Edited version of private advice

Authorisation Number: 1012629659098

Ruling

Subject: Employment termination payment - capital payment for personal injury

Question

Is any part of an amount you received in accordance with the terms of a Deed of Release a tax-free part of a capital payment for, or in respect of, a personal injury ?

Answer

No

This ruling applies for the following period:

The year ending 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You commenced employment with the Employer a number of years ago.

A few years ago, while working. you suffered a medical episode, and was subsequently diagnosed by doctors with a medical condition.

You claim that some time after this, you had a new manager, who began to comment on your communication skills, which you believe was due to your accent. You consequently received an unsatisfactory work performance in that year due to your communication skills, and you believe that you have been discriminated because of your accent and non-English speaking background.

Subsequently, you sent a formal letter to senior management of the Employer to raise the matter of being discriminated because of your accent and communication skills.

You state that despite your formal complaint, you continued to experience victimisation and harassment at your workplace, which significantly affected your health and family.

You were advised by your doctor that your medical condition had deteriorated, and this was associated with stress at work. Consequently, the doctor advised you to take time off work to recover.

You returned to work following your doctors recommendations. Within a short period of time upon returning to work your blood pressure and stress from work returned. As a result, the doctor and family advised you to resign from work due to your health problems.

During the 2012-13 income year, as a result of an agreement between yourself and the Employer, the Employer, without any admission of liability, agreed to pay you an amount of money.

The agreement between you and the Employer was formalised in a Deed of Release (the Deed) made between you and the Employer.

The Deed states:

• your employment will terminate due to the your resignation

• you made various allegations and claims against the Employer including in relation to discrimination, but the Employer denies all liability in relation to the allegations.

• you have agreed with the Employer to resolve all employment related issues in the terms of this deed.

• you were also to receive payments for salary and wages and unpaid leave.

• you release the Employer from all claims and liabilities (other than any claim for workers compensation) in relation to:

• the Employment;

• the Position;

• the resignation;

• the allegations;

• the Employer will pay you an ex gratia termination payment (less tax required to be withheld). This payment was not dissected between the matters subject to release.

In accordance with the terms of the Deed, during the 2012-13 income year you received a payment from the Employer. The payment was treated by the Employer as an employment termination payment (ETP) type 'O'.

You contend that the payment was made with the intention that it would be an ETP type "R" for compensation payment for discrimination, harassment or personal injury.

Relevant legislative provisions

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(a)

Income Tax Assessment Act 1997 Subparagraph 82-130(a)(i)

Income Tax Assessment Act 1997 Subparagraph 82-130(a)(ii)

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

Income Tax Assessment Act 1997 Paragraph 82-130(c)

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Paragraph 82-135(i)

Income Tax Assessment Act 1997 Section 955-1

Reasons for decision

Summary

The payment you received is in consequence of the termination of your employment.

The amount you received does not include a capital payment for personal injury. Therefore, no part of the payment is excluded from being an employment termination payment.

Consequently, the whole payment is an employment termination payment type 'O' and is taxed accordingly.

Detailed reasoning

Employment termination payments

Employment termination payments are defined in subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997), which 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.

To determine if a payment is an employment termination payment, all the conditions in subsection 82-130(1) of the ITAA 1997 must be satisfied. Failure to satisfy any of the conditions under subsection 82-130(1) will result in the payment not being considered an employment termination payment.

Furthermore, any termination payments received more than 12 months after the termination 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

For a payment to be treated as an employment termination payment, the first condition that must be met is that the payment is made in 'consequence of' the termination of your employment.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Taking into account the courts decisions on the meaning of the phrase, the Commissioner's view on the meaning and application of the 'in consequence of' test are set out in Taxation Ruling TR 2003/13 (TR 2003/13).

While TR 2003/13 considered the meaning of the phrase 'in consequence of' in the context of the eligible termination payments, TR 2003/13 can still be relied upon as both the former provision under the Income Tax Assessment Act 1936 and the current provision under the ITAA 1997 both use the term 'in consequence of' in the same manner.

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.

In this case, you resigned from employment, thereby terminating your employment with the Employer, and as a result of the termination, the Employer made the payment to you in full and final settlement of all claims and entitlements which you had, or may have in the future, against the Employer. In other words, but for the termination, the payment would not have been made to you. Therefore, it is considered that the payment was made to you in consequence of the termination of your employment with the Employer.

Payment is received no later than 12 months after termination

Your employment was terminated during the 2012-13 income year and the payment was made to you less than 12 months after your termination. Therefore, this condition is satisfied.

Payment is not a payment mentioned under section 82-135 of the ITAA 1997

Based on the information provided, the only payments listed in section 82-135 of the ITAA 1997 which may be relevant in this case and thus require consideration is:

_ a capital payment for, or in respect of, personal injury

Capital payment for, or in respect of, personal injury

Under paragraph 82-135(i) of the ITAA 1997 (paragraph (i) exclusion), for a payment to be excluded from the definition of an employment termination payment there must be:

_ a capital payment;

_ it must be in respect of 'personal injury'; and

_ the payment must be reasonable, having regard to the nature of the personal injury and its likely effect on your capacity to derive income from personal exertion.

