Edited version of your private ruling

Authorisation Number: 1012510975387

Ruling

Subject: Employment termination payment

Questions:

1. Is the payment made under a Deed of Release an employment termination payment?

2. Is the payment subject to Capital Gains Tax?

Answers:

1. Yes

2. No.

This ruling applies for the following period:

Year ending 30 June 2014

The scheme commences on:

1 July 2013.

Relevant facts and circumstances

You commenced full-time employment at the end of 2011 with an employer entity and resigned early in 2012.

You were age under 20 at the time.

You lodged a complaint three months later against the entity (your former employer) with a government body (the Complaint).

You also lodged a claim for compensation pursuant to the relevant legislation (the Claim).

The Claim was rejected and you subsequently lodged a dispute against the rejected claim.

You and your former employer (the parties) reached agreement to settle issues in dispute and claims including the Complaint and the Claim, under the terms set out in the Deed of Release and Discharge (the Deed).

The intention of the Deed was to extinguish claims by both parties. A summary of the executed Deed included:

· With a denial of liability, your former employer agreed to pay you a gross amount (the payment).

· In consideration of the settlement you agreed to accept the payment and discharge all claims, complaints and issues in dispute which you may have against your former employer in any way relating to or arising out of your former employment.

· You will not commence new claims.

· You will release your former employer from all your claims and discontinue the Complaint.

You received the payment in the 2013-14 income year.

Your representative for your private ruling application has stated the payment is an undissected lump sum.

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 82-10.

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(5).

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 1936 Subsection 160ZB(1).

Reasons for decision

Summary

The payment is an employment termination payment included as assessable income for the 2013-14 income year and subject to tax at a maximum rate of 30% plus Medicare levy.

The payment is not subject to capital gains tax.

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

(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.

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...

Justice Heerey in Dibb v. Commissioner of Taxation 2003 ATC 4613; (2003) 53 ATR 290; [2004] ALMD 5781; [2003] FCA 673 (Dibb) stated that:

22. The concept of a 'payment 'in consequence of the termination of any employment' was expounded by the High Court in Reseck v FC of T 75 ATC 4213; (1975) 133 CLR 45 and by the Full Court of the Federal Court in McIntosh v FC of T 79 ATC 4325; (1979) 25 ALR 557. These authorities are analysed by Goldberg J in Le Grand v FC of T 2002 ATC 4907 at 4911-4913 [25-30] and 4914 [33-34]; (2002) 195 ALR 194 at [25] to [30] and [33] to [34]. I adopt his Honour's analysis.

23. In my opinion the Commissioner was correct in ruling that the payment under the Deed was made 'in consequence of the termination' of the applicant's employment with AVCO. True it is there was a substantial lapse in time between the termination and the commencement of Federal Court proceeding and a further period of time until settlement. However the reason for that delay was the time taken up with the litigation first in the Commission and then in the Federal Court itself. The subject matter of the litigation in the Federal Court was clearly the termination, the allegedly wrongful way AVCO effected it and its financial and other consequences for the applicant. 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 ATC 4915 [36]; ALR [36]), '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.'

This reasoning was accepted by the Full Federal Court in Dibb v. Commissioner of Taxation (2004) 207 ALR 151; 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126 by Justices Spender Dowsett and Allsop in determining the appeal against Justice Heerey's decision.

Therefore, the Courts have held that settlement amounts arising from actions that are in some way connected with the termination of employment are payments made in relation to the taxpayer in consequence of the termination of their employment.

From the information provided, it is clear there was a dispute between yourself and your former employer. You had lodged a complaint with the government body alleging (amongst other things) constructive dismissal.

The settlement payment (the payment) was made to you in consequence of the execution of the Deed under the terms as set out in the Deed.

You accepted the payment in full settlement of your claims. Therefore, by entering into the Deed you agreed to settle all matters of dispute between yourself and your former employer.

Although the dominant cause of the payment was to settle the dispute between yourself and your former employer (the parties to the Deed), there is a causal connection between the termination of employment and the payment that was paid to you pursuant to the Deed.

As per the decision in Reseck discussed earlier, 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 according to relevant clause of the Deed, you accepted the payment in discharge of all claims in dispute arising out of your employment or its cessation.

