Edited version of your written advice

Authorisation Number: 1012930056198

Date of advice: 18 December 2015

Ruling

Subject: Employment termination payment

Question

Is the settlement payment received by the Taxpayer an employment termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following period

Income year ended 30 June 20YY

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

The Taxpayer was employed with the Employer, and has provided the latest Employment Contract (the Contract) with the Employer.

The Contract stated that the Taxpayer was to be employed for a specific period.

In a letter the Employer advised the Taxpayer that their employment was terminated as a result of findings resulting from certain allegations.

The Taxpayer commenced legal action against the Employer for unfair dismissal.

The Taxpayer has provided the legal advice they received in order to pursue any legal action in the event they considered their employment to be terminated on the grounds of unfair dismissal. The legal advice was in response to the Taxpayer having to show cause to their employer why they should not be dismissed.

A financial settlement between the Taxpayer and the Employer was achieved, and a Deed of Settlement and Release was executed stating that one portion of the payment was taxed at the highest marginal rate.

The Taxpayer has confirmed that a portion of the settlement was received in compensation for wrongful dismissal, and that none of this amount is attributable towards compensating them for lost income.

The Employer in settling the matter has included the Taxpayer's legal bills incurred prior to the termination date.

The Taxpayer stated that the settlement was incorrectly taxed.

The Taxpayer provided a copy of the payments made to them on the termination of their employment and a PAYG Payment Summary - which the Taxpayer contends incorrectly, classified the payment.

The payment is not classified as a genuine redundancy payment or an early retirement scheme payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 82-135

Reasons for decision

Summary

The settlement payment received by the Taxpayer is not an employment termination payment (ETP).

Employment termination payment

A payment made to an employee is an employment termination payment (ETP) if it satisfies all the conditions set out in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997).  This section states:

(1) 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.

(4) Paragraph (1)(b) does not apply to you if:

(a)  you are covered by a determination under subsection (5) or (7); or

(b)  the payment is a * genuine redundancy payment or an * early retirement scheme payment.

Note: The part of a genuine redundancy payment or an early retirement scheme payment worked out under section 83-170 is not an employment termination payment: see section 82-135.

(5) The Commissioner may determine, in writing, that paragraph (1)(b) does not apply to you 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;

(d)  any other relevant circumstances.

To determine if a 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 conditions under subsection 82-130(1) of the ITAA 1997 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

For a payment to be treated as an employment termination payment, the first condition that needs to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer (see subparagraph 82 130(1)(a)(i) of the ITAA 1997).

The phrase in consequence of is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Taking into account the courts decisions 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 (TR 2003/13).

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.

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 [2002] 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 employment termination payment. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an employment termination payment.

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'.

Therefore 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.

Furthermore, in paragraph 13 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.

In this case, the Taxpayer made an application for a legal remedy alleging they were unfairly dismissed by their Employer.

Discussions were held between the Taxpayer and their Employer and the matter was settled. A Deed of Settlement and Release (the Deed) was signed by the Taxpayer and the Employer.

The Deed states that the Employer would make a payment to the Taxpayer in full and final settlement of the Claim.

The payment made to the Taxpayer arose as a result of the termination of their employment with the Employer. The Taxpayer stated in their ruling application that the payment was made to them was paid on a commercial basis to settle a legal dispute and as such should be treated as an ETP. As the Deed states that the payment was made to release the Employer from any claims connected with the employment or termination of employment, the gross payment made to the Taxpayer is 'in consequence of' the termination of their employment with the Employer.

As the payment was made in consequence of the termination of the Taxpayer's employment with the Employer, the first condition under paragraph 82-130(1)(a) of the ITAA 1997 has been satisfied.

Payment is received no later than 12 months after termination

In this case, the Taxpayer's claim for legal remedy was not reached within 12 months of their termination.

Therefore, as the compensation payment was made 12 months after the termination date this condition is not satisfied.

Determination under section 82-130(7) of the ITAA 1997

The Commissioner can make a legislative determination that paragraph 82-170(1)(b) does not apply to either or both of the following:

(a) a class of payments;

(b) a class of recipients of payments.

The Commissioner in November 2007, released Employment Termination Payments (12 month rule) Legislative Instrument which further expands on paragraph 82-130(1)(b) of the ITAA 1997. It states at paragraph 4:

Paragraph 82-130(1)(b) of the ITAA 1997 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:

(a) legal action was commenced within 12 months of the termination of employment, of which the subject is either or both:

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

(ii) the amount of the person's entitlement; or

(b) the payment was made by a liquidator, receiver or trustee in bankruptcy of an entity that is otherwise liable to make the payment, where that liquidator, receiver or trustee is appointed no later than 12 months after the termination of employment.

In this case, the Taxpayer has indicated that they commenced negotiations, and engaged a legal team within the week of receiving their show cause letter from the Employer. The Taxpayer advises that the Employer decided not to hold any further negotiation meetings and moved to terminate the Taxpayer. It is at this point the Taxpayer advises that they immediately commenced legal proceedings.

The Taxpayer advises that legal argument went on for a very long and protracted time and they ended up filing for a court hearing, and that this action finally brought the Council to the compulsory negotiation table and then settle. The Taxpayer has advised of only one application being lodged, and that was not within 12 months of their employment being terminated.

The Taxpayer advises that with hindsight they would have immediately filed for a court hearing and pushed the issue much faster as the Employer continued to delay as much as possible.

There appears to be no extenuating circumstances as to why your client lodged their application more than 15 months after their employment was terminated. The fact that the Employer in settling the matter has included the Taxpayer's legal bills incurred prior to the termination date does not prove that litigation was initiated within 12 months of the termination date.

Therefore, this condition is not satisfied.

Payment is not a payment mentioned under section 82-135 ITAA 1997

Section 82-135 of the ITAA 1997 provides a list of certain payments that the Commissioner deems not to be employment termination payments. The payment was made to the Taxpayer as a settlement payment under the Deed. Under section 82-135 ITAA 1997 the payment made to the Taxpayer does not fall within the list.

Therefore, this condition is satisfied.

Conclusion

The payment is not an employment termination payment.

As the payment consists wholly of a taxable component, the entire payment will form part of the Taxpayer's assessable income for the 20XX-YY income year.