Edited version of your private ruling

Authorisation Number: 1012459900777

Ruling

Subject: Ordinary income - employment termination payment - 12 month rule - CGT

Questions and Answers

Will the payment be included in your assessable income as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: No.

Will the payment be an employment termination payment in accordance with subsection 82-130(1) of the ITAA 1997?

Answer: Yes.

Will the Commissioner make a determination under subsection 82-130(5) of the ITAA 1997 that the time between the termination of your employment and the payment in question is reasonable, and that paragraph 82-130(1)(b) of the ITAA 1997 does not apply in respect of that payment?

Answer: Yes, provided the payment is made within 60 days of the date of this private ruling.

Will the payment be excluded from being an employment termination payment by paragraph 82-135(i) of the ITAA 1997?

Answer: No.

Will any part of the payment be an invalidity segment of the tax free component of an employment termination payment under section 82-150 of the ITAA 1997?

Answer: No.

Will the payment be included in your assessable income under the capital gains tax provisions?

Answer: No.

This ruling applies for the following period

1 July 2013 to 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You were an employee of Company A.

Prior to this employment your formal education was primary and secondary school.

While employed by Company A you commenced a University degree.

Your employment with company A was terminated due to injury. At that time you had not completed your degree.

In accordance with your workplace agreement you were entitled to receive a payment if you sustained a career ending injury in the final year of your contract if you satisfied certain conditions.

You satisfied the conditions for the payment and will be receiving the payment more than 12 months after your employment was terminated.

You will be less than 55 years of age when the payment is received.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 1-3

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 82-10(2)

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 subsection 82-130(1)

Income Tax Assessment Act 1997 paragraph 82-130(1)(a)

Income Tax Assessment Act 1997 subparagraph 82-130(1)(a)(i)

Income Tax Assessment Act 1997 paragraph 82-130(1)(b)

Income Tax Assessment Act 1997 paragraph 82-130(1)I

Income Tax Assessment Act 1997 paragraph 82-130(2)

Income Tax Assessment Act 1997 paragraph 82-130(4)(a)

Income Tax Assessment Act 1997 subsection 82-130(5)

Income Tax Assessment Act 1997 subsection 82-130(7)

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 paragraph 82-135(i)

Income Tax Assessment Act 1997 subsection 82-150(1)

Income Tax Assessment Act 1997 paragraph 82-150(1)(b)

Income Tax Assessment Act 1997 paragraph 82-150(1)I

Income Tax Assessment Act 1997 section 83-295

Income Tax Assessment Act 1997 subsection 102-5(1)

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 1997 section 995-1

Income Tax Assessment Act 1936 subsection 27A(1)

Reasons for decision

Ordinary income

Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997).

Ordinary income has generally been held to include 3 categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

· are earned

· are expected

· are relied upon, and

· have an element of periodicity, recurrence or regularity.

Compensation receipts which substitute for income have been held by the courts to be ordinary income; whereas, compensation paid for the loss of a capital asset or amount is regarded as a capital receipt and not ordinary income and is potentially taxable as statutory income.

In your case, the payment is not being made to compensate you for the loss of earnings; rather it is a one-off, lump sum amount, being paid to compensate you for the loss of your employment as a professional sportsperson. The payment was not earned and does not have any element of periodicity, recurrence or regularity.

While it could be argued that the payment is expected, this expectation comes from your rights under your workplace agreement, rather than from a relationship with any personal services performed.

The payment is considered to be capital in nature and is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Statutory income

Your assessable income also includes statutory income amounts which are not ordinary income but are included in your assessable income by provisions about assessable income (section 6-10 of the ITAA 1997).

All allowances, gratuities, compensation, benefits, bonuses and premiums provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you is included your assessable income (subsection 15-2(1) of the ITAA 1997).

However, employment termination payments are not included in your assessable income under section 15-2 of the ITAA 1997 (subsection 15-2(3) of the ITAA 1997).

Employment termination payment

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.

All three conditions need to be satisfied in order for the payment to be treated as an employment termination payment. Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. These conditions are considered below.

Payment received in consequence of the termination of employment

The first condition to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer.

The Commissioner has issued Taxation Ruling TR 2003/13 which deals with payments in consequence of the termination of any employment and, in particular, the meaning of the phrase 'in consequence of '.

In paragraphs 5 and 6 of TR 2003/13, the Commissioner states:

5. The phrase 'in consequence of' is not defined in the ITAA 1936. However, the words have been interpreted by the courts in several cases. Whilst there are divergent views as to the correct interpretation of the phrase, 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.

