Edited version of your written advice

Authorisation Number: 1012686355262

Ruling

Subject: Payment made under a Deed of Release

Question 1

Is a payment made under a Deed of Release (the Deed) an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is an employer required to withhold an amount under the Pay As You Go (PAYG) withholding system from a payment under the Deed to a former employee?

Answer

No.

This review applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts and circumstances

Prior to the relevant income year, an employee (the employee) commenced employment with the employer (the Employer).

During the relevant income year, the employee lodged a complaint with the Employer alleging that the employee was subject to bullying and harassment from one of the Employer's managers (the manager).

The matter was the subject of investigations by the Employer and recommendations were made by a consultant (the consultant).

In the minutes of a meeting the Employer considered the recommendations to resolve the complaint made by the employee. The Employer agreed to offer a termination package of a specific amount to the employee in return for dropping all further action against the Employer.

Discussions were held between the Employer and the employee, with both parties agreeing to settle claims and all other employment related issues in the terms contained in the Deed of Release (the Deed) made during the relevant income year.

Both parties agreed, without an admission of liability, to settle all employment related claims and bring to an end any liability of the Employer in connection with or related in any way to the subject matter of the employment, termination, health, workplace complaints and any other employment related matter on the terms and conditions set out in the Deed.

Furthermore, in the Deed it states, amongst other matters:

(a) the employee's last day of employment;

(b) the amounts to be paid; and

(c) payment (the payment) of a specified amount as full and final legal settlement of all claims the employee may have against the Employer in relation to any ongoing health or personal injury costs, information related claims, and any other damages and claims as outlined in the Deed, and in relation to any workplace complaints, not already specified and specifically not related to the employment termination.

In a meeting held in the relevant income year, the consultant advised the Employer that the employee had voluntarily resigned and that the employee had agreed to a settlement of an amount specified in return for the employee taking no further action against the Employer in any shape or form relating to the employee's claimed personal injury or for any other matters concerning the employee's employment or matters arising from the employee's employment with the Employer.

The employee terminated employment during the relevant income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-130.

Income Tax Assessment Act 1997 Subsection 82-1301).

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

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

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

Income Tax Assessment Act 1997 Section 82-135.

Income Tax Assessment Act 1997 Subsection 82-135(i).

Income Tax Assessment Act 1997 Section 995-1.

Taxation Administration Act 1953 Schedule 1, Subsection 10-5(1).

Taxation Administration Act 1953 Schedule 1, Section 12-35.

Taxation Administration Act 1953 Schedule 1, Section 12-120.

Taxation Administration Act 1953 Schedule 1, Section 359-5.

Summary

The payment as defined in the Deed of Release was not a payment made in consequence of the employee's termination of employment. Accordingly, as the first requirement of an employment termination payment has not been satisfied, the payment in not an employment termination payment.

The payment is not a payment for salary, wages, commissions, bonuses or allowances. In addition, the payment is not for compensation, sickness or accident pay as it was paid to settle a legal dispute and was not calculated at a periodical rate.

Accordingly, regardless of whether the payment is assessable to the recipient, there is no obligation for the Employer to withhold tax on the settlement sum.

Detailed reasoning

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.

A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) of the ITAA 1997 applies.

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

n payment for unused annual leave or unused long service leave;

n the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

n reasonable capital payments for personal injury.

To determine if the lump sum payment constitutes an employment termination payment, all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. Furthermore, any termination payments received outside of the 12 months 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

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 in relation to 'eligible termination payments' (ETPs), the predecessor of employment termination payments.

In Taxation Ruling TR 2003/13 the Commissioner has considered the meaning of the phrase 'in consequence of'.

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 phrase 'in consequence of termination of employment' has been interpreted by the courts in several cases.

Of note are the decisions made by 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).

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 my opinion necessary that the termination of the services should be the dominant cause of the payment.

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 FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; 2002 ATC 4907; (2002) 51 ATR 39 (Le Grand), the issue before the 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.

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 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.

Paragraph 31 of TR 2003/13 the Commissioner states:

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 from the termination of employment, the payment will be made in consequence of the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135.

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.

In the present case, the employee was employed by the Employer.

The employee lodged a complaint with the Employer and made allegations relating to bullying and harassment from one of the Employer's managers.

The matter was the subject of investigations by the Employer and recommendations were made by a consultant.

Discussions were held between the Employer and the employee. Both parties agreed without an admission of liability, to settle all employment related claims and bring to an end any liability of the organisation in connection with or related in any way to the subject matter of the employment, termination, health, workplace complaints and any other employment related matter on the terms and conditions set out in the Deed dated in the relevant income year.

Under the Deed the Employer agreed to pay the employee a specified lump sum amount to the employee in the relevant income year.

Furthermore, at a specific clause of the Deed it stated that payment of the specified amount is a full and final legal settlement of all claims the employee may have against the Employer in terms of any ongoing health or personal injury costs, information related claims, and any other damages and claims as outlined in the Deed, and in relation to any workplace complaints, not already specified. It also specified that it was not in relation to employment termination.

When considering the facts of the case it is considered that the payment is not an employment termination payment.

Although the payment is being made in respect of the employee's employment, the payment is not being made as 'in consequence of' any termination of employment. That is, the payment did not follow as an effect or result of the termination of employment.

The causal connection between the termination of the employee's employment and the payment being made were merely temporal. The payment was made as a result of an agreement made between the Employer and the employee and specifically not related to the employment termination (as shown in the Deed).

As payment is not being made in consequence of the employee's termination of employment from the Employer, the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has not been satisfied.

Therefore, the payment is not an employment termination payment as all the requirements as defined in section 82-130 of the ITAA 1997 have not been satisfied.

Pay As You Go withholding system

Part 2-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) relates to the Pay As You Go (PAYG) withholding system.

Payments and other transactions subject to PAYG withholding are called withholding payments. A summary of these payments may be found in subsection 10-5(1) of Schedule 1 to the TAA 1953.

The list includes the following payments:

• a payment of salary or wages to an employee or officeholder

• a compensation, sickness or accident payment.

Division 12 of Schedule 1 to the TAA 1953 relates to payments from which amounts must be withheld.

Section 12-35 of Schedule 1 to the TAA 1953 provides that an entity must withhold an amount from salary, wages, commission, bonuses or allowances it pays to an individual as an employee (whether of that or another entity).

Section 12-120 of Schedule 1 to the TAA 1953 provides that an entity that makes a payment of compensation, or sickness or accident pay to an individual must withhold an amount if the payment is:

• made because of incapacity for work

• calculated at a periodical rate, and

• not a payment made under an insurance policy to the policy owner.

In this case, the lump sum payment is for the full and final legal settlement of all claims of a former employee. The payment was made as a result of an agreement made between the Employer and the employee.

The payment is not a payment for salary, wages, commissions, bonuses or allowances. In addition, the payment is not for compensation, sickness or accident pay as it was paid to settle a legal dispute and was not calculated at a periodical rate.

Accordingly, regardless of whether the payment is assessable to the recipient, there is no obligation for the Employer to withhold tax on the lump sum payment.