Edited version of private advice

Authorisation Number: 1012654218081

Ruling

Subject: Foreign termination payment

Questions

1. Are the payments made under a foreign insurance policy (the Payments) foreign termination payments under section 83-235 of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Do the Payments, or a portion thereof, constitute employment termination payments under section 82-130 of the ITAA 1997?

3. Are the Payments ordinary income under section 6-5 of the ITAA 1997?

Advice/Answers

1. No.

2. No.

3. Yes.

This ruling applies for the following period

Year ending 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

Your client was a foreign resident

In the 1999-2000 income year your client began employment with the Company.

In the 2000-2001 income year your client was involved in an accident.

Your client suffered injuries which left her/him unable to work.

Your client's employment with the Company was terminated in the 2000-2001 income year.

In the 2000-2001 income year your client was involved in a second car accident.

At the time of the accidents your client held an insurance policy to compensate her/him for pain and suffering incurred and income potential lost should she/he be injured and become unable to work as a result. Your client was, as a consequence of the accidents, entitled to a disability pension from the relevant government.

Your client relocated to Australia in the 2001-2002 income year.

In the 2002-2003 income year your client was notified that she/he was entitled to an insured allowance (the Payments).

The Payments are partly to compensate for pain and suffering that resulted from the accidents.

The Payments were made to your client's foreign bank account with. The payments were paid monthly.

Your client has informed that she/he is not currently employed and has not been employed (whether overseas, Australia or elsewhere) since her/his employment with the Company was terminated.

Assumptions

None.

Relevant legislative provisions

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

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

Income Tax Assessment Act 1997 Subdivision 83-D

Income Tax Assessment Act 1997 Section 83-235

Income Tax Assessment Act 1997 Section 83-240

Income Tax Assessment Act 1997 Section 995-1

Further issues for you to consider

Not applicable.

Anti-avoidance rules

Not applicable.

Reasons for decision

Summary

It is considered that the Payments do not follow as an effect or result of the termination of your client's employment. Further, the Payments are not considered to be received by your client in consequence of the termination of their employment. Therefore, the Payments are not termination payments exempt from tax under section 83-235 of the ITAA 1997 or employment termination payments under subsection 82-130(1) of the ITAA 1997.

The Payments are assessable under subsection 6-5(2) of the ITAA 1997.

Detailed reasoning

Termination payments that arise out of foreign employment are dealt with under Subdivision 83-D of the Income Tax Assessment Act 1997 (ITAA 1997).

Subdivision 83-D of the ITAA 1997 essentially exempts two types of termination payments from tax - termination payments relating to a period when the taxpayer was not an Australian resident (section 83-235 of the ITAA 1997) and termination payments relating to a period when the taxpayer was an Australian resident (section 83-240 of the ITAA 1997).

Section 83-235 of the Income Tax Assessment Act 1997 (ITAA 1997) applies where a person was not a resident of Australia for tax purposes during the period of overseas employment. Section 83-235 of the ITAA 1997 states:

A payment received by you is not assessable income and is not exempt income if:

(a) it was received in consequence of the termination of your employment in a foreign country; and

(b) it is not a superannuation benefit; and

(c) it is not a payment of a pension or an annuity (whether or not the payment is a superannuation benefit); and

(d) it relates only to a period of employment when you were not an Australian resident.

Paid as a consequence of the termination of employment

The requirement in subsection 83-235(a) of the ITAA 1997 is that the payment was received '…in consequence of the termination of your 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.

The phrase in consequence of termination of employment has been interpreted by the courts in several casesOf note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation (1975) 133 CLR 45, (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; [1975] HCA 38 (Reseck) and the Full Federal Court in McIntosh v. Federal Commissioner of Taxation (1979) 45 FLR 279; (1979) 25 ALR 557; (1979) 10 ATR 13; (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 ... (bold emphasis added)

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) 2002 ATC 4907;; (2002) 195 ALR 194; (2002) 51 ATR 139; (2002) 124 FCR 53 (Le Grand), the issue before the Federal 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.

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).

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.

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 Commissioner states in paragraph 31 of TR 2003/13:

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 83-235(a) of the ITAA 1997. The termination of the payment need not be the sole or dominant 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, your client was involved in two accidents whilst she/he was residing overseas. Your client suffered injuries that left her/him unable to work.

At the time of the accidents your client held an insurance policy (the Policy) to compensate her/him for pain and suffering incurred and income potential lost should she/he be injured and become unable to work as a result. In the 2002-2003 income year your client was notified that she/he was entitled to an insured allowance (the Payments).

It is considered that the Payments do not follow as an effect or result of the termination of your client's employment. The Payments, as stated by you, are made to compensate for pain and suffering and income potential lost that resulted from the accidents rather than in consequence of the termination of employment.

Therefore, the Payments are not termination payments exempt from tax under section 83-235 of the ITAA 1997.

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 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 Payments are employment termination payments 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.

As discussed above, the Payments are not considered to be received by your client in consequence of the termination of their employment. Therefore, the requirement under subparagraph 82-130(1)(a) of the ITAA 1997 has not been met. As all conditions under subsection 82-130(1) have not been met the Payments are not employment termination payments.

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.

Payments of salary and wages are income according to ordinary concepts and are included in assessable income under section 6-5 of the ITAA 1997.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon¹). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Commissioner of Taxation v. Inkster²; Tinkler v. Commissioner of Taxation (Cth)³; AAT Case 7328⁴).

The Payments provide your client with income as she/he is unable to work due to injury. The purpose of the Payments, as discussed previously, are to compensate your client for pain and suffering incurred and income potential lost due to her/his injury and resulting inability to work.

It is considered that the Payments are to replace the salary and wages normally earned, expected and relied upon by your client.

These Payments are considered to be ordinary income as they acquire the character of the salary and wages for which they are substituted.

Subsection 6-20(1) of the ITAA 1997 states that an amount of ordinary income is exempt income if it is made exempt from income tax by a provision of the income tax legislation or another Commonwealth law.

However, there are no provisions which exempt a payment under a personal accident, income protection or disability insurance policy from income tax where the payment replaces income that would have been derived if the event that triggered the claim under the policy had not occurred. The payments you have received are therefore not exempt income.

The monthly Payments that you have been receiving under the policy are to replace lost earnings. The Payments are assessable under subsection 6-5(2) of the ITAA 1997 and are not exempt income.

¹ (1952) 86 CLR 540; (1952) 26 ALJ 505; (1952) 10 ATD 82; [1953] ALR 17; [1952] HCA 65

² (1989) 24 FCR 53; (1989) 89 ALR 137; (1989) 20 ATR 1516; (1989) 89 ATC 5142

³ (1979) 40 FLR 116; (1979) 29 ALR 663; (1979) 10 ATR 411; (1979) 79 ATC 4641

⁴ (1991) 22 ATR 3422; (1991) 91 ATC 433