Edited version of your private ruling

Authorisation Number: 1012306660122

Ruling

Subject: Invalidity Segment of an Employment Termination Payment

Question 1

Is any part of the payment made in lieu of notice on termination of employment the invalidity segment of an employment termination payments made under section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is any part of the payment made pursuant to sections 36 and 38 of the Workers Compensation Act 1987 (NSW) the invalidity segment of an employment termination payment under section 82-150 of the ITAA 1997?

Answer

No.

Question 3

Is any part of the payment made pursuant to sections 36 and 38 of the Workers Compensation Act 1987 (NSW) assessable as ordinary income?

Advice/Answers

Yes.

This ruling applies for the following periods:

Year ending 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You are currently under 50 years of age.

You commenced employment with a company during 20XX.

You were on leave during 20XX due to a work related stress and anxiety complaint.

You were terminated from your employment during 20YY and your employer paid you an amount in lieu of notice on termination of employment.

You submitted an application during 201YY to the Workers Compensation Commission to resolve a dispute regarding all outstanding employment issues. Your application sought payment of weekly benefits and medical expenses based on schedule of wages.

The Commission awarded a payment based on weekly dollar amounts allocated to specific periods.

Section 36 of the 1987 Act provides that the weekly payment of compensation to an injured worker in respect of any period of total incapacity for work during the first 26 weeks of incapacity shall be the amount of the worker's current weekly wage rate.

Section 38 of the 1987 Act then determines the rate of compensation available after the first 26 weeks up to a maximum of 52 weeks based on a percentage of the worker's current weekly wage.

A payment was made during 20ZZ to settle the workers compensation claim.

You have attained several qualifications and completed a number of training courses up until the date of the termination of your employment.

You have provided medical certificates from two medical practitioners.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Section 82-150

Income Tax Assessment Act 1997 Subparagraph 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

Reasons for decision

Question 1

Summary of decision

The payment is an employment termination payment which includes an invalidity segment as:

· the payment was made to you because you stopped being gainfully employed;

· you stopped being gainfully employed because you suffered from ill-health;

· your employment stopped before your last retirement day; and

· two legally qualified medical practitioners have certified that, because of ill-health, it is unlikely that you can ever be gainfully employed in a capacity for which you are reasonably qualified because of education, experience or training.

The tax free invalidity segment of the payment received in the 2010-11 income year is $A1.

As the payment is an employment termination payment and you were under the preservation age when the payment was made, the excess amount will be taxed at a maximum rate of 31.5% plus any Medicare levy and, if applicable, Medicare levy surcharge.

Detailed reasoning

Payments that are made in consequence of the termination of any employment of a taxpayer are 'employment termination payments' (ETP).

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 the invalidity segment.

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 being '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 you became ill, you were employed on a full-time basis at your employer. Accordingly, the definition of being 'gainfully employed' has been satisfied in this instance.

Payments for stopping gainful employment

The facts provided indicate that a payment was made to you upon the termination of your employment with your employer.

In this case, it is considered that the payment was made in consequence of the termination of your employment as the payment would not have been approved and paid unless your employment was terminated. In this situation, the termination was based on medical grounds.

Therefore, the payment was made when you ceased gainful employment and therefore satisfies the first condition in paragraph 82-150(1)(a) of the ITAA 1997.

The employment termination occurred because of the ill-health of the taxpayer

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 provided demonstrate that the termination of employment occurred after your employer considered a number of medical reports issued by your medical practitioners. The contents of the medical reports indicated you were unable to resume normal work due to your medical condition.

Therefore, it is considered that the employment termination occurred due to your ill-health and thus, the requirement under paragraph 82-150(1)(b) of the ITAA has been satisfied.

The termination of employment of the taxpayer occurred before the last retirement date in relation to the employment

The third condition for an amount of payment to qualify as an invalidity component is that the termination of employment occurred before the taxpayer's last retirement date. The facts provided demonstrate that on your final day of employment with your employer you were under 50 years of age, well before the retirement age of 65. Therefore, the condition of paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied.

Certification from two legally qualified medical practitioners that the ill-health will result in the taxpayer being unable ever to be employed

In respect of this requirement, it must be demonstrated that the ill-health 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 ill-health of the taxpayer will preclude the taxpayer from ever being employed in a role for which the taxpayer is reasonably qualified.

