Edited version of your written advice

Authorisation Number: 1012684857921

Ruling

Subject: Employment termination payment - payment for personal injury

Question 1

Is any part of the payment received from the Employer an employment termination payment?

Answer

Yes

Question 2

Is any part of the payment received from the Employer excluded from being an employment termination payment as it is a capital payment for, or in respect of, personal injury?

Answer

No

Question 3

Is any part of the payment received from the Employer a tax free invalidity segment of an employment termination payment?

Answer

Yes

This ruling applies for the following period:

The year ending 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Your Client commenced employment with the Employer some time ago as a Technician.

Your Client's duties included doing domestic and commercial fault repair on telephone and internet connections. There were no special education requirements for the job and all training was provided on the job by the Employer.

During the 20XX income year, your Client was on duty when suffered an injury.

Following the injury, your Client returned to work on light duties, completing mostly desk work. Your Client continued to have severe ongoing pain and had been on and off at work.

In 20YY, your Client was advised that there was no position suitable for them given their disability and restrictions.

Your Client sought compensation from the Employer at the Administrative Appeals Tribunal (AAT). However, prior to the completion of the AAT hearings, your Client and the Employer entered into a "Separation Agreement" during the 20ZZ income year.

Relevant to this case, the "Separation Agreement" states:

2 SEPARATION AND PAYMENT

2.1 The employment will end at the close of business during the 2012-13 income year by way of medical retirement.

2.2 The Employer will pay the Employee an ex-gratia payment;

3 EMPLOYEE'S ACKNOWLEDGMENTS, RELEASE AND UNDERTAKINGS

…..

3.2 The Employee releases the Employer from all claims and liabilities arising directly or indirectly out of the Employment of Separation, excluding any claim or liability in respect of worker's compensation under the applicable legislation.

During the 20ZZ income year, your Client received a lump sum payment from the Employer. The payment was treated by the Employer as an employment termination payment (ETP).

There was no basis in the calculation of the payment to your Client. The amount was an offer by the Employer to your Client's solicitor, which they accepted.

You have provided two medically certified documents from two doctors. Both doctors have determined that it is unlikely that your Client can ever be gainfully employed in capacity for which they are reasonably qualified because of education, experience or training.

Your Client was a permanent employee of the Employer and their normal retirement age is 65 years.

The days of employment for your Client have been determined.

The days to retirement for your Client have been determined.

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 82-10(3)(b)

Income Tax Assessment Act 1997 Section 82-130

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

Income Tax Assessment Act 1997 Section 82-135

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

Income Tax Assessment Act 1997 Section 82-140

Income Tax Assessment Act 1997 Paragraph 82-140(a)

Income Tax Assessment Act 1997 Section 82-150

Income Tax Assessment Act 1997 Subsection 82-150(1)

Income Tax Assessment Act 1997 Paragraph 82-150(a)

Income Tax Assessment Act 1997 Paragraph 82-150(b)

Income Tax Assessment Act 1997 Paragraph 82-150(c)

Income Tax Assessment Act 1997 Paragraph 82-150(d)

Income Tax Assessment Act 1997 Subsection 82-150(2)

Income Tax Assessment Act 1997 Section 955-1

Summary

The payment your Client received is an ETP in accordance with 82-130(1) of the ITAA 1997.

The payment your Client received is not exempt from tax, as a capital payment for, or in respect of, a personal injury, in accordance with paragraph 82-135(i) of the ITAA 1997.

An amount of the invalidity segment included in the employment termination payment is tax free.

The remaining is a taxable component of the employment termination payment as defined in section 82-145 of the ITAA 1997. This component is to be included in your Client's tax return for the 2012-13 income year.

Your Client will be eligible to a tax offset under paragraph 82-10(3)(b) of the ITAA 1997. The tax offset will ensure that the rate of tax on the taxable component will be no more than 30% plus Medicare.

