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Ruling

Subject: Employment termination payment/capital gains tax

Question 1:

1. Is the payment made under a Deed of Release an employment termination payment?

Answer:

No.

Question 2:

2. Is the payment subject to Capital Gains Tax?

Answer:

No.

Question 3:

3. Is the payment otherwise included in assessable income?

Answer:

Yes.

This ruling applies for the following period:

1 July 2011 to 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts:

You are under 55 years of age.

You commenced employment with a company (the Company) over five years ago.

You notified the Company and its shareholders of your intended resignation in the 2009-10 income year. Some months later your employment terminated on your resignation.

On termination of employment you received payments which included payments of annual leave.

Following your termination of employment, you received additional payments totalling which related to entitlements associated with an earlier financial year.

In the 2011-12 income year a Deed of Release (the Deed) was made between you and the Company under which it agreed to pay you an amount (settlement payment) less tax. This payment is the subject of the ruling.

The Deed states that you release and forever discharge the Company, against all actions, suits, costs, demands or other liabilities of any nature which you might now have, have had in the past or will have in the future against the Company arising out of your employment or its termination.

Further it states that the Company, the Company directors and officers release and forever discharge you against all actions, suits, costs, demands or other liabilities of any nature which they might now have or will have in the future against the you arising out of your employment or its termination.

You have stated that you resigned as a result of a disagreement with the Company Board. There was a dispute between you and the Company and the matter was settled.

You received the settlement payment from which tax was withheld in the 2011-12 income year.

You have stated that no writ or claim was made in respect of matters settled by the Deed to a court or other authority.

Relevant legislative provisions:

Income Tax Assessment Act 1997 subsection 6-10(2)

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 82-130.

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

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

Income Tax Assessment Act 1997 Section 83-295.

Income Tax Assessment Act 1997 Section 118-20.

Income Tax Assessment Act 1997 Section 118-22.

Income Tax Assessment Act 1997 Section 118-37.

Income Tax Assessment Act 1936 Subsection 27A(1).

Income Tax Assessment Act 1936 Subsection 160ZB(1).

Reasons for decision

Summary

The payment would have been an employment termination payment if it had satisfied the 12 month rule. Consequently, it is assessable as income and taxed at marginal rates.

The payment is not subject to capital gains tax.

Detailed reasoning

Is the payment an employment termination payment?

A payment made to an employee is an employment termination payment if the payment satisfies all the requirements in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997), and is not specifically excluded under section 82-135 of the ITAA 1997.

Subsection 82-130(1) of the ITAA 1997 states:

82-130(1) 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

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

· it is not a payment mentioned in section 82-135.

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 (TR 2003/13) which discusses the meaning of the phrase.

The Full High Court considered the expression 'in consequence of' in Reseck v. FC of T (1975) 133 CLR 45; (1975) 6 ALR 642; (1975) 49 ALJR 370; (1975) 5 ATR 538; (1975) 75 ATC 4213 (Reseck). Justice Gibbs stated:

Within the ordinary meaning of the words a lump 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.

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 v. FC of T (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 (McIntosh) considered the decision in Reseck. Justice Brennan stated:

Though Jacobs J. speaks in different terms, his meaning may not be significantly different from the meaning of Gibbs J... His Honour denies the necessity to show that retirement is the dominant cause, but he does not allow a temporal sequence alone to suffice as the nexus. Though the language of causation often contains the seeds of confusion, I apprehend his Honour to hold the required nexus to be (at least) that the payment would not have been made but for the retirement.

The Commissioner in TR 2003/13 considered the phrase 'in consequence of' as interpreted by the Courts.

Paragraph 5 of TR 2003/13 states:

…the Commissioner considers that 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.

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.

Payments made under a deed of release have also been held to be made in consequence of the termination of employment.

In Le Grand v. Commissioner of Taxation (2002) FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; 2002 ATC 4907; (2002) 51 ATR 139 (Le Grand), the payment received was not only in respect of the termination of employment. In holding the payment for damages to also be an ETP, Goldberg J stated at paragraph 35:

I am satisfied that the payment was an effect or result of that termination in that there were 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 Heerey in Dibb v. Commissioner of Taxation 2003 ATC 4613; (2003) 53 ATR 290; [2004] ALMD 5781; [2003] FCA 673 (Dibb) stated that:

22. The concept of a 'payment 'in consequence of the termination of any employment' was expounded by the High Court in Reseck v FC of T 75 ATC 4213; (1975) 133 CLR 45 and by the Full Court of the Federal Court in McIntosh v FC of T 79 ATC 4325; (1979) 25 ALR 557. These authorities are analysed by Goldberg J in Le Grand v FC of T 2002 ATC 4907 at 4911-4913 [25-30] and 4914 [33-34]; (2002) 195 ALR 194 at [25] to [30] and [33] to [34]. I adopt his Honour's analysis.

