Edited version of your written advice

Authorisation Number: 1012698006861

Ruling

Subject: Ex-gratia payment

Question 1

Is the ex-gratia payment received under a Deed of Release made in consequence of the termination of your employment?

Answer:

Yes

Question 2

Is the ex-gratia payment (or any part of the ex-gratia payment) received under a Deed of Release a capital payment made in respect of a personal injury and therefore not an employment termination payment by virtue of paragraph 82-135(i) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: No

Question 3

Is the total amount of the ex-gratia payment a taxable component of an employment termination payment and required to be included in your income tax return?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2014

The scheme commences on

1 July 2013

Relevant facts and circumstances

You commenced employment with a company.

You commenced a period of sick leave due to an incident which took place at the workplace.

You made a WorkCover claim alleging that you were subject to bullying and harassment and that the Company caused or significantly contributed to your illness and/or injury.

The WorkCover claim was rejected.

You acknowledged that, given the uncertainty of your recovery, it was unreasonable to expect the Company to hold your position unfilled for an uncertain period of time. As such, you resigned from employment.

Both parties agreed to settle claims and all other employment related issues in the terms contained in a Deed of Release (the Deed).

The Company acknowledged that there was medical evidence which showed that you suffered from a medical illness or condition, however, denied that any such injury, illness or condition had been caused or contributed by the Company, its employees or its work place practices.

The Deed states:

The Employee and the Company have agreed to settle all issues arising out of the Employment, Allegation and the Resignation on the terms set out in this Deed.

Without any admission of liability, and on a "without prejudice" basis, the Company will pay to the Employee, a sum of money to be taxed in accordance with the relevant legislation (Settlement Sum).

The Employee hereby releases and forever discharges the Company, its directors, officers etc. arising out of or in connection with:

(i) the Allegation

(ii) the Employment;

(iii) the Resignation;

You have reached preservation age.

The ex-gratia payment received was an un-dissected lump sum.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 27A(1).

Income Tax Assessment Act 1997 Section 995-1

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(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 Paragraph 82-135(i)

Reasons for decision

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.

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

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

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

• reasonable capital payments for personal injury.

To determine if the ex-gratia payment constitutes an employment termination payment, all the conditions in section 82-130 of the ITAA 1997 must 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.

Payment is made in consequence of the termination of your employment

The first condition that needs to be met for a payment to be treated as an employment termination payment is that the payment is made in consequence of the termination of employment of the taxpayer (subparagraph 82-130(1)(a)(i)).

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Whilst the courts have divergent views on the meaning of this 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 Income tax: eligible termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase in consequence of.

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. Eligible termination payments ceased to exist from 1 July 2007, being replaced by employment termination payments.

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 (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation (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, in Reseck, 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 (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.

The Full Federal Court in Dibb v Federal Commissioner of Taxation, 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 of the ITAA 1997.

In this case, you were an employee of the Company and commenced a period of sick leave due to an incident which took place at the workplace.

You made a WorkCover claim and allegations that bullying and harassment in the workplace caused or significantly contributed to your illness and/or injury. The WorkCover claim was rejected.

You acknowledged that, given the uncertainty of your recovery, it was unreasonable to expect the Company to hold your position unfilled for an uncertain period of time. As such, you resigned from employment.

Although the Company acknowledged that there was medical evidence which showed that you suffered from a medical illness or condition they denied that any such injury, illness or condition had been caused or contributed by the Company, its employees or its work place practices.

Further discussions were held, with neither party deterring from their beliefs. However, both parties agreed to resolve the matter and settle all issues arising out of the Employment, Allegation and the Resignation on the terms set out in the Deed of Release (the Deed).

The Deed states:

The Employee and the Company have agreed to settle all issues arising out of the Employment, Allegation and the Resignation on the terms set out in this Deed.

Without any admission of liability, and on a "without prejudice" basis, the Company will pay to the Employee, a sum of money to be taxed in accordance with the relevant legislation (Settlement Sum).

The Employee hereby releases and forever discharges the Company, its directors, officers etc. arising out of or in connection with:

(i) the Allegation

(ii) the Employment;

(iii) the Resignation;

The above shows you agreed to settle all issues arising out of or in connection with the allegation and employment. This included the resignation of your employment and the employer's agreeing to pay your client an ex-gratia payment to settle all issues, subject to the terms and conditions set out in the Deed.

It is considered that the ex-gratia payment was made to you 'in consequence of' the termination of employment. Although claims were brought by you against the employer, there is still a causal connection between the termination and the payment. The dispute, the termination and the payment are all intertwined and connected. Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

The payment is received no later than 12 months after termination

The second condition for the payment to meet the criteria as an employment termination payment is that the payment must be received within 12 months of the termination of employment (paragraph 82-130(1)(b) of the ITAA 1997).

In your case, this condition has been satisfied as you ceased employment and the ex-gratia payment was made to you within 12 months.

In view of the above, the final requirement for the payment to be an ETP is that the payment is not a payment mentioned in section 82-135 of the ITAA 1997.

Exclusions from being an employment termination payment

Certain payments made on termination of employment are excluded from being an employment termination payment under section 82-135 of the ITAA 1997.

