Edited version of your written advice

Authorisation Number: 1012866828940

Date of advice: 26 August 2015

Ruling

Subject: Is there an obligation to withhold from payments made to an ex-employee?

Question

Are there any withholding obligations under section 12-85 of Schedule 1 to the Taxation Administration Act 1953 (TAA) in respect of any component of the settlement sum paid to an ex-employee?

Answer

Yes

This ruling applies for the following period

Year ending 30 June 2016

The scheme commenced on

1 July 2015

Relevant facts

The entity (the Employer) is the former employer of the employee).

A dispute arose between the Employer and the Employee. The Employee lodged a formal grievance.

The Employer suspended the Employee on full pay.

The Employer terminated the Employee's employment.

The Employee commenced legal proceedings against the Employer in a Court of Australia.

The Employer and the Employee commenced settlement discussions.

A Deed of Settlement and Release (the Deed) was signed by the Employer and the Employee.

The Deed stipulates that the Employer pay the Employee a settlement sum. This amount is inclusive of taxation, interest and costs, and is comprised of:

(a) for legal costs and disbursements incurred by the Employee

(b) for non-economic loss being compensation in respect of the Employee's loss of self-esteem, injury to feelings, distress, disappointment, hurt, humiliation, embarrassment, loss of personal reputation and loss of enjoyment derived from employment.

(c) for economic loss being compensation in respect of the Employee's loss of professional reputation and consequential loss of ability to earn wages and non-wage based remuneration from their work speciality. This amount is comprised of:

(i) $X for future economic loss; and

(ii) $X for past economic loss.

The Deed stipulates that the Settlement Sum is paid to the Employee as follows:

• 50% of the Settlement Sum will be paid on or before a date; and

• 50% of the Settlement Sum will be paid within seven days of receipt of this private ruling, subject to any withholding obligations.

Assumptions

Nil

Relevant legislative provisions

Taxation Administration Act 1953 Section 12-85 to Schedule 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(4)(a)

Income Tax Assessment Act 1997 Subsection 82-130(5)

Income Tax Assessment Act 1997 Subsection 82-130(7)

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

Income Tax Assessment Act 1997 Section 307-65

Income Tax Assessment Act 1997 Subsection 307-70(1)

Reasons for decision

Summary

No part of the payments made to the employee under the Deed of Settlement and Release is an employment termination payment (ETP) as the payments were paid more than 12 months after cessation of employment, nor is any part of the payments considered a superannuation lump sum. There is however an obligation to withhold from the payments made for economic loss and non-economic loss as those two amounts would have been an ETP had they been paid within 12 months of cessation of employment.

Detailed reasoning

Section 12-85 of Schedule 1 to the Taxation Administration Act 1953 (TAA) states an entity must withhold an amount from any of the following payments it makes to an individual:

(a) A superannuation lump sum;

(b) A payment that is an employment termination payment or would be one except that it is received more than 12 months after termination of employment.

A "superannuation lump sum" is defined under section 307-65 of the ITAA 1997. Section 307-65 of the ITAA 1997 states a superannuation lump sum is a superannuation benefit that is not a superannuation income stream benefit.

A superannuation income stream benefit is defined under subsection 307-70(1) of the ITAA 1997. It states a superannuation income stream benefit is a superannuation benefit specified in the regulations that is paid from a superannuation income stream.

In this case the payments made to the employee were paid by the employer and not from a Superannuation Fund therefore the payments are not a superannuation lump sum.

We will now address whether the amounts paid are considered an employment termination payment.

Employment termination payment

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 the termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135

All of the above three conditions must be satisfied in order for a payment to be treated as an employment termination payment (ETP).

The key issue in this case is the application of the 12 month rule under paragraph 82-130(1)(b) of the ITAA 1997 as the payment is made more than 12 months after the employment termination date.

Paragraph 82-130(4)(a) of the ITAA 1997 states that the 12 month rule will not apply if a person is covered by a determination made by the Commissioner under either subsection 82-130(5) or subsection 82-130(7) of the ITAA 1997.

Subsection 82-130(7) of the ITAA 1997

Under subsection 82-130(7) of the ITAA 1997 the Commissioner of Taxation (the Commissioner) may, by legislative instrument, determine that the 12 month rule does not apply.