23. In my opinion the Commissioner was correct in ruling that the payment under the Deed was made 'in consequence of the termination' of the applicant's employment with AVCO. True it is there was a substantial lapse in time between the termination and the commencement of Federal Court proceeding and a further period of time until settlement. However the reason for that delay was the time taken up with the litigation first in the Commission and then in the Federal Court itself. The subject matter of the litigation in the Federal Court was clearly the termination, the allegedly wrongful way AVCO effected it and its financial and other consequences for the applicant. The various causes of action, whether breach of contract, conspiracy, breach of fiduciary duty or contravention of the Trade Practices Act were, as Goldberg J would say (Le Grand at ATC 4915 [36]; ALR [36]), 'interwoven and intertwined' with the termination. The payment was a consequence of the settlement, which was a consequence of the Federal Court proceeding, which in turn was a consequence of the termination.'

This reasoning was accepted by the Full Federal Court in Dibb v. Commissioner of Taxation (2004) 207 ALR 151; 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126 by Justices Spender Dowsett and Allsop in determining the appeal against Justice Heerey's decision.

Therefore, the Courts have held that settlement amounts arising from actions that are in some way connected with the termination of employment are payments made in relation to the taxpayer in consequence of the termination of their employment.

In the present case, you have stated that there was a dispute between yourself and your employer (the Company). The settlement payment was made to you in consequence of entering into the Deed of Release (the Deed) requiring your commitment to non-disparagement, confidentiality and release of liability agreements. You believe that the settlement payment was not made as an effect or result of the termination but to settle matters related to the conduct of the Company unrelated to your employment.

However, it is noted that the copy of the Deed forwarded by you was signed by you, thereby indicating that you had agreed to what was written in the Deed.

Therefore, by entering into the Deed with the Company, you agreed to settle all matters between you and the Company and between you and the directors of the Company in relation to your employment and its termination. (Emphasis added) This is in accordance with various clauses of the Deed.

Although the dominant cause of the payment is to settle the dispute there is a causal connection between the termination of employment and payment. As per the decision in Reseck quoted above, it is not necessary that the termination of employment is the dominant cause of the payment.

The payment was made once the Deed was executed, and the Company made that payment, in part because you released it from any further legal action in respect of your employment and the termination of that employment.

Given its nature, the dispute, the Deed, the termination of employment and the payment are all intertwined and connected. Based on the principles stated in Reseck, McIntosh, Dibb and Le Grand; and the Commissioner's views expressed in TR 2003/13, the facts presented demonstrate a clear connection or a link exists between the termination of your employment and the payment.

Accordingly, it is considered that the payment you have received satisfies the first condition of being an employment termination payment in accordance with subparagraph 82-130(1)(a)(i) of the ITAA 1997.

The other conditions of subsection 82-130(1) of the ITAA 1997 will now be considered.

Exclusions under section 82-135 of the ITAA 1997

One of these conditions specified in paragraph 82-130(1)(c) of the ITAA 1997 is that an employment termination payment does not include a payment mentioned in section 82-135 of the ITAA 1997.

Section 82-135 of the ITAA 1997 includes payments such as pensions, foreign termination payments, unused annual leave and unused long service leave and the tax free part of genuine redundancy payments or early retirement scheme payments.

Employment termination payments, therefore, do not include payments for unused annual leave or unused long service leave, or the tax-free part of a genuine redundancy payment or an early retirement scheme payment, in accordance with paragraph 82-130(1)(c) and section 82-135 of the ITAA 1997.

From the information provided, it is clear that the Settlement Sum does not include any payment mentioned in section 82-135 of the ITAA 1997. Therefore this condition is satisfied.

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 taxpayer's employment (paragraph 82-130(1)(b) of the ITAA 1997).

In your case, you have received the settlement payment more than 12 months after termination of employment. Therefore this condition has not been satisfied.

However, paragraph 82-130(4)(a) of the ITAA 1997 states that 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.

The Commissioner has issued two legislative instruments under subsection 82-130(7), SPR 2007/1 and SPR 2009/1. SPR 2007/1 applies where legal action is commenced within 12 months of termination of employment in relation to the payment, or where the payment is made by a liquidator, receiver or trustee in bankruptcy of an entity that is otherwise liable to make the payment and where the liquidator, receiver or trustee is appointed no later than 12 months after the termination of employment. SPR 2009/1 applies to payments made by Redundancy Trusts.

