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Ruling

Subject: Employment termination payment

Question 1

Is any part of the payment made under a deed of settlement an employment termination payment?

Answer:

Yes.

Question 2

Was the correct amount of tax withheld from the payment?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You were employed by an Employer (the Employer).

In the 2010-11 income year your employment with the Employer was terminated.

You lodged a complaint against the Employer alleging discrimination.

In a letter prepared by an entity (the Entity), which acted on your behalf, it stated:

(a) the Entity had received a response from the Employer denying the allegations and the Employer alleged you were unreasonable in your requests for your return to work; and

(b) the Entity had prepared a settlement proposal which included, amongst other matters, that the Employer pay your specific amounts for:

(i) for economic loss; and

(iv) general damages as compensation in relation to the matter.

In the 2011-12 income year, as a result of a conciliation conference between you and the Employer, a Settlement (the Agreement) was signed.

In the Agreement, it stated that:

(a) without any admissions of liability the parties [the Employer and you] agreed to resolve all matters between the Employer ad you on the terms and conditions set out in the Agreement;

(b) a lump sum payment (the Payment) would be paid to you within short period after the was signed; and

(c) the Agreement and payment made to you are in full and final settlement of any claims you have, or in the future may have, against the Employer and this includes any claim in relation to the termination of your employment, damages and any other claims whether present or prospective.

In a letter which the Employer sent you, it stated that a without admitting any liability, the Employer regretted the distress encountered by you in relation to the matter.

You received a 'PAYG payment summary - employment termination payment' (the Summary) from the Employer in relation to the Agreement which shows a lump sum payment was made to you on in the 2011-12 income year.

The Summary shows that the lump sum wholly comprised a Taxable component and the tax withheld.

You are below your preservation age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-10(2).

Income Tax Assessment Act 1997 Subsection 82-10(3).

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(2).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 82-145.

Reasons for decision

Summary

The payment made to you as the result of a Settlement is an employment termination payment. The payment comprises wholly of a taxable component which is to be included in your income tax return for the 2011-12 income year.

In relation to the tax withheld from the payment it has been correctly withheld.

Detailed reasoning

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.

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

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 the termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135.

Section 82-135 of the ITAA 1997 states:

The following payments you receive are not employment termination payments:

(a) a superannuation benefit (see Divisions 301 to 307);

(b) a payment of a pension or an annuity (whether or not the payment is a superannuation benefit); and

(c) an unused annual leave payment (see Subdivision 83-A);

(d) an unused long service leave payment (see Subdivision 83-B);

(e) the part of a genuine redundancy payment or an early retirement scheme payment worked out under section 83-170 (see Subdivision 83-C);

(f) …

To determine if the lump sum payment (the Payment) that was paid to you constitutes an employment termination payment, all the conditions in section 82-130 of the ITAA 1997 must be satisfied.

Failure to satisfy any of the conditions will result in the Payment not being considered an employment termination payment

In consequence of the termination of your employment

The first condition requires that the payment is received by the employee in consequence of the termination of his or her employment.

In your case there was a 'termination of employment' as your employment with the Employer was terminated in the 2010-11 income year.

The next issue to determine in relation to the first condition is whether the payment made to you was 'in consequence of' the termination of employment.

The phrase in consequence of is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Whilst the courts have divergent views on the meaning of this phrase, the Commissioner's view on the meaning and application of the in consequence of test are set out in Taxation Ruling TR 2003/13 Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase in consequence of.

While TR 2003/13 considered the meaning of the phrase 'in consequence of' in the context of the eligible termination payments, TR 2003/13 can still be relied upon as both the former provision under the Income Tax Assessment Act 1936 and the current provision under the ITAA 1997 both use the term 'in consequence of' in the same manner. It should be noted that the eligible termination payments ceased to exist from 1 July 2007 and were replaced by employment termination payments.

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.

In paragraph 6 of TR 2003/13, the Commissioner recognises that:

The phrase requires 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 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 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 ATC 4907; (2002) 51 ATR 39 (Le Grand), the issue before the 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.

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 essence of this analysis is that if the payment follows 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. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135 of the ITAA 1997.

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.

In your case, as mentioned previously, your employment was terminated in the 2010-11 income year.

Subsequent to your termination of employment, a conciliation conference was held to resolve matters between you and the Employer. These matters related to a claim you had filed against the Employer alleging discrimination.

Through the conciliation process, an agreement (the Agreement) was signed between you and the Employer in the 2011-12 income year. In the Agreement you agreed to the Employer paying you a lump sum payment.

