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 6-10.

Income Tax Assessment Act 1997 Section 118-37.

Income Tax Assessment Act 1997 Section 118-305.

Reasons for decision

Question 1: Is the payment you received under a deed of settlement an employment termination payment under subsection 82-130(1) of the Income Tax Assessment Act 1997?

Summary

The payment you received under a deed of settlement is not employment termination payments as the payment has not been made in consequence of the termination of your employment.

Detailed reasoning

Employment termination payment

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that:

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

Subsection 82-130(1) of the ITAA 1997 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

· (b) 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 the Deed signed in early 2011 between you and the department 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 ... (bold emphasis added)

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 Federal 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.

In 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 were employed by a government department.

You claimed that you suffered loss by reason of the defective administration on the part of the department for a period of more than six months in 2000.

You sought compensation for a number of claims (the Claims) early 200Y including:

· failure to stop unnecessary interference by a senior officer in your duties and responsibilities as an officer in charge

· inappropriately causing charges of a trivial nature to be brought against you

· the failure to properly administer your hearing, and

· the posting from one place to another place.

The Deed between you and the department was signed in early 2011 to settle the Claims.

Under the Deed you were entitled to the sum of a specified amount which is inclusive of legal costs.

The Deed sets out that the payment has been made to settle your assertions and refers to your claims in a letter dated early 200Y. A review of these claims show that they relates solely to your claims for detriment caused by defective administration on the part of the department for a period of more than six months in 2000. No part of your claims is connected or intertwined with the termination of your employment.

Therefore, the payment does not follow as an effect or a result of the termination of your employment. It is clear from the above that the payment has not been made in consequence of the termination of your employment.

Because the payment is not 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 not been met and the payment is not an employment termination payment.

Question 2: Is a lump sum payment made in respect of compensation, assessable in the hands of the recipient?

Summary

The lump sum payment received by you pursuant to the Deed is not assessable, either as ordinary income or under the capital gains tax (CGT) provisions.

Detailed reasoning

Whether a compensation payment is capital or revenue depends on what the compensation payment is intended to replace. Generally, a payment will be on revenue account if it is intended to replace another amount which would have been income. It is therefore necessary to distinguish between compensation for loss of income on the one hand and compensation for the loss of the ability to produce income or the right to receive income on the other.

In your situation, the payment that you received was not intended to replace another amount which would have been income. It was compensation for a wrong that you suffered in your occupation. Accordingly, the payment that you received as a result of entering into the deed of release was capital proceeds in respect of relinquishing your right to sue.

The right to sue in respect of any alleged loss suffered is considered to be an intangible CGT asset owned by a person entitled to compensation.

In your case, paragraph 118-37(1)(a) of the ITAA 1997 needs to be considered as this operates to disregard a capital gain or capital loss from a CGT event which relates directly to compensation or damages received for any wrong or injury suffered by a person in their occupation.

Accordingly, in your case, the compensation received by you was for a wrong suffered by you in your occupation. The 'wrong' suffered for the purposes of paragraphs 118-37(1)(a) or (b) of the ITAA 1997 is the loss that you have suffered and therefore, the lump sum payment is exempt from CGT.

In conclusion, the lump sum payment received by you pursuant to the Deed is not assessable, either as ordinary income or under the CGT provisions.