As none of the above circumstances apply in your case, subsection 82-130(7) will not apply.

The Commissioner can make a determination under subsection 82-130(5) which waives the 12 month rule for an individual where he considers that the time between the termination of employment and the payment is reasonable having regard to all the relevant circumstances including:

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

(b) the circumstances of the payment; and

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

In your case, you have stated that no writ or claim was made in respect of matters settled by the Deed to a court or other authority. Therefore the delay was not due the commencement of any legal action.

The Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 which inserted section 82-130 in the ITAA 1997 provides examples as to when the Commissioner may or may not waive the 12 month rule.

One of the examples is when an administrator is appointed when a company is unable to trade and therefore unable to meet its liabilities. The company is only able to pay the employees after 12 months when the assets are sold. Another example is when legal action is commenced by an employee for unfair dismissal and therefore there is a delay in receiving the payment. In these cases the Commissioner would waive the 12 month rule.

After examining the circumstances of your case, the Commissioner considers that there are no grounds under which to waive the 12 month rule.

Therefore all the conditions of section 82-130 of the ITAA 1997 have not been satisfied so the payment is not an employment termination payment. Consequently, the payment is assessable income and is taxed at marginal rates in accordance with section 83-295 of the ITAA 1997 which states:

· A payment received by you that would be an employment termination payment but for paragraph 82-130(1)(b) is assessable income.

Capital gains tax

The general CGT exemptions provisions 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 anti-overlap 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.

In your ruling application you stated that the settlement payment was made as a consequence of entering into the Deed that required non-disparagement, confidentiality and release of the company from all liabilities and that as such it is considered a CGT applicable item. Further, you stated the CGT item relinquished in return for the settlement payment related to your period of employment which ceased more than 12 months before you received the settlement payment and therefore was held for greater than 12 months and is eligible for the 50% discount.

The settlement payment is assessable under section 83-295 of the ITAA-1997 as explained above in response to Question 1. The combined effect of section 118-20 and section 83-295 is that where a capital payment is assessable under a non-CGT provision, then it is treated as being assessable under that non-CGT provision.

In this regard, it is relevant to note the following comment made by Senior Member Dwyer of the Administrative Appeals Tribunal (AAT) in AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258 at paragraph 31:

I accept Mr Gibb's submission that if the 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. …

The above was in respect of the eligible termination payment provisions which, prior to 1 July 2007, were contained in the Income Tax Assessment Act 1936 (ITAA 1936). The term 'eligible termination payment' was defined in former subsection 27A(1) in the ITAA 1936 and included any payments made in consequence of the termination of employment. Subsection 160ZB(1) of the ITAA 1936 was replaced by section 118-37 of the ITAA 1997 for the 1998-99 and later income years.

Section 118-37 of the ITAA 1997 deals with exemptions from capital gains of compensation or damages for wrong or injury suffered by a taxpayer. While the payment you received is not compensation or damages for wrong or injury, the principle still applies.

Therefore, as the settlement sum is to be included as assessable income under section 83-295 of the ITAA 1997 (the non CGT provision) it is to be disregarded as a capital gain under sections 118-20 of the ITAA 1997. The fact that the payment may also be assessable as a capital gain does not change the fact that it is assessable under another provision of the ITAA 1997.

Accordingly, the amount is excluded from the capital gains tax (CGT) provisions. Consequently, as explained above, the payment is assessable as income and taxed at marginal rates.

Other payments received on termination of employment

The assessable income of a taxpayer can consist of both ordinary income and statutory income. Ordinary income is an amount that is income according to the ordinary meaning of the term decided in case law by the courts, such as salary or wages.

Statutory income is not ordinary income but income specifically included as assessable income by a particular provision of either the Income Tax Assessment Act 1936 (ITAA 1936) or the Income Tax Assessment Act 1997 (ITAA 1997). One example of statutory income is a net capital gain which is included as assessable income under section 102-5 of the ITAA 1997.

In the case of termination payments, the majority of these payments are receipts of a capital nature and do not constitute ordinary income. However, payments made more than 12 months after termination of employment are specifically included as assessable income under Division 83 (Other payments on termination of employment provisions) by the operation of section 83-295 of the ITAA 1997. Therefore this payment made on termination of employment is statutory income notwithstanding that it may also be a receipt of a capital nature.

Consequently, the payment is assessable income in accordance with section 83-295 of the ITAA 1997 and is taxed at marginal rates.