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Edited version of your private ruling
Authorisation Number: 1012551299573
Ruling
Subject: Employment termination payment
Question 1
1. Is any part of the payment received from the Employer included in your client's assessable income as an employment termination payment?
2. Is any part of the payment received from the Employer tax free as an invalidity segment of an employment termination payment?
Answer
1. Yes.
2. Yes.
This ruling applies for the following periods:
2013-14 income year
The scheme commences on:
1 July 2013
Relevant facts and circumstances
Your client was employed by the Employer.
Your client commenced employment with the Employer several years ago.
Your client's last day of service with the Employer was during the 2012-13 income year.
Your client's last retirement date is 65 years of age.
You advised that during the 2012-13 income year your client was advised by the Employer that your client had been assessed to be unfit to perform your client's ordinary duties due to illness.
The letter dated in the 2012-13 income year from the Employer advised your client that the Employer has completed the review and made an assessment of your medical condition. As a result of the assessment, the Employer has concluded that your client is permanently unfit to perform their ordinary duties. Your client is therefore considered, for the purposes of an Award to have suffered partial and permanent incapacity (PPI) as of the date of the letter. The Employer has also decided that your client's incapacity is the result of a work injury, as defined by the Award.
.A letter in the 2012-13 income year from the Employer advised your client that if a suitable substantive position is not found for your client within 28 days from the date of this letter, or if your client does not wish to be considered for redeployment to current or pending suitable substantive positions within the indicated timeframe, then your client's separation and exit payments will be confirmed with your client and your client will be medically retired. Also under the Employer's Regulations the Employer may terminate the employee's position if the employee is no longer medically or psychologically fit to exercise the functions of their employment.
A medical certificate in the 2012-13 income year from a consultant psychiatrist certified that because of your client's ill health it is unlikely that your client can ever be gainfully employed in a capacity for which your client is reasonably qualified because of education, experience or training.
A medical certificate in the 2012-13 income year from a medical practitioner certified that due to your client's ill health your client will not ever be gainfully employed in a capacity for which your client is reasonably qualified because of education, experience or training.
Prior to joining the employer, your client received training in another field of employment. Your client also joined a different field of employment several years ago and continued there until your client started with the Employer.
You advised that the certifying Doctors were aware of your client's previous education, training and experience before joining the Employer.
In an e-mail in the 2013-14 income year from the Employer to your client advised that your client's gross partial and permanent incapacity (PPI) payment is an amount.
Your client is not currently in employment.
Your client has been clinically diagnosed with an illness.
A lump sum will be paid by the Employer to your client by 30 June 2014.
The proposed payment will be made under specific clauses in the Award.
Annexure A of the Award determines the amount to be paid as a lump sum under the Award. The amount is calculated by reference to the age and salary of the employee at the time of the termination.
Your client is under 65 years of age.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 1-3.
Income Tax Assessment Act 1997 Subsection 82-10(1).
Income Tax Assessment Act 1997 Subsection 82-10(2).
Income Tax Assessment Act 1997 Subsection 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 Section 82-135.
Income Tax Assessment Act 1997 Paragraph 82-135(i).
Income Tax Assessment Act 1997 Section 82-140.
Income Tax Assessment Act 1997 Section 82-145.
Income Tax Assessment Act 1997 Subsection 82-150(1).
Income Tax Assessment Act 1997 Paragraph 82-150(1)(a).
Income Tax Assessment Act 1997 Paragraph 82-150(1)(b).
Income Tax Assessment Act 1997 Paragraph 82-150(1)(c).
Income Tax Assessment Act 1997 Paragraph 82-150(1)(d).
Income Tax Assessment Act 1997 Subsection 82-150(2).
Income Tax Assessment Act 1997 Section 995-1.
Income Tax Assessment Act 1936 Subsection 27A(1).
Income Tax Assessment Act 1997 Paragraph 82-10(3)(b).
Reasons for decision
Summary
The employment termination payment to be made to your client in the 2013-14 income year by the Employer includes an invalidity segment.
The remaining amount is the taxable component of an employment termination payment and is included in your client's income tax return for the 2013-14 income year.
As your client has not yet reached preservation age, and the taxable component is under the employment termination payment cap, a tax offset will apply to ensure that the taxable component is taxed at no more than 30% plus Medicare levy (if any).
Detailed reasoning
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.
Therefore, prior to determining if the payment includes an invalidity segment, the payment must be an employment termination payment.
