Edited version of private advice

Authorisation Number: 1012641951480

Ruling

Subject: Ex-gratia payment

Question 1

Is an ex-gratia payment paid to the spouse of the deceased an employment termination payment?

Answer

Yes.

Question 2

Should PAYG be withheld on the ex-gratia payment?

Answer

No.

This ruling applies for the following periods:

The year ending 30 June 2014.

The year ending 30 June 2015.

The scheme commences on:

1 July 2013.

Relevant facts and circumstances

Recently, an employee (the deceased) of the employer died.

The spouse of the deceased has not yet received any of the deceased's entitlements.

The employer is intending to make an ex-gratia payment based on compassionate grounds to the spouse of the deceased to assist in meeting current and ongoing financial commitments.

The employer would prefer to make the payments on a fortnightly basis for a short period of time, rather than one lump sum payment.

The employer has not yet determined a specific amount or period over which the payments will be made.

The payments are intended to be made within 12 months of the deceased's death.

The reason the payment is being paid on a fortnightly basis is to attempt to maintain normality for the family cash flow on a fortnightly basis during a traumatic time when no other cash is available to the family. It takes into account the severe emotional distress that the spouse and family will be experiencing as a result of the deceased's death and uncertainties arising from the circumstances surrounding the deceased's death.

There is no requirement for the spouse to pay back the ex-gratia payments to the employer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-60

Income Tax Assessment Act 1997 Section 82-65

Income Tax Assessment Act 1997 Subsection 82-130(1)

Income Tax Assessment Act 1997 Subsection 82-130(3)

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

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 82-160

Taxation Administration Act 1953 Subsection 12-1 (1A) of Schedule 1

Taxation Administration Act 1953 Section 12-85 of Schedule 1

Reasons for decision

Summary

The amount(s) proposed to be made to the spouse of the deceased is considered to be a Death Benefits Termination Payment. Should the amount(s) received be less than the applicable ETP cap for the income year in which the payment is made, then the entire amount will be not assessable, non-exempt income under subdivision 82-B of the ITAA 1997 and no amount of tax is required to be withheld.

Detailed reasoning

Question 1

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.

Subsection 82-130(1) of the ITAA 1997 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 employment; 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

If the above three conditions are satisfied, the payment will be treated as an employment termination payment.

In consequence of employment

The first condition requires that there is:

• a payment;

• received by you; and

• in consequence of the termination of either;

• your employment; or

• another person's employment after their death.

The phrase 'in consequence of termination of employment' in subparagraph 82-130(a)(i) of the ITAA 1997 above is not defined in the legislation. However, the courts have considered the meaning of the words 'in consequence of' in relation to eligible termination payments (ETPs), the predecessor of employment termination payments.

Of note are the decisions made by the Full 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).

The views expressed by both Courts was 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.

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.

Upon the death of the deceased, their employment was terminated.

According to the facts, the spouse of the deceased will receive payments which take into account the severe emotional distress that the spouse and family will be experiencing as a result of the deceased's death and uncertainties arising from the circumstances surrounding the deceased's death. It is also intended to provide sufficient assistance to the spouse of the deceased.

Therefore based on the principles stated in Reseck and other cases, and the Commissioner's views expressed in TR 2003/13, the facts presented demonstrate a clear connection exists between the termination of deceased's employment and the payment. The spouse of the deceased would not otherwise have received the payment except for the termination of their partner's employment upon death. Although the payments are being made ex-gratia based on compassionate grounds to assist with meeting current and ongoing financial commitments, there is still a causal connection between the termination and the payment.

Consequently, the payment is considered to be in consequence of the termination of the deceased's employment. Further, once the payment is received by the spouse of the deceased it will then satisfy all the requirements of paragraph 82-130(1)(a) of the ITAA 1997.

The 12 month rule

To qualify as an employment termination payment, the payment must be received no later than 12 months after the termination of the taxpayer's employment (paragraph 82-130(1)(b) of the ITAA 1997).

You advised that the payment will likely be received within 12 months of the deceased passing away. As the payment will be made within 12 months of the employment being terminated, the requirement under paragraph 82-130(1)(b) of the ITAA 1997 will be satisfied.

Exclusions

The condition specified in paragraph 82-130(1)(c) of the ITAA 1997 is that an employment termination payment does not include a payment mentioned in section 82-135 of the ITAA 1997.