In your 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 qualified medical practitioners have certified that you were suffering from a medical condition which, in their opinion, is likely to preclude your client from ever being able to be employed again in a capacity for which you are reasonably qualified by education, training or experience. Accordingly, the condition of paragraph 82-150(1)(d) of the ITAA 1997 has been satisfied.

Tax exemption for an invalidity 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 or pre-July 83 component (if any); and

· Taxable component: this is the amount remaining after deducting the tax free component from the total payment

As you have satisfied the requirements for the payment of an invalidity payment, the relevant portion of the employment termination payments received will be tax free.

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

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

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.

Calculation of the Invalidity Segment

The calculation of the invalidity payment would be using the payment of and the employment figures relevant to your employment:

$A	x	B
		C1+C2

 = $A1

Therefore, an amount of $A1 will be tax free as this is the invalidity segment included in the employment termination payment. The remaining amount is the taxable component which is to be included in your income tax return for the 2010-11 income year.

Question 2

Is any part of the payment made pursuant to sections 36 and 38 of the Workers Compensation Act the invalidity segment of an employment termination payment under section 82-150 of the ITAA 1997?

Summary of decision

The payment is not an employment termination payment (ETP) as it is not received in consequence of the termination of employment, as required by section 82-130 of the ITAA 1997. Therefore, no concessions for the invalidity segment will be applicable in your case.

Detailed reasoning

Payments that are made in consequence of the termination of any employment of a taxpayer are 'employment termination payments' (ETP) where all the conditions in section 82-130 of the ITAA 1997 have been met. The conditions are as follows:

· the payment is received in consequence of the termination the person's employment

· the payment is received no later than 12 months after the termination, and

· the payment is not mentioned in section 82-135 of the ITAA 1997 as not being an employment termination payment.

The phrase "in consequence of" is not defined in the legislation and 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. Generally, 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 Commissioner has provided his view on the meaning of the phrase "in consequence of" in paragraph 12 of Taxation Ruling TR 2003/13 (TR 2003/13):

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…

In your case, a copy of a Certificate of Determination was provided. Based on the information provided, it appears that the payment was paid to you in order to settle your worker's compensation claims for injuries suffered during the course of employment with your employer. Whilst it is noted that the court proceedings commenced after your employment has ceased, it is found that there is no direct causal connection between the payment in question and the termination of your employment. Therefore, the payment is not considered to be an ETP and no concessions for the invalidity segments are available.

Question 3

Is any part of the payment made pursuant to section 36 and 38 of the Workers Compensation Act 1987 (NSW) assessable as ordinary income?

Summary of decision

The lump sum payment you received is ordinary income and will be assessable in the year of receipt under the provisions of section 6-5 of the ITAA 1997.

Detailed reasoning

Section 6-5 Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident taxpayer includes the ordinary income they derive directly or indirectly from all sources, whether in or out of Australia, during an income year.

Ordinary income is defined in subsection 6-5(1) of the ITAA 1997 to mean income according to ordinary concepts; however, the legislation does not provide any specific guidance on what is meant by income according to ordinary concepts.

The courts have identified a number of factors which indicate whether an amount has the character of income according to ordinary concepts. These include amounts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

It is not necessary for all of these characteristics to be present for a receipt to be considered ordinary income.

A compensation amount generally bears the character of that which it is designed to replace (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; (1952) 10 ATD 82). If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not assessable as ordinary income.

Generally, payments that are income (such as lost wages) will be assessable under the ordinary income provisions of section 6-5 of the ITAA 1997.

Taxation Determination TD 93/58 provides the Tax Office view on when the receipt of a lump sum compensation payment is assessable income and specifies that such a receipt will be assessable if;

· the payment is for loss of income only, and/or interest associated with that lost income; or

· a portion of the lump sum is identifiable and quantifiable as income.

In your case your application to the Workers Compensation Commission identified weekly benefits and the schedule of wages claimed as the basis of your dispute. The Commission awarded a payment based on weekly dollar amounts allocated to specific periods. This clearly is identifiable as compensation for payment of wages as requested in your application.

Therefore the amount you were awarded is ordinary income and will be assessable in the year of receipt under the provisions of section 6-5 of the ITAA 1997.