Employment termination payment
Employment termination payments are defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997). Subsection 82-130(1) declares:
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 termination; 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.
Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:
Ÿ payment for unused annual leave or unused long service leave;
Ÿ the tax-free part of a genuine redundancy payment or an early retirement scheme payment;
Ÿ reasonable capital payments for personal injury.
Therefore, it can be seen that 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. Any termination payments received more than 12 months after the termination of employment will be taxed as ordinary income at marginal tax rates.
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.
It is considered that the payment to be made to your client from the Employer will be made in consequence of the termination of your client's employment. From the facts the Employer completed a review and made an assessment of your client's medical condition. The Employer has concluded that your client is permanently unfit to perform ordinary duties. Your client is considered for the purposes of the Award to have suffered Partial and Permanent Incapacity (PPI).
The payment to be made by the Employer would not have been paid unless your client's employment was terminated and in this case the termination was based on medical grounds.
Therefore, the 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 second condition for the payment to meet the criteria is that the employment termination payment was paid to the taxpayer no later than 12 months after the taxpayer's employment was terminated.
The facts of this case show that your client's final day of employment with the Employer was during the 2012-13 income year and the payment will be made within 12 months of the termination of employment. As the payment will be received within 12 months of the termination the requirement under paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied.
Not a payment mentioned in section 82-135 of the ITAA 1997
As noted earlier section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments. These include:
Ÿ superannuation benefits;
Ÿ payment for unused annual leave or unused long service leave;
Ÿ the tax-free part of a genuine redundancy payment or an early retirement scheme payment;
Ÿ reasonable capital payments for personal injury.
The payment is the result of a calculation of a partial and permanent incapacity benefit under the Award. It is not a superannuation benefit, a payment for unused annual leave or unused long service leave, nor is it the tax-free part of a genuine redundancy payment or an early retirement scheme payment.
However, consideration must be given as to whether the payment represents a reasonable capital payment for personal injury. If it does, then the payment will not be an employment termination payment under paragraph 82-135(i) of the ITAA 1997 (payments that are not employment termination payments).
Paragraph 82-135(i) of the ITAA 1997 states that an employment termination payment does not include:
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);
Payments that fall within this exclusion are payments or benefits that compensate or reimburse the person for or in respect of the particular injury.
Prior to 1 July 1997, former paragraph (n) of the definition of an eligible termination payment in former subsection 27A(1) of the Income Tax Assessment Act 1936 (ITAA 1936) (the former paragraph (n) exclusion) applied to exclude similar payments from being eligible termination payments. The former paragraph (n) exclusion stated:
Consideration of a capital nature for, or in respect of, personal injury to the taxpayer, to the extent to which the amount or value of the consideration is, in the opinion of the Commissioner, reasonable having regard to the nature of the personal injury and its likely effect on the capacity of the taxpayer to derive income from personal exertion.
From 1 July 2007, the former paragraph (n) exclusion has been replaced by paragraph 82-135(i) of the ITAA 1997. However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 which, as enacted, inserted section 82-135 of the ITAA 1997, states that:
consistent with current legislation, certain payments are prevented from qualifying as employment termination payments.
Paragraph 82-135(i) of the ITAA 1997 represents a rewrite of the former paragraph (n) exclusion. Despite the fact that the wording of the legislation has changed from 'consideration of a capital nature' to 'capital payment', the meaning of the legislation has not changed.
In accordance with section 1-3 of the ITAA 1997,section in the ITAA 1936 which have been rewritten in the ITAA 1997 will have the same meaning where it is expressing the same idea, even when 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] HCA 6; (2000) 2000 ATC 4111; (2000) 169 ALR 459; (2000) 43 ATR 718; (2000) 74 ALJR 504; (2000) 201 CLR 148 (Scully) the Full Bench of the High Court considered whether a payment made by a superannuation fund as a result of the taxpayer's termination of employment because of invalidity was:
o 'consideration'; and
o consideration 'for, or in respect of, personal injury'.
It was held that the payment was 'consideration' within the broad sense of that term. However, the payment was not 'consideration for or in respect of personal injury to the taxpayer' which would fall within the paragraph (n) exclusion. The clauses of the trust deed which calculated the payment made no attempt to place a monetary value on the taxpayer's injury, nor was it the purpose of superannuation schemes to compensate for 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.
From the foregoing it is apparent that for an amount to be a capital payment for, or in respect of, personal injury, the payment must actually be for personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.