Section 82-135 of the ITAA 1997 includes, but is not limited to, amounts received that are:

• superannuation benefits;

• pension or annuity payments;

• unused annual leave and unused long service leave;

• the tax-free part of genuine redundancy payments or early retirement scheme payments; and

• foreign termination payments.

In this case, the payment described does not resemble any of the payments mentioned in section 82-135 of the ITAA 1997. As such, the condition pertaining to paragraph 82-130(1)(c) of the ITAA 1997 is satisfied.

As all of the conditions in section 82-130 of the ITAA 1997 have been satisfied, the payment the spouse will receive is considered to be an employment termination payment.

Death benefit termination payment

Subsection 82-130(3) of the ITAA 1997 states:

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

As the payment is being received after the death of an employee and in consequence of the termination of their employment, it is considered that subparagraph 82-130(1)(a)(ii) of the ITAA 1997 applies in this case.

As such, it is considered that the payment is also a death benefit termination payment (DBTP) as defined under subsection 82-130(3) of the ITAA 1997.

Tax treatment of the payment as an DBTP

As the DBTP was paid by an employer rather than a superannuation fund, section 82-140 and 82-145 of the ITAA 1997 apply. These sections state an ETP is comprised of the following components:

Tax-free component this includes the pre-July 83 segment of the payment (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.

Subsection 82-65 of the ITAA 1997 provides that the tax-free component of a DBTP that you receive after the death of a person whom you are a death benefits dependent is not assessable income and is not exempt income. Section 995-1 of the ITAA 1997 states that a DBTP has its meaning contained within subsection 302-195(1). The definition contained within subsection 302-195(1) defines death benefits dependant to include a deceased person's spouse.

Therefore the tax-free component does not count towards assessable (or taxable) income.

Further, paragraph 82-65(2)(a) of the ITAA 1997 states that the amount of the taxable component up to the ETP cap amount for the relevant year is not assessable income and is not exempt income. However, paragraph 82-65(2)(b) of the ITAA 1997 provides that the taxable component amount exceeding the ETP cap for the relevant year is assessable income and is taxed at the top marginal rate in accordance with the Income Tax Rates Act 1986.

From the facts provided, the period of employment to which the DBTP relates does not appear to occur before 1 July 1983 and therefore the DBTP does not have a pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997.

The payment will include an invalidity segment if the requirements under section 82-150 of the ITAA 1997 are satisfied. 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.

As the payment will be made to the spouse of the deceased directly it is clear that the spouse of the deceased does not satisfy these conditions. This is because the DBTP will not be made to the spouse of the deceased because they ceased being gainfully employed as a result of suffering from ill-health. Therefore there is no invalidity segment for the purposes of section 82-150 of the ITAA 1997.

As the DBTP contains neither a pre-July 83 segment nor an invalidity segment, there is no tax-free component as defined in section 82-140 of the ITAA 1997. Rather the entire DBTP is a taxable component as defined in section 82-145 of the ITAA 1997.

However, as the recipient of the payment(s) will be the spouse of the deceased, they are considered a 'death benefits dependent' for the purposes of section 302-195 of the ITAA 1997.

As stated previously, any amounts exceeding the ETP cap for the relevant income year are taxed at the top marginal tax rate pursuant to 82-65(2)(a) of the ITAA 1997. The ETP cap for the 2013-14 income year is $180,000. The ETP cap for the 2014-15 income year is $185,000.

As such, should the total amount of DBTP the spouse of the deceased receives not exceed the relevant ETP caps, then the entire amount of the payments is not assessable and is not exempt income.

However, should the payments received by the spouse of the deceased exceed the applicable ETP caps, then the excess amount will be taxed at the spouse of the deceased's top marginal tax rate.

Question 2

PAYG Withholding

Section 12-85 of Schedule 1 of the Taxation Administration Act 1953 (TAA) states that:

An entity must withhold an amount from any of the following payments it makes to an individual:

(a) a superannuation lump sum;

(b) an employment termination payment.

As shown above, the payment(s) to be made to the spouse of the deceased is an employment termination payment. The amount to withhold depends on whether a Tax File Number (TFN) has been provided. If a TFN has not been provided before the payment is made, tax must be withheld at the rate of 46.5%. This represents the top marginal rate plus Medicare.

However, Subsection 12-1 (1A) of the TAA states that an entity need not withhold an amount under Subdivision 12-C from a payment if the whole of the payment is not assessable and is not exempt income of the entity receiving the payment.