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Ruling

Subject: Employment termination payment

Questions:

1. Is the undissected lump sum payment received by you under a deed of release from your former employer an employment termination payment?

2. Is the undissected lump sum payment received by you under a deed of release from your former employer assessable income?

Advice/Answers:

1. Yes.

2. 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 over 55 years of age.

You were employed by a company (the employer) for more than 30 years. Over the course of your employment you were promoted to a number of positions.

You were told that you would get a redundancy package. However, when there was a restructure you were not offered one while younger employees were.

The employer gave you an unfavourable performance review which you disputed.

You made an official complaint about not getting written reasons for the unfavourable review. You sent an email to the employer about the unfavourable review and comments made about your age.

You took sick leave. After the paid sick leave the employer ceased paying you sick leave on the grounds that you had exhausted your sick leave entitlement.

The employer wrote to you stating that if they did not hear from you with a prognosis of your likely return to work they would regard your contract of employment as being terminated.

The employer terminated your employment.

Some months later your lawyers wrote two letters to the employer, the first stated, among other things, that you be paid for your period of sick leave from the time you were not paid until the date of your termination of employment. The second letter stated the terms you were prepared to accept under a Deed of Release without recourse to litigation.

The employer's lawyers responded to the first letter rejecting your claims.

Your lawyers sought advice from Counsel in relation to your legal complaint claim. Due to scheduled leave of Counsel there were delays in progressing your matter.

There were more delays in your case because of Counsel's unavailability on account of the illness of a family member and until another member of Counsel was found to deal with the matter.

Some months later Counsel provided you advice regarding your entitlements.

Your lawyers lodged a complaint against the employer with a human rights organisation (the organisation).

The employer wrote to the organisation in response to their letter.

The organisation wrote to your lawyers asking for the reasons for delay in lodging the complaint as it was more than 12 months after the alleged discrimination took place.

Your lawyers replied to the organisation explaining the reasons for the delay.

The employer wrote to the organisation asking them to terminate your complaint on account of the delay in lodging it.

Your lawyers wrote to the organisation putting forward a settlement proposal in relation to a payment in lieu of notice among other things.

In the 2011-12 income year the employer's lawyers wrote to your lawyers stating that you had accepted the employer's offer of a settlement payment and that it would be treated as an employment termination payment.

Your lawyers responded saying that the payment should be treated as a capital payment.

Under a Deed of Release you agreed to a settlement amount and agreed that the payment included the full amount owed to you, whether for salary, wages or other remuneration, leave entitlements, payment in lieu of notice, severance pay, or anything else connected with the complaint, the employment or cessation of the employment.

In the 2011-12 income year, you received the settlement payment.

In email correspondence between the employer and the organisation, the employer advised the AHRC of your Superannuation insurance plan and details of how you could make a claim for Total and temporary disability (TTD).

You made a TTD claim and were successful in obtaining a payment in the 2011-12 income year.

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(2).

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

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 82-140.

Income Tax Assessment Act 1997 Section 82-145.

Income Tax Assessment Act 1997 Section 82-150.

Income Tax Assessment Act 1997Section 82-155.

Reasons for decision

Question 1

Summary

The payment is an employment termination payment. It comprises a taxable component which is taxed at 15% plus Medicare levy. The remainder is tax free and does not have to be declared in your tax return.

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:

(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

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

(b) 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...

In paragraph 32 of TR 2003/13, the Commissioner considers a payment is in consequence of the termination of employment where there are a number of reasons for a dispute, and subsequent settlement, between an employee and their former employer, one of which was the termination of employment. That paragraph states:

The Federal Court in Raymond Joseph Dibb v. FC of T adopted the approach of Goldberg J in Le Grand. At issue was whether a payment received by the taxpayer under a deed of release, following the settlement of Federal Court proceedings against his former employer, was an ETP. In deciding the payment was an ETP, Heery J held that the length of time between the termination of employment, the commencement of court proceedings and payment following settlement did not sever the causal connection between the termination and the payment. It was sufficient that the subject matter of the litigation was the termination. Heery J found at 296 that:

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), '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.

