Edited version of your private ruling

Authorisation Number: 1012460676144

Ruling

Subject: Lump sum payment for workers compensation

Questions

1. Is the payment of an employment termination payment under subsection 82-130(1) of the Income Tax Assessment Act 1997?

2. Is any part of the lump sum payment received by the taxpayer assessable as ordinary income?

Advice/Answers

1. No.

2. No.

This ruling applies for the following period

Year ending 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

You were employed by your employer on a project to finish in the subsequent income year.

You sustained an injury in the relevant income year.

Your injury had not healed and in relevant year you decided to undertake a further operation.

You decided there was no point in going back to your employment after a planned trip and resigned from your employment.

On advice from your doctor the operation was not carried out until late in the relevant year.

You have been receiving weekly workers compensation payments.

A conciliation conference was held between you and your employer and agreement was reached to settle a workers compensation claim.

The lump sum is comprises of weekly payments of compensation by way of redemption of liability to make future weekly payments as for permanent partial incapacity and expenses as are provided for in the Workers Compensation and Injury Management Act 1981, Schedule 1, Clauses 9 , 10, 17, 18, 18A and 19 namely.

A Memorandum of Agreement made in the subsequent income year between you and your employer is evidences that the payment results solely to your injuries and in settlement to your workers compensation claims.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

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)(c).

Income Tax Assessment Act 1997 Subsection 82-130(2).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Subsection 82-135(e).

Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)

Income Tax Assessment Act 1997 Section 995-1.

Does Part IVA apply to this ruling?

No.

Reasons for decision

Summary:

The payment does not follow as an effect or result of a termination of employment. Therefore, the payment is not an employment termination payment.

In addition, the lump sum payment is a capital receipt and is not ordinary income. Further, the lump sum payment would not be considered as an assessable capital gain.

Detailed reasoning:

Employment termination payment

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that:

employment termination payment has the meaning given by section 82-130 of the ITAA 1997.

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.

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(2) of the ITAA 1997).

To determine if the payment made to you by your employer is an employment termination payments all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

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

It should be noted that the phrase 'in consequence of the termination of your employment' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

In light of these decisions, the Commissioner discusses the meaning of the phrase in Taxation Ruling TR 2003/13 titled Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of' (TR 2003/13).

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.

As further stated by the Commissioner in paragraph 6 of TR 2003/13, there must be:

… 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 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 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) 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. 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 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 Full Federal Court in Dibb v. Federal Commissioner of Taxation [2004] FCAFC 126; (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786, has applied the above decisions in finding that the payment received by the taxpayer under a Deed of Release to settle various causes of action against the employer following the termination of employment was an ETP.

Paragraph 31 of TR 2003/13 the Commissioner states:

It is clear from the decision in Le Grand, that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of the taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

The essence of this analysis is that if the payment follows as an effect or a result of 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.

In this case, you were employed by your employer on a project to finish in the subsequent income year. You sustained an injury in the relevant income year. You have been receiving weekly workers compensation payments.

A conciliation conference was held between you and your employer and agreement was reached to settle a workers compensation claim.

The lump sum is comprises of weekly payments of compensation by way of redemption of liability to make future weekly payments as for permanent partial incapacity and expenses as are provided for in the Workers Compensation and Injury Management Act 1981, Schedule 1, Clauses 9 , 10, 17, 18, 18A and 19 namely.

It is clear that the payment is in regards to your injuries. Further, a Memorandum of Agreement made in the subsequent income year between you and your employer is further evidence that the payment results solely to your injuries and in settlement to your workers compensation claims. Therefore, it is considered that the payment does not follow as an effect or result of a termination of your employment.

As the payment is not considered to be received by you in consequence of the termination of your employment the requirement under subparagraph 82-130(1)(a) of the ITAA 1997 has not been met. As all conditions under subsection 82-130(1) have not been met the payment is not employment termination payment.

Ordinary Income

Section 6-5 of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include three 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

· have an element of periodicity, recurrence or regularity.

The lump sum payment you accepted is not income from rendering personal services, income from property or income from carrying on a business.

The payment was a one off payment and thus it does not have an element of recurrence or regularity.

The nature of the payment described in the scheme generally bears the character of that which it is designed to replace. If the lump sum payment is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

The payment is not a lump sum payment which substitutes for an income stream but rather for entering into an agreement with the employer for the purpose of surrendering your rights under the Workers Rehabilitation and Compensation Act.

The lump sum payment is a capital receipt and is not ordinary income. Therefore the amount is not assessable under section 6-5 of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but may be assessable under another provision called statutory income.

Capital gains tax (CGT)

Amounts received in respect of personal injury which are not direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the CGT provisions of the ITAA 1997.

Receipt of a lump sum payment may give rise to a capital gain (statutory income). However, paragraph 118-37(1)(b) of the ITAA 1997 disregards payment or receipts for capital gains purposes where the amount relates to compensation or damages a person receives for any personal wrong, injury or illness.

Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

When settling with a lump sum payment you surrendered your rights, not only to recover any such benefits in the action, but also to claim any further benefits to which you might now or in the future have an entitlement under your policy.

As each of these claims relate to your incapacity, any capital gain or loss arising from the surrender of your rights under your policy will be disregarded.

Applying paragraph 118-37(1)(b) of the ITAA 1997 to your circumstances, the lump sum payment would not be considered as an assessable capital gain.