Edited version of your private ruling

Authorisation Number: 1012533592599

Ruling

Subject: Employment termination payment

Questions

1. Is the settlement payment made under a Deed of Release an employment termination payment in accordance with subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. If the payment is not an employment termination payment will it be assessable as a capital gain?

3. If the payment is neither an employment termination payment nor a capital gain will it be assessable as ordinary income?

Answers

1. Yes

2. No

3. No

This ruling applies for the following period

For the year ending 30 June 2013

The scheme commences on

1 July 2012

Relevant facts and circumstances

You were employed by the employer several years ago.

The employer terminated your employment on a specific date during the relevant income year.

Following the termination of your employment, an application for Unfair Dismissal Remedy was lodged with Fair Work Australia which commenced proceedings against the employer (the proceedings).

The matter was settled between you and the employer out of court prior to any formal determination.

A Deed of Release (the Deed) was signed by you and the employer.

The Deed states that you and the employer agreed to settle all matters arising out of the Employment, the termination of the Employment and the Proceedings without any admission as to liability by either party, on the terms and conditions set out in the Deed.

The settlement payment was made to you in the subsequent income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-10(3).

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 Paragraph 82-130(1)(c).

Income Tax Assessment Act 1997 Subsection 82-130(4).

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 995-1.

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 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 6-5

Reasons for decision

Summary

The settlement sum is an employment termination payment as it was made in consequence of your termination of employment. The entire amount is assessable as a taxable component of the employment termination payment and is to be included in your income tax return for the subsequent income year.

No part of the payment is assessable under the capital gains tax provisions because it is included in your assessable income as an employment termination payment.

The payment made under the Deed of Settlement is not assessable as ordinary income under section 6-5 of the ITAA 1997.

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.

A life benefit termination payment (LBTP) is an employment termination payment to which subparagraph (1)(a)(i) of the ITAA 1997 applies.

A death benefit termination payment is an employment termination payment to which subparagraph (1)(a)(ii) of the ITAA 1997 applies.

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

§ payment for unused annual leave or unused long service leave;

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

§ reasonable capital payments for personal injury.

To determine if a settlement sum constitutes an employment termination payment, all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. Furthermore, any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule.

Paid as a consequence of the termination of your 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 Taxation Ruling TR 2003/13 the Commissioner has considered the 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 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 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 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 eligible termination payment (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.

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 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 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. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135.

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.

From the facts provided you were employed with the employer several years ago. You were dismissed from employment on a specific date during the relevant income year.

Subsequent to your termination of employment, an application for Unfair Dismissal Remedy was lodged with Fair Work Australia which commenced proceedings against the employer.

The matter was settled between you and the employer out of court. A Deed of Release (the Deed) was signed and a gross settlement amount (the payment) was made to you.

The payment is considered to be made in consequence of the termination of your employment with the employer. The payment would not have been made had there been no termination of employment. The legal action, the termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the issue of paying a lump sum would not have arisen.

As the lump sum payment is considered to be received by you in consequence of the termination of employment, the requirement of subparagraph 82-130(1)(a) of the ITAA 1997 has been met.

The payment is received no later than 12 months after termination

The second condition for the payment to meet the criteria, as an employment termination payment is stated under paragraph 82-130(1)(b) of the ITAA 1997. The settlement sum must be received within 12 months of the taxpayer's termination of employment, unless the taxpayer is covered by a determination exempting them from the 12 month rule.

As shown in the facts, your employment was terminated on a specific date during the relevant income year and the payment was made to you on a specific date during the subsequent income year.

Accordingly, as the payment was made within 12 months of the termination of your employment, the requirement under paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied.

The final requirement under paragraph 82-130(1)(c) of the ITAA 1997 is that the payment is not a payment mentioned in section 82-135.

Exclusions from being an employment termination payment

As previously mentioned, section 82-135 of the ITAA 1997 excludes certain termination payments from being an employment termination payment. These payments include any accrued annual and long service leave and the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments which do not apply to an employment termination payment.

As stated 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. Thus, the requirement in paragraph 82-130(1)(c) is satisfied in this instance.

Consequently, the payment to be made to you is considered to be an employment termination payment as it satisfies all the requirements in section 82-130 of the ITAA 1997, and is not specifically excluded under section 82-135.

Capital gains tax (CGT)

The general exemptions provisions (from CGT) 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 provision is to reduce the amount of any assessable capital gain by any amount which is also assessable under non-CGT provisions or by amounts which are exempt income under non-CGT provisions.

Section 118-22 of the ITAA 1997 is a related section, which recognises that a CGT event could give rise to an employment termination payment as well as a capital gain. It ensures that, for the purposes of section 118-20 only, the whole of the payment is included as assessable income.

The combined effect of these two sections is that where a capital payment is assessable under a non-CGT provision (in this case as an employment termination payment) then it is treated as being assessable under that non-CGT provision.

Therefore an employment termination payment is excluded from being a capital gain.

A payment may be disregarded as a capital gain by the operation of section 118-37 of the ITAA 1997 (which replaced former subsection 160ZB(1) of the Income Tax Assessment Act 1936 for the 1998-99 and later income years).

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. …

In this case, as the payment is to be included as assessable income because it is an employment termination payment as defined under subsection 82-130(1) of the ITAA 1997, it is to be disregarded as a capital gain under sections 118-20 and 118-22. The fact that the payment may also be disregarded as a capital gain under section 118-37 does not change the fact that it is assessable as an employment termination payment.

Accordingly, no part of the settlement payment is assessable under the CGT provisions because it is included in your assessable income as an 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 characteristic of income that has evolved from case law includes receipts that:

· are earned;

· are expended;

· are relied upon; and

· have an element of periodicity, recurrence or regularity.

The settlement payment received under the Deed by you were not income from rendering personal services, income from property and income from carrying on a business. The payment is also a one-off payment and thus it does not have an element of recurrence or regularity.

Therefore the payment received under the Deed is not assessable under section 6-5 of the ITAA 1997.

Tax Treatment of the employment termination payment

An employment termination payment will be comprised of the following components:

· Tax free component - as provided in section 82-140 of the ITAA 1997, this includes an invalidity segment within the meaning of section 82-150 of the ITAA 1997 (if any) and/or a pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997 (if any); and

· Taxable component - the amount remaining after deducting the tax free component calculated in accordance with section 82-140 from the total payment, as prescribed in section 82-145 of the ITAA 1997.

You commenced employment with the employer on a specific date during the relevant income year. Accordingly the period of employment to which the settlement sum relates commenced after 1 July 1983. Hence, the LBTP does not have a pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997.

As the LBTP contains neither a pre-July 83 segment nor an invalidity segment within the meaning of section 82-150 of the ITAA 1997, the LBTP has no tax free component as defined in section 82-140 of the ITAA 1997. Rather the entire LBTP is a taxable component of an employment termination payment as defined in section 82-145 of the ITAA 1997. Accordingly, the entire amount is a taxable component of an employment termination payment should be included in your income tax return for the subsequent income year.