Edited version of your private ruling

Authorisation Number: 1012588631787

Ruling

Subject: Settlement payment

Question 1

Is the payment you received in settlement of court proceedings an employment termination payment under subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does the contribution towards your legal costs, which you received under the settlement agreement, form part of your assessable income?

Answer:

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

As part of your terms of employment you were required to hold a licence.

You were notified that you failed to meet a requirement to hold a licence.

You lodged a claim under an insurance policy (the Policy) to which you and your employer were parties.

The Policy applies to all eligible employees as defined who apply for benefits.

Your employer advised that your claim could not be accepted and that no benefits would be paid because the claim fell within an exclusion clause of the Policy.

You lodged a Statement of Claim claiming that you were entitled to payment of a full capital benefit under the Policy. Further, your employer's failure to pay you the capital benefit was in breach of its obligations to you under the Policy.

An out of court settlement agreement was signed and you were paid an amount including costs.

The settlement agreement states that your employer will pay and you will accept a sum in full and final settlement and satisfaction of all claims by you arising from or in any way connected with the circumstances recited in the Agreement, to be paid by your employer to you as follows:

a) $X in settlement of the Court Proceedings in relation to your claim for benefits under the Policy; and

b) $Y for contribution to your costs in the Court Proceedings.

Your employment with your employer ceased less than 12 months prior to the payment being made.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Subsection 20-20(2)

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 Section 995-1.

Reasons for decision

Summary

The payment you received to settle the Court Proceedings is an employment termination payment and forms part of your assessable income.

The contribution towards your legal expenses, which was paid under the settlement agreement, does not form part of your assessable income as it is neither an assessable recoupment nor an ETP.

Detailed reasoning

Payment to settle Court Proceedings

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.

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 payment 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, as part of the terms of employment with your employer you were required to hold a licence. You were notified that you failed to meet a requirement to hold a licence. You lodged a claim under the Policy which was not accepted by your employer. A Statement of Claim was subsequently lodged claiming that you were entitled to payment of a full capital benefit under the Policy. Further, your employer' failure to pay you the capital benefit was in breach of its obligations to you under the Policy.

An out of court settlement agreement was signed and you were paid an amount including costs. Your employment with your employer ceased less than 12 months before the payment.

The circumstances are similar to that in Purvis and Ors vs. Federal Commissioner of Taxation 2013 ATC 10-296; [2013] AATA 58 where it was found that the payment received by three former Qantas airline pilots due to loss of licence were received in consequence of the termination of their employment and was therefore an employment termination payment. It was found that the connection between the payment and the termination of employment was not simply temporal. The termination of employment as a pilot was a pre-requisite to the payment and in that sense payment followed on the termination of employment and had a necessary connection with it.

The Statement of Claim and the settlement agreement sets out that the payment was made in settlement of your claims in regards to your entitlement a capital benefit under the Policy. However, the loss of your licence meant you were unable to work in your existing employment capacity with your employer and consequently your employment was terminated. It is concluded that there is a nexus between the payment and the termination of employment. Therefore, the payment is made in consequence of the termination of employment.

Payment is received no later than 12 months after that termination

The second condition for the payment to meet the criteria as an employment termination payment requires the payment in question be received within twelve months of that termination (paragraph 82-130(1)(b) of the ITAA 1997), unless they are covered by a determination exempting them from the 12 month rule.

In this case, paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied as the payment was paid to you within 12 months of the termination of your employment.

Payment is not a payment mentioned in section 82-135

The final requirement for a payment to qualify as an employment termination payment, as per paragraph 82-130(1)(c) is, that the payment is not a payment mentioned in section 82-135 of the ITAA 1997.

This condition is satisfied as no part of the payment is a payment mentioned in section 82-135 of the ITAA 1997.

Conclusion

As all conditions under subsection 82-130(1) have been met the payment is an employment termination payment.

Contribution to legal expenses

Contribution to legal costs as ordinary income

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

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, and

· have an element of periodicity, recurrence or regularity.

In your case, you have not earned the contribution towards your legal costs as it does not relate to services performed. The payment is a one-off payment and thus does not have an element of periodicity, recurrence or regularity.

Therefore, the contribution is not considered to be ordinary income and is not assessable under section 6-5(2) of the ITAA 1997.

Contribution to legal costs as an assessable recoupment

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income.

Assessable recoupments are a form of statutory income.

Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as a recoupment of a loss or outgoing is an assessable recoupment if:

· you received the amount by way of insurance or indemnity, and

· you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it in an earlier income year, under any provision of this Act.

As you are not entitled to deduct legal expenses incurred to obtain an ETP the contribution to your legal expenses does not meet the requirements of section 20-20 of the ITAA 1997.

Therefore, the contribution is not considered to be an assessable recoupment and is not assessable under section 20-20 of the ITAA 1997.

Contribution to legal costs as an ETP

Legal cost awards are paid to reimburse the expenses incurred in engaging in legal proceedings. Although an award for legal costs may be paid in relation to litigation concerning the termination of employment, an award for legal costs is not paid 'in consequence of termination' of employment.

The award of legal costs and the quantum of those costs are generally subject to the discretion of the Court. An award of costs is an action in itself rather than part of the underlying object of any proceeding. The award of particularised legal costs is to ensure the successful party is not out of pocket for their legal expenses as a result of being required to bring or defend an action. The same principle applies where a party to legal action settles out of court and the settlement agreement provides a monetary amount for reimbursement of, or a contribution to, the party's legal costs.

In your case you incurred legal costs relating to the legal action against your former employer. Whilst you received an ETP as a result of the original legal action, the contribution to legal costs is not considered to be in consequence of the termination of your employment.

Therefore, the contribution to your legal costs is not considered to be an ETP and does not form part of your assessable income.

Conclusion

The contribution to your legal expenses, paid in accordance with the settlement agreement, does not form part of your assessable income.