In an e-mail in the 2013-14 income year the Employer advised that your client's gross PPI payment is an amount. The payment was made because your client has suffered a Partial and Permanent Incapacity (PPI) as a result of a work duty injury and their employment is subsequently terminated.
Annexure A of the Award determines the amount to be paid as a lump sum under the Award. The amount is calculated by reference to the age and salary of the employee at the time of the termination.
Consequently, the level of incapacity is irrelevant as to the amount received under the Award.
The lump sum payments are consideration for, or in respect of your client's termination of employment and your client's rights under the Award and not consideration for, or in respect of your client's injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss to your client. In other words, the payment is to compensate your client for the loss of their employment as a result of the injury sustained rather than to compensate for the injury itself and any subsequent loss of earning capacity.
Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the lump sum payment being made under the Award.
Therefore your client's payment is not of a type paragraph 82-130(1)(c) of the ITAA 1997 would exclude.
As all the conditions under subsection 82-130(1) of the ITAA 1997 have been met, the payment will be an employment termination payment.
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 being 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 becoming ill, your client was employed by the Employer on a full-time basis. During the 2012-13 income year your client's employment with the Employer was terminated on medical grounds as the Employer, after an assessment, concluded that your client was permanently unfit to perform your client's ordinary duties, and for the purposes of the Award to have suffered PPI .
Under normal conditions of employment your client would have retired at age 65. Your client was under 65 years of age at the time of the termination of your client's employment. Therefore the conditions in paragraphs 82-150(1)(a), (b) and (c) of the ITAA 1997 have been satisfied.
Certification from 2 legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed.
In respect of this requirement, it must be demonstrated that the disability was such that it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.
Therefore, paragraph 82-150(1)(d) of the ITAA 1997 requires that there must be the likelihood that the disability of the taxpayer will preclude the taxpayer from ever being employed in a role, for which the taxpayer is reasonably qualified.
Further, the requirement that the disability is likely to result in the taxpayer being unable ever to be employed in a capacity for which he or she is reasonably qualified extends to full-time employment, part-time or casual employment. A person who is not able to work full-time but can work part-time or casual in any employment for which the taxpayer is reasonably qualified will not receive the concessional component.
In your client's case, two legally qualified medical practitioners have certified that as a result of your client's injury your client will never be able to be gainfully employed in any capacity for which your client is reasonably qualified because of education, training or experience.
It is noted that prior to joining the Employer your client received training in another field of employment. Your client also entered another field of employment several years ago and continued there until your client commenced employment with the Employer several years ago. You advised that your client is not currently in employment.
You advised that the certifying Doctors were aware of your clients previous education, training and experience before commencing work with the employer.
Therefore, as two medical practitioners have provided certificates that attest to your client being unable to ever be employed in a capacity for which he is reasonably qualified because of education, training or experience, it is considered that the final condition of subsection 82-150(1) of the ITAA 1997 has been satisfied.
Components of an employment termination payment
An employment termination payment comprises the following components:
§ Tax free component this includes the pre-July 83 component (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 tax-free component of an employment termination payment is not assessable income and is not exempt income (subsection 82-10(1) of the ITAA 1997). However, the taxable component is assessable income (subsection 82-10(2)) and subject to tax, depending on the person's age when the payment is received.
Calculation of invalidity segment
As noted above, the invalidity segment of an employment termination payment is included in the tax-free component (section 82-140 of the ITAA 1997). As a consequence, the invalidity segment is not assessable income and is not exempt income.
The amount of the invalidity segment is worked out by applying the formula in subsection 82-150(2) of the ITAA 1997:
Work out the amount of the invalidity segment by applying the following formula:
Amount of employment termination payment |
X Days to retirement ¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾¾ Employment days + Days to retirement |
Where:
This amount is the invalidity segment which, as noted above, forms part of the tax-free component of the employment termination payment.
As your client's employment commenced after 30 June 1983 there will not be any pre-July 83 segment. Therefore the tax-free component of the employment termination payment is calculated to be an amount.
Tax treatment of taxable component
The remaining amount is a taxable component of the employment termination payment as defined in section 82-145 of the ITAA 1997. This component is to be included in your client's tax return for the 2013-14 income year. As this amount is under the employment termination payment cap ($180,000 for the 2013-14 income year), and your client has not yet reached preservation age, it will be taxed at 30% plus Medicare levy.
Your client will be eligible to a tax offset under paragraph 82-10(3)(b) of the ITAA 1997. The tax offset will ensure that the rate of tax on the taxable component will be no more than 30% plus Medicare.