It is proposed to look at each of these requirements in turn.

Capital payment

The paragraph (i) exclusion requires the receipt of a payment that compensates or reimburses the taxpayer for or in respect of the particular injury.

In AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258 (Case 11,722) a taxpayer negotiated a settlement with their past employer by agreeing to a certain amount and that they would agree to forgo all past, present and future claims against the employer, except for personal injury. Senior Member Dwyer ruled that, given the 'exception' in the settlement clause, no amount of the settlement could be for personal injury, therefore the employment termination payment exclusion provisions could not apply to the amount.

From the foregoing it is apparent that for an amount to meet the definition of 'consideration' in the paragraph (i) exclusion, the payment must, to some extent, be for 'personal injury'.

Further, the payment must be a capital payment, not income. Payments that would be income under ordinary concepts, such as salary and wages or periodic workers' compensation payments, are not capital payments.

In this case a lump sum payment was made to you. The payment, in your hands, is not one that is received in a regular, recurrent or periodic manner through deriving your income. The payment is a one-off payment for the reasons set out under the Deed. Accordingly, the amount is considered to be a 'capital' payment.

Personal injury

The AAT has considered the meaning of 'personal injury', in respect of termination payments. The decisions in both Case 11,722 and McMahon v FC of T [1999] AATA 5; (1999) 41 ATR 1056; (1999) 99 ATC 2025 (McMahon's Case), cited Graham v. Robinson [1992] 1 VR 279 (Graham v. Robinson), and held that personal injury does not extend beyond physical injury or mental illness.

In Graham v. Robinson the Victorian Supreme Court had to decide if 'emotional hurt' (ie hurt, distress, public scandal, hatred, odium, ridicule and contempt) was a personal injury. In its decision Justice Smith stated, at 281:

In the absence of express authority, I have come to the conclusion that the expression "personal injury" does not extend beyond physical injury and mental illness to include emotional hurt. I am encouraged to this view by the fact that the law has rejected grief or sorrow as a form of injury which can be relied on to mount a claim in negligence: Mount Isa Mines Ltd. v. Pusey  (1970) 125 CLR 383, at p. 394 and Jaensch v. Coffey (1984) 155 CLR 549, at p. 587. It is true that damages are awarded for pain and suffering in the typical personal injury case. They are awarded, however, where pain and suffering flow from and are connected with physical or mental injury and may therefore be said to be damages "in respect of personal injury".

Flowing from these decisions, it can be said that only an injury that involves physical injury and/or mental injury that is clearly discernible to a qualified medical practitioner falls within the meaning of the term 'personal injury' as used in the paragraph (i) exclusion.

While injuries involving hurt, distress, anxiety, etc., may have legal remedies (e.g., defamation, slander, sexual harassment, discrimination), they are not personal injuries within the meaning of the paragraph (i) exclusion.

The decision in Graham v. Robinson was applied in McMahon's Case in relation to a payment for alleged damage to a taxpayer's reputation. In McMahon's Case, a critical performance appraisal of McMahon and other comments were published in the media. Subsequent to this, McMahon's employment was terminated and it was agreed to pay him certain amounts including an amount for the alleged damage to his reputation. Senior Member Block stated:

26. The tribunal also notes the stipulation in the concluding portion of s27A(1)(n) of the ITAA 1936 that the amount of consideration for personal injury is to be regarded as an ETP only to the extent that it is reasonable having regard to the nature of the injury and the taxpayer's capacity to derive income from personal exertion. The tribunal considers that the inclusion by the legislature of the words "from personal exertion" tends to confirm that the section is intended to exclude from the definition of ETP payments in respect of injuries to the person, where such injuries being physical injuries or mental illnesses which have an assessable and identifiable impact on the capacity of the taxpayer to earn income. The tribunal considers in summary that an injury to person is distinguishable from an injury to a person's reputation.

27. For the Reasons set out previously (and bearing in mind that the decision in Graham v. Robinson is binding on the tribunal), the reputation payment was not made in respect of personal injury within s27A(1)(n) of the ITAA 1936; accordingly the reputation payment was correctly assessable as an ETP.

To reiterate, for an amount to be excluded from the definition of employment termination payment by virtue of paragraph (i), there must be a 'physical injury or mental illness'.

Where a deed of release contains a specific exclusion for claims you may have for personal injury, the decision in Case 11,722 supports the contention that an amount to settle all claims except for claims you may have for personal injury is not consideration in relation to a personal injury.

A payment is not consideration for a personal injury where it is being paid in recognition of the taxpayer's service and any claims relating to the taxpayer's resignation.

In this case, you contend that you received the payment as compensation for the alleged discrimination at your work place. You state that your health deteriorated due to the continued stress from the discrimination you faced at work. This consequently led you to sign the Deed and resign from the Employer during the 2012-13 income year.

The stress resulting from the alleged discrimination faced by you does not fall within the term of a physical injury or mental illness. Hence, it is considered that there is no 'personal injury' for the purposes of paragraph 82-135(i) of the ITAA 1997.