6. 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.

In your case it is considered that the payment will be made in consequence of the termination of your employment. This is because you were unable to continue your employment due to your injury. Under the relevant terms of the workplace agreement, you made an application for the compensation payment. Your application was approved and you are entitled to receive a payment.

In your case the termination was based on medical grounds. Therefore, the first condition under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

Payment is received no later than 12 months after termination of employment

The facts show that your final day of employment with Company A was in the 2011-12 financial year. The payment has not been made as yet, which means that the payment will be received more than 12 months after the termination of your employment with Company A.

To qualify as an employment termination payment, the payment must be received no later than 12 months after the termination of your employment (paragraph
82-130(1)(b) of the ITAA 1997).

However, 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) of the ITAA 1997, or subsection 82-130(7) of the ITAA 1997, or if the payment is a genuine redundancy payment or an early retirement scheme payment (paragraph 82-130(4)(a) of the ITAA 1997).

Subsection 82-130(5) of the ITAA 1997 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.

You have provided information about the sequence of events that have led to the payment being made later than 12 months after your termination of employment.

It is noted that the procedure to resolve the matter was time consuming which indicates that there was no agreement between the parties to merely postpone the payment. Further, you wished to know the tax implications before receiving the payment.

You started the process as soon as practicable after the termination of your employment, and, whilst it took some time to resolve the matter, it was due to the lengthy assessment process involved, which is considered to be a circumstance beyond your control.

If the payment is received within 60 days of this private ruling issuing the Commissioner will consider the time between the termination of your employment and the making of the payment to be reasonable having regard to all the circumstances. As such, the Commissioner makes a determination under subsection 82-130(5) of the ITAA 1997 that paragraph 82-130(1)(b) of the ITAA 1997 does not apply to you in relation to the payment in question, provided it is received within 60 days of this private ruling issuing

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, among others, include:

· accrued annual leave and long service leave payments which are covered by Subdivision 83-A and Subdivision 83-B respectively

· superannuation benefits which are covered by Divisions 301 to 307

· the tax-free parts of a genuine redundancy payment or an early retirement scheme payment worked out under section 83-170; and

· certain capital payments for personal injury.

Paragraph 82-135(i) of the ITAA 1997 specifically excludes from being an employment termination payment:

a capital payment for, or in respect of, personal injury to you so far as the payment is reasonable having regard to the nature of the personal injury and its likely effect on your capacity to derive income from personal exertion (within the meaning of the definition of income derived from personal exertion in subsection 6(1) of the Income Tax Assessment Act 1936).

This exclusion is for a payment or benefit that compensates or reimburses you for, or in respect of, the particular injury.

In relation to the payment, the Commissioner accepts:

· it is a capital payment

· you did sustain an injury, and

· the payment was made due to the injury and its likely effect that you would no longer be able to derive income from the type of employment you were engaged in with Company A.

The principal question for determination therefore is whether the payment can be characterised as 'a capital payment for, or in respect of, the personal injury'. The words require a relationship between the injury and payment.

From 1 July 2007, paragraph 82-135(i) of the ITAA 1997 has replaced former paragraph (n) of the definition of 'eligible termination payment' in former subsection 27A(1) of the Income Tax Assessment Act 1936 (ITAA 1936) (former paragraph (n)). However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 stated, in relation to section 82-135 of the ITAA 1997, that:

consistent with current legislation, certain payments are prevented from qualifying as employment termination payments.

In accordance with section 1-3 of the ITAA 1997, provisions in the ITAA 1936 which have been rewritten in the ITAA 1997 will have the same meaning where they express the same idea, even if the words used are different. It is therefore appropriate to cite cases that refer to the previous legislation.

In Commissioner of Taxation v. Scully (2000) 201 CLR 148; [2000] HCA 6; 2000 ATC 4111; (2000) 169 ALR 459; (2000) 74 ALJR 504; (2000) 43 ATR 718 (Scully) the High Court, in considering former paragraph (n), held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

The payment in Scully was held not to be in respect of personal injury. Acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stated in their joint decision:

In our opinion, the payment in this case cannot be characterised as consideration... in respect of, personal injury. The fact that the payment is not calculated by reference to the nature and extent of the injury or likely loss to the respondent and the fact that the other benefits are similar to that for total and permanent disablement point inevitably to the conclusion that the payment was consideration... for, or in respect of the respondent's termination of employment and her rights under the Trust Deed and was not consideration... for, or in respect of her injury.

