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Ruling

Subject: Invalidity segment

1. Is the entire payment in respect of the partial and permanent disability (PPD) benefit payment exempt from tax as a capital amount in respect of personal injury?

2. Is any part of the PPD benefit payment an invalidity segment of the tax free component?

3. Will the Commissioner exercise his discretion and issue a determination under subsection 82-130(5) of the Income Tax Assessment Act 1997 (ITAA 1997) that the time between the employment termination and the payment in question is reasonable, and that paragraph 82-130(1)(b) of the ITAA 1997 does not apply in respect of that payment?

Advice/Answers:

1. No.

2. Yes.

3. Yes.

This ruling applies for the following period:

1 July 2010 to 30 June 2011

The scheme commenced on:

1 July 2010

Relevant facts:

Your client is under 55 years of age.

Your client completed higher school certificate and was an exchange student after finishing school. Your client then started a Bachelor's degree which was not completed.

Your client commenced employment with the employer several years ago.

Your client's last retirement date is at the age of 65 years.

Your client was injured on duty and was certified as unfit for work in the 2008-09 income year.

The employer wrote to your client's doctor to clarify your client's medical status, treatment needs and a prognosis for a return to work then and in the future. The doctor replied stating that the doctor had no way of estimating how much time your client should work in the beginning or how quickly your client should increase work time and suggested six months to begin with.

In a letter the employer advised that your client was being medically assessed.

The employer exited your client as 'non hurt on duty'.

Your client's employment was terminated and your client received part of a partial and permanent disability (PPD) entitlement sum which was taxed appropriately.

A worker's compensation board issued a determination regarding amounts to be paid by the employer to your client. They stated that the employer had agreed that your client was hurt on duty for the purposes of benefits under an award (the Award) for weekly payments and la ump sum payment.

More than a year later your client commenced legal action as your client claimed your client was entitled to an "on duty" PPD benefit. Your client states that it took longer than 12 months to take legal action as your client had to apply to an organisation that represents employees (employee organisation) for legal assistance and then there was a lot of legal wrangling between the parties such as letters of demand and paperwork gathering etc.

Your client states that on the eve of the hearing the employer made an offer to your client which your client accepted.

In a letter the employer wrote to the employee organisation to settle the matter by, among other things, paying your client the top-up PPD entitlement and the parties entering a Deed of Release (the Deed).

Your client and the employer entered into the Deed which was signed a few months later.

In a letter from the employee organisation, your client was asked if your client had received the 'settlement sum in satisfaction of the Deed bringing the legal matter to a close.

Your client received a benefit in the 2010-11 income year. 

You have advised that the employer approved a benefit under a death and disability scheme. Further you state that the lump sum payment was made under the Award, being compensation for the employees suffering total and permanent disablement and was not for reimbursement of medical expenses or direct compensation for loss of income.

You have provided medical certificates from three medical practitioners. All of them state that it is unlikely that your client can ever be gainfully employed in the capacity for which your client is reasonably qualified because of education, experience or training.

Your client completed a Bachelor's degree after leaving the employer which enabled your client to be currently employed.

Relevant legislative provisions:

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

Income Tax Assessment Act 1997 Paragraph 82-130(1)(c).

Income Tax Assessment Act 1997 Subsection 82-130(5).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Paragraph 82-135(i).

Income Tax Assessment Act 1997 Section 82-140.

Income Tax Assessment Act 1997 Section 82-145.

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

Income Tax Assessment Act 1997 Paragraph 82-150(1)(a).

Income Tax Assessment Act 1997 Paragraph 82-150(1)(b).

Income Tax Assessment Act 1997 Paragraph 82-150(1)(c).

Income Tax Assessment Act 1997 Paragraph 82-150(1)(d).

Income Tax Assessment Act 1997 Subsection 82-150(2).

Income Tax Assessment Act 1997 Section 995-1.

Income Tax Assessment Act 1997 Section 307-120.

Income Tax Assessment Act 1997 Section 307-145.

Income Tax Assessment Act 1936 Section 27A.

Income Tax Assessment Act 1936 Section 27G.

Reasons for decision

Summary

The employment termination payment received by your client from the employer includes an invalidity segment.

Detailed reasoning

Invalidity segment

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.

Therefore, prior to determining if the payment includes an invalidity segment, the payment must be an employment termination payment.