'Reasonable' having regard to the nature of the personal injury

For completeness, we consider whether part of the payment you received would have been 'reasonable', had you suffered a 'personal injury'.

The final requirement under the paragraph (i) exclusion is that the consideration is excluded from being an employment termination payment to the extent that it is reasonable, having regard to the nature of the injury and its likely effect on the capacity of you to derive income from personal exertion.

In Commissioner of Taxation v. Scully [2000] HCA 6; 2000 ATC 4111; (2000) 43 ATR 718; (2000) 169 ALR 459; (2000) 74 ALJR 504; (2000) 201 CLR 148, the High Court held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In other words, the amount of the capital payment must have been determined with the nature and effect of the personal injury in mind.

Further, the full Federal Court case 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 (Dibb's Case), while considering whether any part of a settlement payment was in respect of personal injury, Justices Spender, Dowsett and Allsop accepted the argument of Justice Heerey in Dibb v. Federal Commissioner of Taxation 2003 ATC 4613; (2003) 53 ATR 290; [2004] ALMD 5781; [2003] FCA 673 (Dibb), saying:

45. As to this matter, the reasons of the primary Judge were as follows [ATC at 4618]:

"32. Before the Commissioner on the objection hearing were two medical certificates dated respectively 21 July 1997 and 19 December 2002 from Dr Jim Ryan of Wishart, Queensland. In the first of these reports Dr Ryan stated:

'This is to certify that I have been treating Mr Dibb for Anxiety/Depression since September 1996. This I believe has come about I believe as a result of losing his job. Currently he takes anti depressant medication with a gradually increasing dosage. He received a medical certificate excusing him from Jury Duty partly because of his serious condition.'

33. In the second certificate Dr Ryan stated:

'This is to certify that I am treating this (patient/man) for dermatitis, hypertension, gastrointestinal disorder and depression.'

34. Counsel for the Commissioner accepted that, in an appropriate case, a single payment made in consequence of the termination of employment of a taxpayer may be apportioned amongst several heads to which it relates. One of those heads could be consideration in respect to personal injury within the meaning of s 27A(1)(n). To that extent the payment may be treated as not being an ETP.

35. 'Personal injury' encompasses injury or disease of a physical or psychological nature. However it would not extend to anguish, distress or embarrassment of the kind traditionally taken into account in assessing damages for defamation:
FC of T v Scully 2000 ATC 4111 at 4119 [28]; (2000) 201 CLR 148 at [28],
Graham v Robinson [1992] VR 279.
However, even accepting that some of the complaints of damage the applicant raised in the Federal Court proceeding consisted of anxiety and depression and thus personal injury', the Commissioner was correct in concluding there was no way of dissecting the total settlement sum to include an amount for such a payment:
McLaurin v FC of T (1961) 12 ATD 273; (1960-1961) 104 CLR 381."

46. The last sentence of [35] of the primary Judge's reasons contains a premise with which we agree. The occasion for apportionment pursuant to par 27A(1)(n) only arises if there can be said to be ''consideration of a capital nature for, or in respect of, personal injury to the taxpayer...''. Here, it is impossible to say whether there was or was not personal injury. AVCO denied it. The section does not provide for ''consideration... of, or in respect of, allegations of personal injury.'' As can be seen from the description of the allegations in the Federal Court proceedings and the terms of the deed, there was no agreement between the parties that Mr Dibb had suffered personal injury. It was submitted on his behalf (as it had to be) that the respondent was obliged to sit, in effect, as a tribunal to decide whether he suffered personal injury and if so, the amount of a reasonable payment therefor. We disagree. The respondent was correct, as was his Honour, in concluding that it was impossible to identify any part of the total sum of $788,544 as consideration for, or in respect of personal injury.

From these decisions, it can be seen that where a payment made is under a judicial decision, deed of settlement or similar instrument, for any part of that payment to be considered a reasonable amount:

_ the instrument must state that part of the payment is being made in respect of 'personal injury';

_ the payment made in respect of 'personal injury' must be calculated with reference to the effect of the injury on the taxpayer to earn future income from personal exertion; and

_ the amount being paid in respect of 'personal injury' should be specified.

It is not necessary, however, that the payment for personal injury be made separately from other payments made under a legal instrument.

Applying these principles to this case, the lump sum amount you received is not considered to be a 'reasonable amount in respect of personal injury' based on the following reasons:

_ the Deed states that the lump sum amount was made as an 'ex gratia termination payment';

_ the Deed provides that the lump sum payment was made for full and final settlement of all claims and entitlements on a number of matters, with no references to how the lump sum amount was calculated; and

_ you received an undissected lump sum amount from the Employer.

In other words, there is no evidence that the payment was in any way calculated with regard to the nature of your personal injury and its likely effect on your capacity to derive income from personal exertion.

Conclusion

The amount you received does not include a capital payment for personal injury. Therefore, no part of the payment is tax-free for the purposes of section 83-170 of the ITAA 1997.

The amount you received is in consequence of the termination of your employment.

Consequently, the payment is an employment termination payment type 'O' and is taxed accordingly.