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Ruling

Subject: Assessability of compensation payment

Question 1:

Is any portion of the compensation payment an employment termination payment?

Answer:

Yes.

Question 2:

Is any portion of the compensation payment ordinary income?

Answer:

Yes.

Question 3:

Is any portion of the compensation payment statutory income?

Answer:

Yes.

Question 4:

Is any portion of the compensation payment subject to capital gains tax?

Answer:

No.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on:

1 July 2009

Relevant facts and circumstances

You took legal action against your employer for discrimination.

You received a compensation payment.

The payment was made up of:

· Pain and suffering

· Past losses of earning capacity

· Future loss of earning capacity

· Future medical expenses

· Interest until judgment was made

· Interest from when judgement was made and payment received.

Relevant legislative provisions:

Income Tax Assessment Act 1936 Section 27A

Income Tax Assessment Act 1936 Subsection 27A(1)

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Section 83-295

Income Tax Assessment Act 1997 Subdivision 118-A

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 118-22

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Assessable income consists of ordinary income and statutory income provided it is neither exempt nor non-assessable non-exempt income.

Subsection 6-10(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an amount is statutory income if it is not ordinary income but is included in assessable income by another provision.

Section 10-5 of the ITAA 1997 lists those provisions about assessable income.

Included in this list is section 82-10 of the ITAA 1997 which deals with Employment Termination Payments and section 102-5 of the ITAA 1997 which deals with capital gains. Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes the taxpayer's net capital gain, if any, for the income year.

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(1) of the ITAA 1997 states that:

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

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

(c) 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.

Paid as a consequence of the termination of employment

If the payment is received 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. 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.

The payment is received no later than 12 months after termination

The second condition is stated under paragraph 82-130(1)(b) of the ITAA 1997. The settlement sum must be received within 12 months of the employee's termination of employment. However, subsection 82 130(4) provides that the 12 month rule does not apply if a determination under subsection (5) or (7) is made.

Subsection 82-130(7) of the ITAA 1997 provides that the Commissioner may determine, by legislative instrument that the 12 month rule will not apply to a class of payments or a class or recipient. The Commissioner has issued legislative determination SPR 2007/1 which states that the 12 month rule will not apply where:

· legal action commenced within 12 months of the termination; or

· the payment was made by a liquidator, receiver, receiver/manager or trustee in bankruptcy provided they were appointed within 12 months of the termination.

Such a payment, if it meets the other requirements of subsection 82-130(1) of the ITAA 1997, will be a late termination payment.

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 payment under section 82-135 of the ITAA 1997. These payments include any accrued annual and long service leave, the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments which do not apply to your client's compensation payment.

Payments received by the taxpayer

To determine if any part of the gross compensation payment made by your former employer constitutes an employment termination payment, all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

The Federal Court instructed the payment of the amounts referred to under the heading 'The Assessment of Damages', to compensate you for 'the unlawful discrimination overall'. Further, these damages were dissected into amounts relating to:

· Pain and suffering

· Past losses of earning capacity

· Future loss of earning capacity

· Future medical expenses

· Interest until judgment was made

Interest payable since the Order was made and until compensation was paid On the facts provided, and in light of the dissection of the amounts expressed under the Order, it is appropriate to examine the components separately.

Pain and suffering

Paragraph 353 of the Order makes an allowance of $90,000 for 'both the past and future disadvantage for pain and suffering' experienced by your client. This payment takes into consideration the symptoms and risk exposed to you as a result of the injuries suffered.

It is noted that this amount was separately identified under the Order as a payment in respect of your injury and is calculated by reference to the nature and extent of your injury and likely loss to you arising from your injury. Hence it is clear that this amount is a capital payment for, or in respect of, personal injury to you.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 operates to exclude this amount from being an employment termination payment.

Future medical expenses

Paragraph 357 of the Order, under the heading 'The Assessment of Damages', makes an allowance to be paid for your 'future medical expenses'.

The termination of employment did not give rise to the payment of this amount. Instead, this amount compensates you for future ongoing medical expenses in respect of the injuries suffered by you.

Therefore this amount of the compensation payment does not form part of an employment termination payment.

Past and future losses of earning capacity

Paragraph 355 of the Order provides for the payment as 'an appropriate allowance for past loss of earning capacity'. Similarly, paragraph 356 provides for the payment as 'the appropriate allowance for future loss of earning capacity'.