In the present case, you have stated that there was a dispute between yourself and the employer as you had lodged a complaint against the employer for failing to provide written reasons for the unfavourable review of your work performance, discrimination because of your age and sick leave entitlements.

The amount of the payment was made to you in consequence of entering into the Deed of Release (the Deed). This amount is the subject of the private ruling. The Deed does not provide any dissection of the payment. While it states various items for which the payment is made, it does not specify the amount paid for each item.

By entering into the Deed with the employer, you agreed that the payment includes the full amount owed to you for salary, wages or other remuneration; leave entitlements, payment in lieu of notice, severance pay or anything else connected with the Complaint, the employment or cessation of the employment. Further it states that your rights are satisfied and you release the employer from all claims relating to your employment and its cessation.

Although the dominant cause of the payment is to settle the dispute there is a causal connection between the termination of employment and settlement 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 employer 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 concluded 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, the settlement payment does include your leave entitlements. However, as stated earlier, the amount is not dissected to show how much relates to leave payments. Therefore it is considered that the payment is not a payment included in section 82-135 of the ITAA 1997.

As a result 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, your employment terminated some years ago and you have received the settlement payment in the 2011-12 income year, which is 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.

Subsection 82-130(5) of the ITAA 1997 is relevant in this case. It 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.

The 'legislative purpose' of the 12 month rule and accompanying subsection 82-130(5) discretion can be ascertained through an examination of the Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006, with paragraph 4.19 stipulating as follows:

The 12-month rule exists to prevent abuse of the tax concession offered for these payments by using a series of payments over a number of income years. The provisions dealing with the Commissioner's ability to issue a determination are provided to allow flexibility where delays in payment are reasonable and not constructed with the intent of delivering taxation advantages.

In your case the payment was made in order to resolve a dispute between you and your employer. The payment was made under a Deed of Release by the employer in order to prevent further litigation.

The reasons for the delay in the payment is mainly because Counsel had been unavailable on account of which you were unable to commence legal action against the employer. Furthermore, you did not have sufficient ability to influence the timing and control of the payment to obtain any sort of taxation advantage.

Therefore it is considered that the time between the termination and the subsequent payment is reasonable.

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. Therefore the 12 month rule has been satisfied.

As all the conditions for a payment to be an employment termination payment have been satisfied, the payment is accepted as being made in consequence of termination of employment for the purposes of subsection 82-130(1).

Tax Treatment of the payment as a Life Benefit Termination Payment (LBTP):

Under subsection 82-130(2) a LBTP is a payment to which subparagraph 82-130(1)(a)(i) applies, that is, it is a payment made in consequence of termination of employment.

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 tax free component is not assessable income and is not exempt income. The taxable component is included, in full, as assessable income. As your employment was not terminated due to invalidity the LBTP will not contain an invalidity segment.

You commenced employment with the employer on before 1 July 1983. As the period of employment to which the payment relates occurred before 1 July 1983, the LBTP will comprise a tax free component. The pre-July 83 segment is calculated under subsection 82-155(2) of the ITAA 1997 which states:

Work out the amount of the pre-July 83 segment as follows:

Step 1.

Subtract the invalidity segment (if any) from the *employment termination payment.

Step 2.

Multiply the amount at step 1 by the fraction:

Amount of payment	×	Number of days of employment to which the payment relates that occurred before 1 July 1983
		Total number of days of employment to which the payment relates

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

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

The taxable component of the LBTP is taxed at 15% plus Medicare levy for amounts below the employment termination payment cap of $165,000 for the 2011-12 income year, and at the top marginal rate for the amount above this cap.

In your case, you were over preservation age on the last day of the income year in which the payment was made and the taxable component is below the cap of $165,000. As a result the taxable component will be taxed at 15% plus Medicare levy

The taxable components of all LBTPs received in an income year are counted towards this cap. Any tax-free amounts are not counted towards the cap.

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.

Question 2

Summary

The settlement payment is assessable income and is taxed as an employment termination payment.

Detailed reasoning

Assessable income

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 on termination of employment which qualify as employment termination payments are specifically included as assessable income under Division 82 (Employment termination payments) by the operation of section 82-130 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 82-130 of the ITAA 1997.