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Ruling

Subject: Employment termination payment

Question 1

Does the payment amount of $X (the Payment) paid to the Taxpayer qualify as an employment termination payment (ETP) under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does the Payment include an invalidity segment under section 82-150 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

Income year ended 30 June 2014

The scheme commenced on:

1 July 2013

Relevant facts and circumstances

The Taxpayer is a professional who holds qualifications in engineering and finance.

In 2008, the Taxpayer commenced employment with the Employer.

Some months later, the Taxpayer contracted an infection which led to a serious medical condition.

In 2009, the Taxpayer commenced treatment with a medical practitioner who is a specialist (the Specialist) dealing with the medical condition suffered by the Taxpayer.

In mid-2009, the Taxpayer's condition deteriorated and the Employer agreed to a flexible part-time arrangement with the Taxpayer. In this period of part-time employment, the Taxpayer underwent an operation for an injury.

In 2012, the Taxpayer started to see a medical practitioner (the General Practitioner), in addition to the Specialist, for the treatment of their medical condition.

In mid-2011, some of the Taxpayer's symptoms subsided. However, in mid June 2013, stress related to issues with a senior employee resulted in a relapse of the symptoms, resulting in a significant amount of sick leave taken by the Taxpayer. Also during that time, the Taxpayer underwent a series of follow-up operations in respect of their injury.

The Taxpayer's employment was terminated in early 2014 on terms agreed by the Taxpayer and the Employer and set out in the Separation Deed (the Deed).

The Deed states that employment was terminated 'on grounds of redundancy' and sets out the terms and conditions of the termination and the amounts to be paid to the Taxpayer.

In accordance with the Deed, the parties are required to keep the terms and conditions of the Deed, as well as circumstances leading to the Deed, strictly confidential. In particular, it states that the Taxpayer's agreement to confidentiality is a significant element of the consideration for the payment to the Taxpayer. To this effect, the reason for the Taxpayer's termination to be given by the Taxpayer to their colleagues in a departure announcement was as 'spending time with family and rehabilitation of the injury'.

It is asserted that the departure announcement was necessary because of the sensitivity of the Taxpayer's condition and senior position and is not, in fact, the reason for the termination of the Taxpayer's employment. The Taxpayer's employment was, in fact, terminated because the Taxpayer was not able to perform the duties required in their position and because the Employer did not have another position which was less mentally demanding.

It is stated that since the Taxpayer's relapse, the symptoms associated with their medical condition have not subsided and this has significantly handicapped their ability to commence employment in their field of qualification and experience.

A medical report provided by the Specialist documenting the Taxpayer's illness states that the Taxpayer's condition had worsened in 2013 and the Taxpayer ultimately accepted a redundancy. It further states that the Taxpayer had not been able to resume any form of employment in the last six months and that the workplace with long hours, high demand and stress was a significant contribution to the Taxpayer's condition and the Taxpayer should not return to a similar work role:

The Specialist subsequently amended their previous medical report to add that due to the Taxpayer's condition, it is unlikely that the Taxpayer will ever be gainfully employed in a capacity for which they are reasonably qualified because of their education, experience or training.

The medical report provided by the General Practitioner documenting the Taxpayer's condition stated that the Taxpayer's condition worsened in the high demand job and the Taxpayer ultimately took a redundancy. The doctor was of the opinion that the Taxpayer should return to work in a less demanding role once their medical condition resolves.

A third medical practitioner provided a report stating that due to the Taxpayer's condition, it is unlikely that the Taxpayer will ever be gainfully employed in a capacity for which they are reasonably qualified because of their education, experience or training. It states that flexible, part-time work in a less demanding position should be sought by the Taxpayer instead.

A PAYG payment summary - employment termination payment issued to the Taxpayer indicates that the Payment was made to the Taxpayer soon after their termination in the 2013-14 income year.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 27G
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 section 82-150

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

Income Tax Assessment Act 1997 paragraph 82-150(1)(a)

Income Tax Assessment Act 1997 paragraph 82-150(1)(b)

Income Tax Assessment Act 1997 paragraph 82-150(1)(d)

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Act 1997 section 83-170

Income Tax Assessment Act 1997 subsection 83-170(3)

Income Tax Assessment Act 1997 section 83-175

Reasons for decision

Summary

The payment made to the Taxpayer by the Employer qualifies as an ETP under section 82-130 of the ITAA 1997.

Detailed reasoning

Employment termination payments

Subsection 82-130(1) of the ITAA 1997 states:

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.

All three requirements must be satisfied in order for the payment to be treated as an ETP.

For a payment to qualify an ETP, the first condition that must be met is that the payment is received 'in consequence of' the termination of the Taxpayer's employment.

The phrase 'in consequence of' is not defined in the ITAA 1997. However, the words have been interpreted by the courts in several cases. In light of these decisions, the Commissioner discusses the meaning of the phrase 'in consequence of' in the context of the expression 'in consequence of the termination of any employment' (as used in Subdivisions A and AA of Division 2 of Part III of the Income Tax Assessment Act 1936) in Taxation Ruling TR 2003/13 (TR 2003/13).