For these two amounts to be considered a part of an employment termination payment, they need to have been paid in consequence of your employment.

The two amounts were respectively calculated by reference to what you would have earned (including superannuation), less expenses that would have been incurred for motor vehicle and phone, during the period.

The termination of employment, the Order, and the payment for past and future losses of earning capacity are all intertwined and connected. If not for the termination of employment, the payments to compensate for loss of earning capacity would not have been made. It is considered that the sum of $340,000 was made in consequence of the termination of your employment.

Consequently, the requirement under paragraph 82-130(1)(b) of the ITAA 1997 will not apply to this part of the payment.

Therefore, the amount for loss of past and future earning capacity is not a payment that paragraph 82-130(1)(c) of the ITAA 1997 would exclude from being an employment termination payment.

As all the conditions in section 82-130 of the ITAA 1997 have been satisfied, the amount for loss of past and future earning capacity is considered to be an employment termination payment.

Interest on compensation

Paragraph 360 of the Order provides for the payment reflecting the interest on the compensation payment calculated to the date the judgment was made. In addition to this amount, a further interest amount was made to reflect the interest payable for the period from the date the Order was made until the date the compensation was paid.

Since this interest amount is calculated in relation to the entire compensation payment, it is necessary to apportion the interest amount.

Tax treatment of the payment as a life benefit termination payment (LBTP):

An employment termination payment will comprise 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 taxable component is subject to tax, depending on the person's age, as follows:

* Preservation age is the age at which retirees can access their superannuation benefits. This will be 55 for persons born before 1 July 1960 and between 55 and 60 for persons born after 30 June 1960.

The $140,000 cap on concessionally taxed employment termination payments is indexed annually to average weekly ordinary time earnings. For the 2009-10, 2010-11, and 2011-12 income years, the caps are $150,000, $160,000, and $165,000 respectively.

The taxable components of all life benefit employment termination payments received in an income year are counted towards this cap. Any tax-free amounts are not counted towards the cap.

The tax free component is not assessable income and is not exempt income. The taxable component is included, in full, as assessable income.

As the period of employment to which the payment relates occurred after 1 July 1983, the whole LBTP was comprised of a taxable component.

The taxable component is subject to tax, depending on the person's age when the compensation payment is received.

In this case, you were under preservation age on the last day of the relevant income year in which the instalment payments were made. On the facts provided, and in light of the four instalments, it is convenient to examine the income years separately.

Employment termination payments cannot be rolled over into a complying superannuation fund, complying approved deposit fund (ADF) or to a retirement savings account (RSA) provider.

Amounts that do not form part of the employment termination payments

The amounts which do not form part of the employment termination payment are:

· Pre judgement interest

· Post judgement interest

· Pain and suffering

· Future medical expenses

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources whether in or out of Australia during the income year.  

Ordinary income generally includes three categories, namely, income from rendering personal service, income from property investments, and income from carrying on a business. 

Taxation Ruling TR 95/35 states at paragraph 26: 

Interest awarded as part of a compensation amount is assessable income of the taxpayer under the general income provisions. If the taxpayer receives an undissected lump sum compensation amount and the interest cannot be separately identified and segregated out of that receipt, no part of that receipt can be said to represent interest. If the compensation cannot be dissected it is likely that the whole amount relates to the disposal of the right to seek compensation. 

The compensation payment you received had a dissected interest amount shown on the settlement statements.

Therefore, the interest component paid to you for pre judgment interest and post judgment interest received by you from the amount paid as compensation is ordinary income and is assessable.

Pain and suffering

The portion of the payment relating to non-economic loss (pain and suffering) does not meet the characteristics of ordinary income and is therefore not assessable as ordinary income.

Future medical expenses

Medical expenses are private expenses and therefore, compensation for medical and legal expenses incurred is not assessable as ordinary income.

Will any capital gains arising from the compensation payment be disregarded?

Section 118-37 of the ITAA 1997 states that you may disregard any capital gain or capital loss from any capital gains tax event relating directly to compensation or damages you receive for any wrong or injury you suffer in your occupation.

Section 118-37 of the ITAA 1997 will apply to the compensation payment you received so that any capital gain or capital loss you make will be disregarded.