Employment termination payment

Employment termination payments are defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997).

Three conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. Any termination payments received more than 12 months after the termination of employment will be taxed as ordinary income at marginal tax rates.

Payment received in consequence of the termination of employment

The first condition to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer.

It is considered that the payment received by your client from the employer was made in consequence of the termination of your client's employment. Your client was unable to continue work due to your client's injury and, consequently, was medically discharged.

After medical assessment, retirement on medical grounds was recommended to the employer who approved your client's termination of employment. As a result, the payment of a partial and permanent disability (PPD) benefit and later, a further amount of the PPD p benefit, were made under the Award.

The payments received by your client from the employer would not have been approved and paid unless her employment was terminated. In this case the termination was based on medical grounds.

Therefore, the condition under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

Payment is received no later than 12 months after termination of employment

The facts of this case show that your client's final day of employment with the employer was in the 2008-09 income year. The PAYG payment summary from the employer shows that all the payment was received in the 2010-11 income year which is more than 12 months of your client's termination of employment.

The 12 month rule set out in paragraph 82-130(1)(b) of the ITAA 1997:

To qualify as an employment termination payment, the payment must be received no later than 12 months after the termination of the taxpayers employment (paragraph 82-130(1)(b) of the ITAA 1997).

However, by virtue of paragraph 82-130(4)(a) of the ITAA 1997, the 12 month rule will not apply if a person is covered by a determination made by the Commissioner under either subsection 82-130(5) or subsection 82-130(7) of the ITAA 1997, or if the payment is a genuine redundancy payment or an early retirement scheme payment.

Subsection 82-130(5) of the ITAA 1997 states:

The Commissioner may determine, in writing, that paragraph (1)(b) does not apply to you if the Commissioner considers the time between the employment termination and the payment to be reasonable, having regard to the following:

(a) the circumstances of the employment termination, including any dispute in relation to the termination;

(b) the circumstances of the payment;

(c) the circumstances of the person making the payment;

(d) any other relevant circumstances.

Your client has provided information in two emails about the circumstances that led to the payment being made after 12 months of her termination of employment.

The Deed of Release (the Deed) confirms that there was a dispute with regard to the circumstances surrounding the termination of your client's employment. It also confirms that your client would receive a payment from the employer as a result of the resolution of the dispute.

The employer determined that your client was entitled to an "off duty" PPD benefit under the an Award (the Award). Your client claimed your client was entitled to an "on duty" PPD benefit and therefore began legal proceedings.

Your client made an application for legal assistance to the employee organisation. Your client has stated that there was a lot of legal wrangling between the parties such as letters of demand and paperwork gathering. Further, your client states that the legal team was awaiting outcomes of matters with similar circumstances so as to make a considered decision as to how to approach your client's situation and this took several months.

That your client received legal assistance from the employee organisation is confirmed by letters from the employer to employee organisation in order to resolve the matter. Further, the Deed was entered into to resolve the dispute which indicates that there was no agreement between the parties (the employer and your client) involved to merely postpone the payment.

Having regard to all of the above, the Commissioner has determined that the delay in payment in this case is reasonable given your client was engaging legal services of the employee organisation, which ultimately led to the matter going through legal proceedings and the subsequent signing of the Deed to resolve the matter.

Accordingly, the Commissioner exercises his discretion under subsection 82-130(5) of the ITAA 1997, meaning that paragraph 82-130(1)(b) of the ITAA 1997 has no application in relation to the payment in question.

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

Certain payments made on termination of employment are excluded from being an employment termination payments under section 82-135 of the ITAA 1997. These payments, among others, include:

· accrued annual leave and long service leave payments which are covered by Subdivision 83-A and Subdivision 83-B respectively;

· superannuation benefits which are covered by Divisions 301 to 307; and

· the tax-free parts of a genuine redundancy payment or an early retirement scheme payment worked out under section 83-170.

However, consideration must be given as to whether the payments made by the employer represent reasonable capital payments for personal injury. If they do, then the payments will not be employment termination payments under paragraph 82-135(i) of the ITAA 1997. Paragraph 82-135(i) specifically excludes from being an employment termination payment:

a capital payment for, or in respect of, personal injury to you so far as the payment is reasonable having regard to the nature of the personal injury and its likely effect on your capacity to derive income from personal exertion (within the meaning of the definition of income derived from personal exertion in subsection 6(1) of the Income Tax Assessment Act 1936);

This exclusion is for a payment or benefit that compensates or reimburses the taxpayer for or in respect of the particular injury.