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 considered that the payment you received pursuant to the Deed 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, it is clear that the settlement sum (the payment) does not include any payment mentioned in section 82-135 of the ITAA 1997. Therefore 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 early in 2012 and you received the payment at the beginning of the following income year, which is more than 12 months after the termination date and therefore would otherwise fail the condition in paragraph 82-130(1)(b).

However, paragraph 82-130(4)(a) 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.

The Commissioner has issued Determination SPR 2007/1 which is a legislative instrument pursuant to subsection 82-130(7) of the ITAA 1997. The legislative instrument extends the definition of 'employment termination payment' to include certain payments that are received more than 12 months after the termination of a person's employment under certain circumstances.

Paragraphs 5 and 7 of the explanatory statement to the legislative instrument are as follows:

…

5. This instrument makes a payment received more than 12 months after termination

of a person's employment an employment termination payment, if the delay in the payment was due to the commencement of legal action concerning either or both:

(a) the person's entitlement to the payment;

(b) the amount of the person's entitlement.

…

7. The legal action must have commenced within 12 months of the termination of a person's employment. The legal action is intended to cover any Court, Tribunal or other proceedings of a judicial or quasi-judicial nature which may result in the payment of an amount in consequence of the termination of a person's employment.

As you lodged the Complaint and the Claim against your former employer within 12 months of your termination date, therefore, the exemption from the 12 month rule provided by paragraph 82-130(4)(a) will apply to the payment.

Therefore all the conditions of subsection 82-130(1) have been satisfied to render the payment an employment termination payment and a life benefit termination payment as defined in subsection 82-130(2).

You received the payment in consequence of the termination of your employment and the payment is an employment termination payment included as assessable income under section 82-10 of the ITAA 1997. This is also in accordance with sections 6-10 and 10-5 of the ITAA 1997.

Consequently the whole amount of the payment is subject to tax and you are entitled to a tax offset that ensures that the rate of income tax on the amount does not exceed the maximum rate of 30% plus Medicare levy (paragraph 82-10(3)(b) of the ITAA 1997).

Capital gains tax

The general CGT exemptions provisions are found in subdivision 118-A of the ITAA 1997. Included amongst them is an anti-overlap provision, section 118-20, which ensures that an amount cannot be assessable under both the CGT provisions and non-CGT provisions. The effect of the anti-overlap provision is to reduce the amount of any assessable capital gain by any amount which is also assessable under non-CGT provisions and by amounts which are exempt income.

The payment you received was made as a consequence of entering into the Deed by yourself and your former employer (the parties to the Deed). The payment is assessable income under section 82-10 of the ITAA 1997 as the taxable component of a life benefit termination payment (the employment termination payment).

The combined effect of section 118-20 and section 82-10 is that where a capital payment is assessable under a non-CGT provision, then it is treated as being assessable under that non-CGT provision.

In this regard, it is relevant to note the following comment made by Senior Member Dwyer of the Administrative Appeals Tribunal (AAT) in AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258 at paragraph 31:

I accept Mr Gibb's submission that if the payment is caught, as I am satisfied it is, by s 27A(1), there is no advantage to the applicant in the fact that it would have been exempt by virtue of s 160ZB(1), if it were not so caught. …

The above was in respect of the eligible termination payment provisions which, prior to 1 July 2007, were contained in the Income Tax Assessment Act 1936 (ITAA 1936). The term 'eligible termination payment' was defined in former subsection 27A(1) in the ITAA 1936 and included any payments made in consequence of the termination of employment. Subsection 160ZB(1) of the ITAA 1936 was replaced by section 118-37 of the ITAA 1997 for the 1998-99 and later income years.

Section 118-37 of the ITAA 1997 deals with exemptions from capital gains of compensation or damages for wrong or injury suffered by a taxpayer. While the payment you received is not compensation or damages for wrong or injury, the principle still applies.

Therefore, as the payment in question is to be included as assessable income under section 82-10 (the non-CGT provision) any capital gain made is to be reduced under sections 118-20 by the amount assessable under section 82-10. The fact that the payment may also be assessable as a capital gain does not change the fact that it is assessable under another provision of the ITAA 1997.

Accordingly, the payment is excluded from the capital gains tax (CGT) provisions.

As explained above, the payment is assessed as an employment termination payment and subject to tax which will not exceed the maximum rate of 30% plus Medicare levy.