While TR 2003/13 contains references to repealed provisions, some of which may have been rewritten, the ruling still has effect. At paragraphs 5 and 6 of TR 2003/13, the Commissioner states:

5. The phrase 'in consequence of' is not defined in the ITAA 1936. However, the words have been interpreted by the courts in several cases. Whilst there are divergent views as to the correct interpretation of the phrase, the Commissioner considers that 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.

6. The phrase requires 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.

In this case, the Taxpayer's employment was terminated and, as a result, the Taxpayer was paid a termination payment. Therefore, it can be said that, but for the termination, the payment would not have been made to the Taxpayer. Consequently, the payment is considered to be received by the Taxpayer in consequence of the termination of the Taxpayer's employment with the Employer.

The Payment was received less than 12 months after the termination of the Taxpayer's employment and it does not fall under the type listed in section 82-135 of the ITAA 1997.

Consequently, the payment satisfies the definition in section 82-130 of the ITAA 1997 and is an ETP for the purposes of that section.

Question 2

Summary

The Taxpayer's employment was terminated on grounds of redundancy and not because of ill-health. Therefore, the payment does not include an invalidity segment as defined in section 82-150 of the ITAA 1997.

Detailed reasoning

Meaning of 'invalidity segment'

In accordance with subsection 82-150(1) of the ITAA 1997, an ETP 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 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.

Subsection 995-1(1) of the ITAA 1997 defines gainfully employed as follows:

gainfully employed means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment.

In this case, as stated above, the Payment was received by the Taxpayer as a result of the termination of their employment with the Employer. As such, it is accepted that the Payment was made to the Taxpayer because they stopped being gainfully employed for the purposes of paragraph 82-150(1)(a) of the ITAA 1997.

Paragraph 82-150(1)(b) of the ITAA 1997 requires that the termination of employment resulted from the Taxpayer's ill-health. That is, the ill-health was the immediate cause for the termination of the Taxpayer's employment.

When characterising a particular payment for income tax purposes, and where, as here, there is an agreement between the parties which sets out the terms, conditions and circumstances under which the payment is made, the reason or reasons for the payment are determined by that agreement. Thus, in this case, the reason for the Payment is to be determined with reference to the Deed.

Whilst it is accepted that the Taxpayer had suffered from ill-health while employed by the Employer, the Deed clearly states that the Taxpayer's employment was terminated 'on the grounds of redundancy'. Although this statement conflicts with the Taxpayer's statement to colleagues on the reasons for the departure, the conflict may be resolved with reference to the confidentiality clauses that prevent the parties to the Deed from disclosing the terms and conditions of the Deed, including the circumstances leading up to the Deed.

Therefore, it is considered that the Taxpayer did not stop being gainfully employed because they suffered from ill-health but because their position was made redundant. As such, the requirement of paragraph 82-150(1)(b) of the ITAA 1997 is not satisfied.

As the condition under paragraph 82-150(1)(b) of the ITAA 1997 is not met, the remaining conditions of section 82-150 of the ITAA 1997 do not need to be considered.

Even if it may be argued that the reason the Taxpayer stopped being gainfully employed was the injury suffered by the Taxpayer (as stated in the departure announcement), the payment would fail paragraph 82-150(d) of the ITAA 1997 because the certificates provided by the medical practitioners specifically refer to the medical condition and not to the injury.

In addition, the reports provided by two medical practitioners indicate that, as far as the medical condition is concerned, the Taxpayer can undertake alternative employment in a reduced capacity. As such, it cannot be said that the Taxpayer is unlikely to ever be gainfully employed in a capacity for which they are reasonably qualified because of education, experience or training.

The Explanatory Memorandum to the Taxation Laws Amendment (Superannuation) Bill 1992 (EM) which amended former section 27G of the Income Tax Assessment Act 1936 (the immediate predecessor of section 82-150 of the ITAA 1997) confirms this. In explaining the test for invalidity, the EM states:

The invalidity payment concession is extended only to people who are unable to undertake any form of employment for which they are reasonably qualified. A person who is unable to continue his or her current employment, but is able to undertake other appropriate employment, will not have access to the concession.

Therefore, the payment received by the Taxpayer on termination of their employment with the Employer does not include an invalidity segment as defined in section 82-150 of the ITAA 1997.

Other relevant comments

Where an employee is dismissed from employment because their position is genuinely redundant, section 83-170 of the ITAA 1997 may apply so that so much of the relevant payment that does not exceed the amount worked out under subsection 83-170(3) of the ITAA 1997 is not assessable income and is not exempt income of the employee. That is, it is tax-free.

A payment will be a genuine redundancy payment, if all the conditions set out in section 83-175 of the ITAA 1997 are met.