In this case, consideration must be given as to whether the personal injury you suffered is covered by the specific exemption for personal injury in paragraph 82-135(i) of the ITAA 1997 (payments that are not employment termination payments).

Paragraph 82-135(i) states that employment termination payments do not include:

a capital payment for, or in respect of, personal injury to you so far as the payment is reasonable having regard to the nature of the personal injury and its likely effect on your capacity to derive income from personal exertion (within the meaning of the definition of income derived from personal exertion in subsection 6(1) of the Income Tax Assessment Act 1936);

This exclusion is for a payment or benefit that compensates or reimburses a person for or in respect of the particular injury.

In Commissioner of Taxation (Cth) v. Scully (Scully) the High Court, in considering former paragraph (n) of the definition of an eligible termination payment (ETP) in former subsection 27A(1) of the ITAA 1936 (former paragraph (n)),held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In considering the meaning of personal injury for the purposes of the former paragraph (n) exclusion, the Administrative Appeals Tribunal (AAT) has cited the decision by the Victorian Supreme Court in Graham v Robinson (Graham v. Robinson), in AAT Case 11,722, McMahon v Commissioner of Taxation (Cth) (McMahon) and, more recently, in Re Applicant and Federal Commissioner of Taxation, and held that personal injury does not extend beyond physical injury or mental illness.

The Victorian Supreme Court had to decide if emotional hurt (that is, hurt, distress, public scandal, hatred, odium, ridicule and contempt) was a personal injury in its decision in Graham v. Robinson, where 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 there are three types of injury a person can receive:

(a) behavioural injury - one that involves physical injury (internal and/or external) and/or mental injury that is clearly discernible to a qualified medical practitioner;

(b) non-behavioural injury - hurt, distress, anxiety, et cetera., that flows from the death of, or serious injury to, a relative or close friend; wrongful dismissal; defamation; et cetera. This type of injury may have legal remedies under the law of torts (for example, defamation, slander), statute (for example, sexual harassment, discrimination), or contract (for example, employment, professional negligence); and

(c) property injury - damage to a person's property.

Notwithstanding it may be said all three types of injury may be personal, it is considered only the first type (that is, behavioural injury) falls within the meaning of the term personal injury as used in the paragraph (n) exclusion.

The decision in Graham v. Robinson was applied in McMahon in relation to a payment for alleged damage to a taxpayers reputation. In McMahon, 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:

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 taxpayers 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.

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 an ETP by virtue of paragraph (n), there must be a behavioural type personal injury.

From 1 July 2007, paragraph (n) has been replaced by subsection 82-135(i) of the ITAA 1997. However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 stated, in relation to section 82-135 of the ITAA 1997, that:

consistent with current legislation, certain payments are prevented from qualifying as employment termination payments.

It is therefore appropriate to cite cases that refer to the previous legislation.

The payment in Scully was held not to be in respect of personal injury. Acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stated in their joint decision:

In our opinion, the payment in this case cannot be characterised as consideration... in respect of, personal injury. The fact that the payment is not calculated by reference to the nature and extent of the injury or likely loss to the respondent and the fact that the other benefits are similar to that for total and permanent disablement point inevitably to the conclusion that the payment was consideration... for, or in respect of the respondent's termination of employment and her rights under the Trust Deed and was not consideration... for, or in respect of her injury.

Accordingly, for an amount to meet the definition in subsection 82-135(i) of the ITAA 1997, the payment must be for personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In your case, though the Company acknowledged there was medical evidence showing that you suffered from medical illnesses, the Company denied that any such injury, illness or condition had been caused or contributed to by the Company, its employees or its work place practices.

Under the terms of the Deed, the Company agreed, without admission of liability, to make an ex-gratia payment to you and you agreed to release the employer from all claims and liability arising out of or in connection with the employment and the cessation of your employment.

It follows, even if the bullying and harassment claimed by you amount to 'personal injury', there is no evidence to indicate that any part of the payment was calculated with regard to the nature and extent of your injury.

The ex-gratia payment is a single un-dissected lump sum payment which bears no relation to a capital payment for, or in respect of, personal injury to you.

Further, there is nothing to indicate that any part of the settlement sum has been calculated with regard to your likely loss of income producing capacity. Rather, the payment was simply made in full resolution of claims arising from or in relation to the dispute, the employment, the termination and any act or omission of the Company during your employment.

Accordingly, it is considered that the ex-gratia payment was made to settle all matters and claims arising out of, or in connection with, your employment and for the cessation of your employment. The payment was not made in respect of your illness or any personal injury.

In view of the above, paragraph 82-130(1)(c) of the ITAA 1997 is satisfied as the exclusion under paragraph 82-135(i) does not apply to the ex-gratia payment.

Consequently, the ex-gratia payment satisfies all the requirements in section 82-130 of the ITAA 1997 to be considered an employment termination payment.

Tax treatment of an employment termination payment

The ex-gratia payment is an employment termination payment as defined under subsection 82-130(1) of the ITAA 1997.

As the payment is under the ETP cap of $180,000 for the 2013-14 income year, and you have reached preservation age, you are entitled to a tax offset that ensures that the rate of income tax on the amount does not exceed 15% (subsection 82-10(3) of the ITAA 1997). In addition, the Medicare levy may apply.