Edited version of your written advice

Authorisation Number: 1012891571692

Date of advice: 12 October 2015

Ruling

Subject: Lump sum payment

Question 1

Is any part of the payment made to a former employee in settlement of legal proceedings brought against the former employer, considered to be an employment termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Question 2

Are there any tax implications in relation to the components of the gross settlement that represent the back payment of wages and compensation for loss suffered by the former employee because of the former employer's actions related to the termination of the former employee's employment?

Question 3

Are you entitled to a deduction for any part of the payment made to a former employee in settlement of legal proceedings under section 8-1 of the ITAA 1997?

Answers

1. Yes.

2. Yes.

3. Yes.

This ruling applies for the following period:

Year ending 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

The former employee commenced employment with the former employer in the 20WW-XX income year.

The former employee's employment with the former employer was terminated in the 20YY-ZZ income year.

The former employee's dismissal was not caused by reason of redundancy.

The former employee commenced proceedings for unfair dismissal within several months of their employment being terminated.

The former employee and the relevant parties agreed to resolve the Proceedings in the 20AA-BB income year.

The former employee and relevant parties executed a Deed of Settlement and Release (the Deed).

As per the Deed, it was agreed to that a net settlement sum would be paid to the former employee in the 20AA-BB income year. The gross settlement sum was made up of component relating to the former employee's termination of employment and a sum for the back payment of wages underpaid including interest.

The former employee has not recommenced employment with the former employer.

The former employee is less than 60 years old and has not reached their preservation age in the relevant income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 82-135

Reasons for decision

Summary

All the component sums of the gross settlement sum, except the component for the back payment of wages, were received 'in consequence' of the termination of the former employee's employment.

The back payment of wages component is not an employment termination payment.

All the components of the gross settlement sum represent expenses incurred in gaining or producing assessable income and accordingly are allowable deductions to the former employer.

Detailed reasoning

Question 1

Employment termination payment

A payment is an employment termination payment if it satisfies all the requirements in section 82-130 of the ITAA 1997 and is not specifically excluded under section 82-135.

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.

Section 82-135 of the ITAA 1997 provides that certain payments are not employer termination payments. These include (among others):

• superannuation benefits

• unused annual leave or long service leave payments

• foreign termination payments covered under Subdivision 83-D of the ITAA 1997 and

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

Based on the information provided, the former employee's employment terminated in the 20YY-ZZ income year.

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' (TR 2003/13) states that:

5. ...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 payment received by the former employee was in settlement of legal proceedings brought against their former employer. The former employee successfully instigated court proceedings against their former employer, seeking payment of their employment entitlements, on the basis that they had been unfairly dismissed.

Paragraph 31 of TR 2003/13 states:

31. 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 former employee's payment under the Deed (except for the component relating to the back payment of wages) was made in consequence of the termination of their employment with their former employer. There is a clear causal connection between the termination of their employment and the payment made under the Deed. The lump sum was paid 'in consequence' of the termination of employment as defined in subparagraph 82-130(1)(a)(i) of the ITAA 1997.

Paragraph 82-130(1)(b) of the ITAA 1997 also requires the payment to be received within 12 months of the termination. The former employee's employment ended on 8 March 2012 and payment was made to the former employee on or about 6 August 2015. However, as per paragraph 82-130(4) of the ITAA 1997, the '12 month rule' under paragraph 82-130(1)(b) will not apply if:

• the individual is covered by a determination under subsection (5) or (7); or

• the payment is a genuine redundancy payment or an early retirement scheme payment.

The Commissioner has determined in Employment Termination Payments (12 month rule) Determination 2007 (the Determination), which is made under subsection 82-130(7) of the ITAA 1997, that paragraph 82-130(1)(b) does not apply to a late termination payment if the payment is received more than 12 months after the termination of a person's employment because of legal action commenced within 12 months of the termination of employment, of which the subject is either or both, the person's entitlement to the payment, or the amount of the person's entitlement.

In this case, the Determination applies as the former employee's employment ended and court proceedings commenced in the same calendar year. Accordingly, the payment is exempt from the 12 month rule found in paragraph 82-130(1)(b) of the ITAA 1997.

Further, the settlement sum received by the former employee is not a payment excluded from being an employment termination payment under section 82-135 of the ITAA 1997.

In view of the above and the facts provided, all the component sums of the gross settlement, except the component for the back payment of wages, satisfy the relevant conditions in section 82-130 of the ITAA 1997 to be treated as an employment termination payment.

The sum for the back payment of wages is not an employment termination payment as it is considered the back payment was not contingent on the former employee's termination of employment but rather payment for work performed by the former employee.

Question 2

Taxation

As explained above, the component sum related to the termination of the former employee's employment, including interest, forms part of the employment termination payment.

As the former employee is under their preservation age in the income year in which they received the payment, it is subject to tax at the rate of 32%.

The amount received for the back payment of salary and wages is not considered to be an employment termination payment. To determine the amount of withholding please refer to:
https://www.ato.gov.au/Rates/Schedule-5---Tax-table-for-back-payments-commissions-bonuses-and-similar-payments/.

Question 3

General deductions

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

• it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478);

• there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47); and

• it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

In this case, the expenses were all incurred in gaining or producing assessable income of the former employer. Therefore, they are deductible under section 8 -1 of the ITAA 1997.