SPR 2007/1 is a legislative instrument made by the Commissioner pursuant to subsection 82-130(7) of the ITAA 1997.

This instrument makes a payment received more than 12 months after termination of a person's employment an ETP if the delay in the payment was due to the commencement of legal action concerning either or both:

(a) the person's entitlement to the payment;

(b) the amount of the person's entitlement

and the legal action was commenced within 12 months of the termination of employment.

According to SPR 2007/1, legal action is intended to cover any Court, Tribunal, and other procedures of a judicial or quasi-judicial nature which may result in the payment in consequence of the termination of a person's employment.

In this case, as the Employee did not commence legal action within 12 months of their termination of employment, subsection 82-130(7) of the ITAA 1997 will not apply.

Subsection 82-130(5) of the ITAA 1997 authorises the Commissioner to determine in writing that the '12 month rule' does not apply if the Commissioner considers the time between the employment termination and the payment to be reasonable having regard to the following:

(a) The circumstances of the employment termination, including any dispute in relation to the termination;

(b) The circumstances of the payment;

(c) The circumstances of the person making the payment; and

(d) Any other relevant circumstances.

The Explanatory Memorandum to the Tax Laws Amendment (Simplified Superannuation) Bill 2006, which inserted section 82-130 into the ITAA 1997, provides examples as to when the Commissioner may or may not waive the 12 month rule.

One of the examples is when an administrator is appointed when a company is unable to trade and therefore unable to meet its liabilities. The company is only able to pay the employees after 12 months when the assets are sold. Another example is when legal action is commenced by an employee for unfair dismissal and therefore there is a delay in receiving the payment. In these cases the Commissioner would waive the 12 month rule.

In this case, the employment termination occurred on a certain date. The Employee commenced legal action in the Court against the Employer in relation to the termination of employment over 12 months after termination of employment).

Based on the above, the Commissioner considers that there are no grounds under which to waive the 12 month rule. Therefore, subsection 82-130(5) will not apply to the payment.

As one of the conditions of section 82-130 of the ITAA 1997 has not been satisfied, i.e. the 12 month rule, the payment cannot be an employment termination payment.

However, for completeness, the components of the settlement sum have been examined notwithstanding the failure to meet the 12 month rule.

(a) the amount paid for legal costs and disbursements incurred by the Employee are not an ETP as per Taxation Ruling TR 2012/8. TR 2012/8 states that an amount received in relation to a dispute concerning termination of employment is not an ETP where the amount is identified as relating specifically to the reimbursement of legal costs.

(b) the amount for non-economic loss (compensation in respect of the Employee's loss of self-esteem, injury to feelings, distress, disappointment, hurt, humiliation, embarrassment, loss of personal reputation and loss of enjoyment derived from employment) is considered to be an ETP or forms part of an ETP. This component is not excluded from being an ETP under subsection 82-135(i) of the ITAA 1997 as the payment is not for a physical or mental personal injury.

(c) the amount for economic loss (compensation in respect of the Employee's loss of professional reputation and consequential loss of ability to earn wages and non-wage based remuneration from work as a specialist in their field) is considered to be an ETP or forms part of an ETP.

Therefore, part of the settlement sum would be an ETP but for the failure to satisfy the 12 month rule. Furthermore, the amount paid for the reimbursement of legal costs would nonetheless be precluded from the definition of an ETP.

As the two payments (non-economic loss and the economic loss) would have been an ETP except that they were received more than 12 months after termination of employment the condition under subsection 12-85(b) has been met therefore there is a withholding obligation on those two payments.

Rate of Withholding

Generally, a payment must be made within 12 months of termination to qualify as an ETP. In this case as the payments will be made outside the 12 months of termination of employment none of the concessional treatments afforded to ETPs will apply to these payments.

A payment made outside 12 months is a delayed termination payment, unless the Commissioner has given approval for the payment to be treated as an ETP.

The rate of withholding will depend on whether the employee has provided their TFN. If they have provided their TFN then the employer is obligated to withhold an amount equal to 32% from the payments. If the employee did not provide their TFN 49% must be withheld from the payment (provided they are a resident) and if they are not a resident, 47% must be withheld.