From 1 July 2007, paragraph 82-135(i) of the ITAA 1997 has replaced former paragraph (n) of the definition of 'eligible termination payment' in former subsection 27(1) of the Income Tax Assessment Act 1936 (ITAA 1936) (former paragraph (n)). However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 stated, in relation to section 82-135 of the ITAA 1997, that:

consistent with current legislation, certain payments are prevented from qualifying as employment termination payments.

In accordance with section 1-3 of the ITAA 1997, sections in the ITAA 1936 which have been rewritten in the ITAA 1997 will have the same meaning where it is expressing the same idea, even if the words used are different. It is therefore appropriate to cite cases that refer to the previous legislation.

In Commissioner of Taxation v. Scully (2000) 201 CLR 148; [2000] HCA 6; 2000 ATC 4111; (2000) 169 ALR 459; (2000) 74 ALJR 504; (2000) 43 ATR 718 (Scully) the High Court, in considering former paragraph (n), held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

The payment in Scully was held not to be in respect of personal injury. Acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stated in their joint decision:

In our opinion, the payment in this case cannot be characterised as consideration... in respect of, personal injury. The fact that the payment is not calculated by reference to the nature and extent of the injury or likely loss to the respondent and the fact that the other benefits are similar to that for total and permanent disablement point inevitably to the conclusion that the payment was consideration... for, or in respect of the respondent's termination of employment and her rights under the Trust Deed and was not consideration... for, or in respect of her injury.

From the foregoing it is apparent that for an amount to meet the requirements of paragraph 82-135(i) of the ITAA 1997, the payment must be for, or in respect of, personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In this case, a payment made in accordance with the Award to an employee is only made if an employee has suffered a Partial and Permanent Disability (PPD) as a result of an on duty injury.

Sometime after a PPD payment was made it was determined that your client had a further entitlement to a PPD benefit after the matter went to legal proceedings. Consequently, your client was entitled to a further payment.

The amounts paid as lump sums in accordance with a schedule (for the PPD benefit) of the Award are based on the age and salary of the employee at the time of the injury.

Consequently, the level of incapacity is irrelevant as to the amount received under the Award. The only criterion is that the employee has suffered a PPD and cannot be redeployed elsewhere within the employer.

The lump sum payments are consideration for, or in respect of, the employee's termination of employment and the employee's rights under the Award and not consideration for, or in respect of, the employee's injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss to the employee. In other words, the payment is to compensate the employee for the loss of their employment as a result of the injury sustained rather than to compensate for the injury itself and any subsequent loss of earning capacity.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the lump sum payments being made under the Award. Therefore your client's payments by the employer would not be excluded by paragraph 82-130(1)(c) of the ITAA 1997.

As discussed above, the payment is considered to be a payment received in consequence of the termination of employment and is not a payment under section 82-135 of the ITAA 1997. With the Commissioner's discretion being exercised under subsection 82-130(5) of the ITAA 1997 so that that paragraph 82-130(1)(b) of the ITAA 1997 has no application, all the conditions of subsection 82-130(1) of the ITAA 1997 have been met. Therefore the payment is considered to be an employment termination payment.

The Settlement Sum constitutes a life benefit termination payment

Subsections 82-130(1) and 82-130(2) of the ITAA 1997, provide that where an employment termination payment is made during the life of a taxpayer, the payment is known as a life benefit termination payment.

In particular, subsection 82-130(2) of the ITAA 1997 states:

82-130(2) A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies:

Because the Settlement Sum is an employment termination payment to which subparagraph 82-130(1)(a)(i) of the ITAA 1997 applies, the Settlement Sum constitutes a life benefit termination payment (LBTP) within the meaning of subsection 82-130(2) of the ITAA 1997.

The Settlement Sum is assessable in the 2010-11 income year as an LBTP

In light of the foregoing, it is clear that the Settlement Sum is an employment termination payment as defined under subsection 82-130(1) of the ITAA 1997. Hence it is considered that the Settlement Sum is both a late termination payment and a LBTP as defined under subsection 82-130(2) of the ITAA 1997.