In the Agreement, it states, amongst other items:

(a) without any admissions of liability the parties [the Employer and you] agreed to resolve all matters between the Employer ad you on the terms and conditions set out in the Agreement;

(b) a lump sum payment (the Payment) would be paid to you within short period after the was signed; and

(c) the Agreement and payment made to you are in full and final settlement of any claims you have, or in the future may have, against the Employer and this includes any claim in relation to the termination of your employment, damages and any other claims whether present or prospective.

The above shows that there was a connection between the Payment and the termination of your employment as 'termination of your employment' is included as one of the claims from which the Payment arises.

Though a letter prepared by the Entity (an entity which acted on your behalf) detailed your grievances, and quantified amounts for some of the grievances, it should be noted that there is nothing to show whether any part of the Payment, which was an undissected lump sum, related to any of those grievances.

As shown in the Agreement, the matters between you and the Employer are settled in accordance with the terms of the Agreement.

It is noted that IT 2424, which deals with compensation payments in respect of unlawful acts of discrimination, provides guidance on situations where some payments made in relation to discriminatory actions may not be liable to tax.

Though IT 2424 provides some examples where compensation payments may be tax free, it should be noted that paragraphs 7, 8 and 9 of that Ruling state:

7. To illustrate the operation of the income tax law in relation to the receipt of compensation payments under the Act [i.e. the Sex Discrimination Act (Commonwealth) 1984] some common examples of sex discrimination and payments of compensation have been selected…Ultimately, whether or not a particular payment of compensation is assessable will depend on the facts of the given case.

8. …the determination of the character of a compensation payment, and in particular whether it is liable to tax in the hands of an employee, depends on the nature of the payment. A compensation payment to make up for lost earnings or in substitution for income or in substitution of income which would have otherwise been earned is in the nature of income and is liable for income tax in the hands of the employee…

9. A second issue which is relevant to determining the assessability of a compensation payment is whether a payment in respect of the unlawful dismissal of an employee constitutes an eligible termination payment and subject to special taxation treatment.

In view of the above, it is noted that the facts in your case show there is nothing in the Agreement that states or indicates what amount of the Payment, if any, relates to any one of the particular grievances raised. However, as the Agreement does make reference to termination of employment, it is considered that the Payment is intertwined with your termination of employment.

Accordingly, it is considered that the Payment made to you under the Agreement was made 'in consequence of the termination of employment' as there is a causal connection between the termination and the Payment.

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

Payment received no later than 12 months after termination

In addition to meeting the other conditions for a payment to be an employment termination payment, paragraph 82-130(1)(b) of the ITAA 1997 specifies that the payment must be received within 12 months of the employee's termination of employment, unless they are covered by a determination exempting them from the '12 month rule'.

As shown in the facts, your employment was terminated in the 2010-11 income year and the Payment was made to you shortly after.

Accordingly, as the payment was made within 12 months of the termination of your employment, the requirement in paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied.

A payment mentioned in section 82-135 of the ITAA 1997

As previously mentioned, section 82-135 of the ITAA 1997 excludes certain payments from being employment termination payments. These payments include:

· a payment for unused annual leave

· a payment for unused long service leave

· capital payments for personal injury.

In your case, the facts provided show that the Payment did not include any of the payments mentioned in section 82-135 of the ITAA 1997 which would preclude any part of the payment from being an employment termination payment.

Consequently, the Payment is not of a type mentioned in section 82-135 of the ITAA 1997.

Conclusion:

The lump sum payment received by you is an employment termination payment.

An employment termination payment may comprise of a:

· Tax free component - as provided in section 82-140 of the ITAA 1997, this includes an invalidity segment within the meaning of section 82-150 of the ITAA 1997 (if any) and/or a pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997 (if any); and

· Taxable component - the amount remaining after deducting the tax free component from the total payment, as prescribed in section 82-145 of the ITAA 1997.

As shown in the facts, the Payment does not contain an invalidity segment within the meaning of section 82-150 of the ITAA 1997 but is comprised wholly of a taxable component.

Subsection 82-10(2) of the ITAA 1997 provides that the taxable component of a life benefit termination payment (LBTP), which the Payment in your case satisfies, is assessable income. Accordingly, it is to be included in your income tax return for the 2011-12 income year.

In relation to the rate of tax that applies to the Payment, subsection 82-10(3) of the ITAA 1997 specifies that a taxable component is subject to tax and the rate applied depends on the recipient's age.

As you are less than your preservation age, the Payment is taxed at a maximum rate of 30% plus Medicare levy. Accordingly, the tax which the Employer withheld from the Payment is correct.