Edited version of your private ruling

Authorisation Number: 1012616946591

Ruling

Subject: Settlement payment

Question 1

Is the payment under the 'Term of Settlement' assessable as ordinary income?

Answer

No.

Question 2

Is the payment under the 'Term of Settlement' assessable as an employment termination payment?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

You met with your employer to discuss matters that were affecting your employment.

Subsequently you received an unsolicited offer subject to not taking any further action against the employer.

You signed the 'Terms of Settlement' (the Settlement) with the employer. The Settlement set out your last date of employment. It also stated that upon receipt of the settlement payment you will release and forever discharge the employer and its associates from any liability past, present or future from all claims, actions or proceedings arising out of or connected with your employment with the employer including but not limited to the cessation of employment.

You received the settlement payment within 12 months of the last date you were required to attend your place of employment.

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 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 Subparagraph 82-130(1)(a)(i)

Income Tax Assessment Act 1997 Paragraph 82-130(1)(b)

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Section 82-140

Income Tax Assessment Act 1997 Section 82-145

Income Tax Assessment Act 1997 Subsection 301-20(2)

Reasons for decision

Summary

The lump sum settlement payment made to you by your employer is an employment termination payment as it was made in consequence of the termination of your employment.

Detailed reasoning

Lump sum settlement payment as ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (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 lump sum settlement payment 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.

Whilst the lump sum settlement payment may be said to be 'expected' this expectation has resulted from you signing a settlement agreement.

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

Lump sum settlement payment as an employment termination payment

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. Subsection 6-10(1) of the ITAA 1997 refers to provisions about assessable income - a summary list of these provisions is contained within section 10-5 of the ITAA 1997.

One of the statutory income provisions listed is section 82-10 of the ITAA 1997, which deals with the taxation treatment of employment termination payments.

The term 'employment termination payment' is defined in subsection 82-130(1) of the ITAA 1997 which states:

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:

_ 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.

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 outside of the 12 months will be taxed as ordinary income at marginal tax rates.

Payment made in consequence of the termination of employment

The first condition subparagraph 82-130(1)(a)(i) of the ITAA 1997 requires that the payment received by you is made in consequence of the termination of your employment.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the words have been interpreted by the courts in several cases.

Of note are the decisions made by the Full Bench of 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).

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.

The Commissioner in Taxation Ruling TR 2003/13 considered the phrase 'in consequence of' as interpreted by the Courts. 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.

Thus 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 and will be an employment termination payment unless it fails to satisfy the other requirements of an employment termination payment under section 82-130 of the ITAA 1997.

In this case, you met with your employer and outlined a number of matters that were affecting your ability to remain at your place of work.

As a result of the above actions, an agreement was reached between yourself and your employer to settle all claims by you against the employer on the terms contained in a settlement agreement.

Under the settlement agreement you and your employer agreed on your last date of service. The term of settlement also states that upon receipt of the payment referred under this settlement, you will release and forever discharges the employer and its associates from any liability past, present or future from all claims, actions or proceedings arising out of or connected with your employment with the employer including but not limited to the cessation of employment.

It is clear from the facts provided that the settlement payment made to you is made as 'in consequence of the termination of employment'. There is still a causal connection between the agreement, 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 payment must be received within 12 months of the employee's termination of employment.

According to the facts, payment was made within 12 months from termination date, therefore this condition is satisfied for this particular payment.

Not a payment mentioned in section 82-135 of the ITAA 1997

Certain payments made on termination of employment are excluded from being an employment termination payment under section 82-135 of the ITAA 1997. These payments include any accrued annual and long service leave, the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments.

Based on the information provided, it is accepted that this section does not apply to your payment. Hence, no part of the settlement payment is excluded from being an employment termination payment in accordance with paragraph 82-135(e) of the ITAA 1997.

In this case, as all the conditions in section 82-130 of the ITAA 1997 have been satisfied, the payment is an employment termination payment.