In view of the above, the amount is an LBTP under the terms of subsection 82-130(2) of the ITAA 1997.

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.

Gainful employment

Section 995-1 of the ITAA 1997 defines the term 'gainfully employed' as follows:

gainfully employed means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment.

Until your client became ill your client was employed on a full-time basis with the employer.

Payment for stopping gainful employment

As stated above, the payments are considered to be payments made on the termination of your client's employment.

Employment termination occurred because of ill-health

The requirement under paragraph 82-150(1)(b) of the ITAA 1997 is that the termination of employment resulted from the taxpayer's ill-health, that is, the ill-health was the immediate cause for the termination of the taxpayer's employment.

In this case, the facts show the termination of employment occurred after a medical assessment. Your client's discharge from employment was recommended after considering your client's injuries. This indicates your client was unable to resume normal work due to your client's disability. Therefore, it is considered that this requirement is satisfied.

Termination of employment occurred before last retirement date

The third condition for a payment to qualify as an invalidity component is that it was made before the taxpayer's last retirement date. The payment was made when your client was under the normal retirement age of 65. Therefore, the condition of paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied.

Certification from 2 legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed.

In respect of this requirement, it must be demonstrated that the disability at the time of termination was such that:

...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.

Therefore, paragraph 82-150(1)(d) of the ITAA 1997 requires that there must be the likelihood that the disability of the taxpayer will preclude the taxpayer from ever being employed in a role, for which the taxpayer is reasonably qualified.

The requirement that the disability is likely to result in the taxpayer being 'unable ever to be employed in a capacity for which he or she is reasonably qualified' extends to full-time employment, part-time or casual employment. A person who is not able to work full-time but can work part-time or as a casual in any employment for which the taxpayer is reasonably qualified will not receive the concessional treatment.

In this case, after examining the contents of the medical reports provided it is considered that there are two reports that satisfy the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997.

Two legally qualified medical practitioners have certified, in two medical certificates, that your client is suffering from a medical condition as a result of which, in their opinion, it is unlikely that she can ever be employed in any capacity for which she is reasonably qualified because of education, experience and training.

It is also noted that prior to working with the employer your client was not employed. It is further noted, however, that your client has commenced employment since leaving their employ. Your client has gained the qualification of a Bachelor's degree after leaving the employer. This tertiary qualification is a pre requisite for her employment in the new organisation. Therefore your client is not using their training, qualifications and experience gained while working for the employer.

Consequently, as two medical practitioners have provided certificates that attest to your client being unable to ever be employed in a capacity for which she is reasonably qualified because of education, training or experience, it is considered that the final condition of subsection 82-150(1) of the ITAA 1997 has been satisfied.

Components of an employment termination payment

Under section 82-140 of the ITAA 1997 the invalidity segment included in an employment termination payment is tax free.

An employment termination payment comprises the following components:

· Tax free component - this includes the invalidity segment and/or pre-July 83 component (if any); and

· Taxable component - the amount remaining after deducting the tax free component from the total payment.

Calculation of invalidity segment

As your client has satisfied the requirements for the payment of an invalidity segment, an element of the employment termination payment received from the employer will be tax free.

The amount of the invalidity segment is worked out by applying the formula in subsection 82-150(2) of the ITAA 1997:

Work out the amount of the invalidity segment by applying the following formula:

Amount of employment termination payment	×	Days to retirement
		Employment days + Days to retirement

where:

· days to retirement is the number of days from the day on which the person's employment was terminated to the last retirement day.

· employment days is the number of days of employment to which the payment relates.

The term 'last retirement day' is defined in subsection 995-1(1) of the ITAA 1997 as meaning:

(a) if an individual's employment or office would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be); or

(b) in any other case - the day on which he or she would turn 65.

In the present case the last retirement day will be the day on which your client would turn 65.

Calculation

The amount calculated is the invalidity segment included in the employment termination payment which is tax-free. The remaining amount is a taxable component to be included in your client's income tax return for the 2010-11 income year.

As this amount is under the 2010-11 income year employment termination payment cap of $160,000, and your client has not yet reached preservation age, your client will be eligible to a tax offset under paragraph 82-10(3)(b) of the ITAA 1997. The tax offset will ensure that the rate of tax on the taxable component of $118,696.57 will be no more than 30% (plus Medicare levy).