Reasons for decision

Employment termination payments

By virtue of subsection 995-1(1) of ITAA 1997, employment termination payments are defined in subsection 82-130(1) of the 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 ETP, 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 ETP.

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 ETP, the first condition that must be met is that the payment is made in 'consequence of' the termination of employment of the taxpayer.

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, your Client suffered a workplace injury during the 20XX income year. Following the injury, your Client returned to work on light duties, completing mostly desk work. Your Client continued to have severe ongoing pain and had been on and off at work.

During the 20ZZ income year, your Client was advised that there was no position suitable for them given their disability and restrictions.

Your Client sought compensation from the Employer at the AAT. However, prior to the completion of the AAT hearings, your Client and the Employer entered into a "Separation Agreement" during the 20ZZ income year.

Clause 2 of the Separation Agreement states:

2.1 The employment will end at the close of business during the 2012-13 income year by way of medical retirement.

2.2 The Employer will pay the Employee an ex-gratia payment;

Hence, the payment was made to your Client when he ended his employment with the Employer during the 20ZZ income year by way of medical retirement. In other words, but for the termination, the payment would not have been made to your Client. Therefore, it is considered that the payment was made to your Client 'in consequence of' the termination of their employment with the Employer.

Payment is received no later than 12 months after termination

Your Client's payment was received within 12 months after their 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 are:

_ 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;

_ for, or 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.

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 your Client. The payment, in your Client's hands, is not one that is received in a regular, recurrent or periodic manner through deriving your Client's income. The payment is a one-off payment based on the terms of the Separation Agreement. Accordingly, the amount is considered to be a 'capital' payment.

For, or in respect of, 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.

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.

Based on the documents you have provided for this case, your Client's injuries have satisfied the meaning of a 'personal injury'.

Furthermore, consideration is made as to whether the payment was made 'for, or in respect of', personal injury.

In Scully v. Commissioner of Taxation (1998) 84 FCR 41; (1998) 39 ATR 213; (1998) 164 ALR 281; (1998) 98 ATC 4671, in relation to former section 27A(1)(n) of the Income Tax Assessment Act 1936 (ITAA 1936), the Federal Court considered the meaning of 'in respect of personal injury' and states that:

The words ``in respect of personal injury'' are to be given a meaning which extends beyond what would otherwise be included by use of the expression

``for personal injury''. While both expressions ``for'' and ``in respect of'' require a connection between the consideration and the injury, the expression ``for'' denotes a more immediate connection. For example, an order of a court or tribunal awarding general damages for a broken leg could be said to be an award made for personal injury in the sense of being compensation for the disability arising from that injury.

…

In order to resolve the present question, it is necessary to consider the bases on which the payment has been made. Under cl 2.4.1 of the Deed, set out above, the obligation on the Trustees to pay the benefit arises in the event of termination of employment on the grounds of total and permanent disablement. There are two elements in this description of the event which give rise to an entitlement. The first is termination of employment. The second is that termination must be on the ground of total and permanent disablement. As seen earlier, the term ``disablement'' is defined as disablement caused through a number of matters; the relevant one for present purposes being ``bodily injury''. This latter term equates with the expression ``personal injury''. Clause 3.5.1 of the Deed is concerned with such a payment made in the event of total and permanent disablement whilst in the employ of the employer. If the member becomes totally and permanently disabled during the employment then the entitlement arises.

The member's entitlement, under the Deed, in the present case, arises not simply upon termination of employment alone but upon termination on the ground of total and permanent disablement. This is a composite requirement. It is an essential requirement of any entitlement that it arise because of the total and permanent disablement, which results from bodily or physical injury. Therefore, in a practical and significant respect, the payment is made as a consequence of the underlying basis of personal injury. A classification of the personal injury as being simply a condition precedent

Accordingly, it must be demonstrated that there is a connection between the payment made to your Client and the personal injury.

