Edited version of your private ruling

Authorisation Number: 1012464267334

Ruling

Subject: Employment termination payment

Question

Is the payment representing the balance of salary payable under a contract of employment, an employment termination payment where the employment is terminated before the contractual period has expired?

Answer

Yes.

This ruling applies for the following periods:

2012-13 income year.

The scheme commences on:

1 July 2012.

Relevant facts and circumstances

Your client is an Australian company for tax purposes.

In a letter dated in the middle of the 2012-13 income year, your client employed the Employee on a short-term contract starting in the middle of the 2012-13 income year and ending towards the end of the 2012-13 income year. The contract specified the gross amount of salary for this period.

The letter does not contain any mention of the process to be taken if employment is terminated by either party.

The Employee Handbook (the Handbook) issued at the time contains a clause titled 'Termination by the Company'. The clause provides the relevant periods of notice in writing to be provided on termination of an employee's employment for reasons other than serious misconduct in respect of

· Employees paid monthly;

· Employees paid fortnightly;

· Casual employees.

The clause also provides that your client may:

· pay an employee in lieu of all or part of any period of notice of termination;

· terminate the employment of any employee who commits serious misconduct or disobeys a reasonable and lawful direction without giving any notice or payment in lieu of notice.

In the third quarter of the 2012-13 income year an incident occurred which resulted in a meeting between your client and the Employee.

A day later your client received a letter from the Employee, outlining two proposals to resolve the incident. One of the proposals was to pay out the balance of the Employee's contract.

Following this letter, your client agreed to terminate the Employee's employment and pay out the balance of the Employee's contract. This amount was to be paid within several days of your client receiving a properly executed Deed of Release (the Deed).

The Deed was subsequently signed by your client and the Employee. The Deed provided that:

· the Employee's employment was terminated on the day following the execution of the Deed; and

· within a number of days of the Employer receiving a copy of the Deed, the amount representing the balance of the contract was to be paid to the Employee.

The compensation payment is final and the Employee has no further rights to seek additional compensation from your client.

Relevant legislative provisions

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 Paragraph 82-130(1)(b)

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(1)

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Summary of our decision

The payment made by your client in the 2012-13 income year is an employment termination payment as:

· it was made in consequence of the termination of the Employee's employment,

· the payment was made within 12 months after the termination of the Employee's employment, and

· the payment was not a payment which is excluded from being an employment termination payment.

The amount is to be included in the Employee's assessable income as an employment termination payment.

Detailed Reasoning

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(2) of the Income Tax Assessment Act 1997 (ITAA 1997)).

Section 995-1 of the 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.

Paid as a consequence of the termination of employment

It should be noted that the phrase 'in consequence of' 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'.

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 Taxation¹ (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation² (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 Taxation³ (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 applicants employment and the payment to warrant the finding that the payment was made in consequence of the termination of the applicants 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 Full Federal Court in Dibb v Federal Commissioner of Taxation⁴, 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 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.

In the facts of this case, your client was the employer of the Employee. The Employee was on a short-term contract from middle of the 2012-13 income year until the last quarter of the 2012-13 income year.

During the course of the Employee's employment, an incident occurred which resulted in discussions between your client and the Employee.

On the recommendation of the Employee, the Deed was entered into and signed by both your client and the Employee.

In the Deed, it was agreed between your client and the Employee to resolve all issues arising out of or in connection with the Employee's employment or the termination of that employment. Your client would make a compensation payment, as described under a clause of the Deed, to the Employee within several days of the signing of the Deed. This compensation payment is dissected into several separate elements.

The specific payment which is the subject of the ruling request is the element representing the balance of the short-term contract.

The Deed prescribes that the Employee's employment would end effective from a date in the last quarter of the 2012-13 income year.

It is clear from the facts provided that the specific payment made to the Employee is made 'in consequence of the termination of employment'. Although the dominant cause of the payment was to settle any claims brought by the Employee against your client, there is still a causal connection between the termination and the payment. The claims, the termination and the payment are all intertwined and connected. Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

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, unless the payment is covered by a determination exempting them from the 12 month rule.

As noted in the facts, the payment was made within 12 months after termination.

As the payment was made to the Employee within the 12 months of the Employee's termination of employment, the requirements of paragraph 82-130(1)(b) of the ITAA 1997 has been met.

Exclusions under section 82-135 of the ITAA 1997

Section 82-135 of the ITAA 1997 lists payments that are not employment termination payments. These include (among others):

· superannuation benefits;

· unused annual leave or long service leave payments;

· foreign termination payments covered under Subdivision 83-D of the ITAA 1997; and

· the tax free part of a genuine redundancy payment or an early retirement scheme payment.

In your client's 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, it is considered that the payment is not of a type mentioned in section 82-135 of the ITAA 1997. As the payment is not it is not a payment mentioned in section 82-135, the requirement under subparagraph 82-130(1)(c) is met.

As all the conditions in section 82-130 of the ITAA 1997 have been satisfied, the amount representing the balance of the short-term contract is considered to be an employment termination payment.

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 2012-13 income year, the cap is $175,000.

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.

In this case, the payment is a taxable component of an employment termination payment.

¹ (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45.

² (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325.

³ [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39.

⁴ [2004] FCAFC 126; (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786.