Using the principles in Scully, for an amount to meet the requirements of paragraph 82-135(i) of the ITAA 1997, the payment must be for, or in respect of, personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In Purvis and Ors v. Federal Commissioner of Taxation (2013) 2013 ATC 10-296; (2013) AATA 58 (Purvis) the Administrative Appeals Tribunal held that the payment was not compensation for personal injury as the injury was not a factor in determining the amount of the payment. Senior Member RW Dunne referred to Scully in his judgement. The payment, in that case, depended on the age and rank of the person and there was no correspondence between the amount of the payment and the likely effect of the personal injury on the capacity of each applicant to derive income from personal exertion.

In your case, the payment is compensation for the termination or loss of your employment due to injury, rather than compensation in relation to a claim of personal injury.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not exclude the lump sum payment from being an employment termination payment. As the payment is not a payment mentioned in section 82-135 of the ITAA 1997, paragraph 82-130(1)(c) of the ITAA 1997 is satisfied.

As discussed above, the payment is considered to be a payment received in consequence of the termination of employment and is not a payment mentioned in section 82-135 of the ITAA 1997. With the Commissioner making a determination under subsection 82-130(5) of the ITAA 1997 so that paragraph 82-130(1)(b) of the ITAA 1997 does not apply to you in relation to the payment that is the subject of this ruling, all the conditions of subsection 82-130(1) of the ITAA 1997 will be met. Therefore, the payment is considered to be an employment termination payment.

Invalidity segment

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 an 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.

Section 995-1 of the ITAA 1997 defines the term '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 were injured you were employed on a full-time basis. Hence you were gainfully employed.

As stated above, the payment is considered to be a payment made on the termination of your employment.

In this instance while the payment was made on termination of employment it is considered that the payment was not made because you stopped being gainfully employed.

When the requirements are taken together it is clear that 'stops being gainfully employed' should be taken to mean that gainful employment has ceased altogether. That has not happened in your circumstances as you have returned to employment in a different capacity.

At any rate the termination of employment was not before your last retirement day.

The term 'last retirement day' is defined in section 995-1of the ITAA 1997 as follows:

last retirement day means:

(a) if an individual's employment or office would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be); or.

(b) in any other case - the day on which he or she would turn 65.

In your case the termination of employment occurred before you were 55 years of age. You were employed under a contract for a specified period, and as such the 'last retirement day' in your case is as defined in paragraph (a) of the definition.

As the termination of your employment occurred on the last retirement day this was not prior to your contract being completed.

For an employment termination payment to have an invalidity segment all the conditions in subsection 82-150(1) of the ITAA 1997 must be satisfied. Since all the conditions cannot be satisfied the payment will not have an invalidity segment.

The payment constitutes a life benefit termination payment

Subsection 82-130(2) of the ITAA 1997 states:

A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies:

Because the payment is an employment termination payment to which subparagraph 82-130(1)(a)(i) of the ITAA 1997 applies, the payment constitutes a LBTP within the meaning of subsection 82-130(2) of the ITAA 1997.

Capital gains tax (CGT)

Your assessable income includes your net capital gain (if any) for the income year (subsection 102-5(1) of the ITAA 1997).

CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied (paragraph 104-25(1)(b) of the ITAA 1997). A CGT asset is a legal or equitable right that is not property (paragraph 108-5(1)(b) of the ITAA 1997).

You acquired a right to receive a payment under the relevant clauses in your workplace agreement. When you receive the payment this right will be released, discharged or satisfied; and CGT event C2 will happen.

Section 118-20 of the ITAA 1997 recognises that a capital gain you make from a CGT event is reduced if, because of the event, a provision of the ITAA 1997 includes an amount in your assessable income for any income year. Section 118-22 of the ITAA 1997 treats an employment termination payment that you receive as being included in your assessable income.

The payment you will receive is included in your assessable income as the taxable component of an employment termination payment (section 118-22 of the ITAA 1997). As such, any capital gain you make will be reduced to nil (section 118-20 of the ITAA 1997).

As any capital gain you make will be reduced to nil, the capital gains exemption in section 118-37 of the ITAA 1997 for compensation or damages you receive for any wrong or injury you suffer in your occupation has not been considered.

The rulings in the register have been edited and may not contain all the factual details relevant to each decision. Do not use the register to predict ATO policy or decisions.