Under the terms of the Separation Agreement, your Client received an "ex-gratia" payment upon the end of their employment by way of medical retirement. The payment was a goodwill payment, and made because your Client's employment was terminated and not because of their personal injury.

In other words, under the terms of the Separation Agreement, there was no connection between the payment made to your Client and the personal injury sustained.

Accordingly, the payment is not considered to have been made 'for, or in respect of' personal injury.

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

For completeness, we consider whether part of the payment received by your Client would have been 'reasonable', had the payment been made 'for, or in respect of' 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 your Client 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 your Client received is not considered to be a 'reasonable amount in respect of personal injury' based on the following reasons:

1. The Separation Agreement does not state that part of the payment being made to your Client was in respect of 'personal injury'.

2. The lump sum payment was not calculated with reference to your Client's personal injury. The amount was an offer made by the Employer to settle your Client's dispute outside of the AAT. As such, the nature of the personal injury suffered by your Client was not a factor that was considered in relation to the lump sum payment; and

3. The amount being paid in respect of 'personal injury' is not specified in the Separation Agreement.

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

Conclusion

As all the requirements under paragraph 82-135(i) of the ITAA 1997 are not met, the payment your Client received is not exempt from tax, as a capital payment for, or in respect of, a personal injury.

The payment is an ETP in accordance with 82-130(1) of the ITAA 1997 and is taxed accordingly.

Invalidity segment

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.

To determine if a ETP includes an invalidity segment, all the conditions in subsection 82-150(1) of the ITAA 1997 must be satisfied. Failure to satisfy any of the conditions under subsection 82-150(1) will result in an ETP payment excluding an invalidity segment.

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

Person stops being 'gainfully employed'

Your Client's employment with the Employer ended upon their medical retirement. Hence, this requirement is satisfied.

Person stopped being gainfully employed because he or she suffered from ill-health

Because of the injuries your Client sustained, they were unable to return to work as a Technician. Hence, this requirement is satisfied.

Gainful employments stopped before last retirement day

As the gainful employment has stopped before your Client's last retirement day (at the age of 65 years), this requirement is satisfied.

Person has two medically certified documents

You have provided two medically certified documents from two doctors. Both doctors have determined that it is unlikely that your Client can ever be gainfully employed in capacity for which they are reasonably qualified because of education, experience or training.

As you have provided two medically certified documents, your Client has satisfied this requirement.

Conclusion

As all the requirements under subsection 82-150(1) of the ITAA 1997 are the satisfied, the ETP received by the Taxpayer from the Employer includes an invalidity segment.

Tax exemption for an invalidity payment

Under section 82-140 of the ITAA 1997 the invalidity segment included in an employment termination payment is tax free.

An employment termination payment made after 1 July 2007 may be comprised of the following components:

• Tax free component this includes the invalidity segment or pre-July 83 component (if any); and

• Taxable component the amount remaining after deducting the tax free component from the total payment.

The amount of the invalidity segment is worked out by applying the formula in subsection 82-150(2) of the ITAA 1997:

Work out the amount of the invalidity segment by applying the following formula:

where:

days to retirement is the number of days from the day on which the person's employment was terminated to the last retirement day.

employment days is the number of days of employment to which the payment relates.

In this case, an amount of the invalidity segment has been determined and is included in your Client's employment termination payment which is tax free.

As your Client's employment commenced after 30 June 1983 there will not be any pre-July 83 segment.

Tax treatment of taxable component

The remaining payment is a taxable component of the employment termination payment as defined in section 82-145 of the ITAA 1997. This component is to be included in your Client's tax return for the 2012-13 income year.

In this case, as the amount is under the employment termination payment cap ($175,000 for the 2012-13 income year) and your Client has not yet reached preservation age, it will be taxed at 30% plus Medicare levy.

Your Client will be eligible to a tax offset under paragraph 82-10(3)(b) of the ITAA 1997. The tax offset will ensure that the rate of tax on the taxable component will be no more than 30% plus Medicare.