Edited version of your written advice

Authorisation Number: 1012934981436

Date of advice: 12 January 2016

Ruling

Subject: Employment termination payment

Question

Is the ex-gratia payment made to you an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You commenced employment with the Employer many years ago.

During the relevant income year, your employment was terminated on the same date that an Agreement was signed between you and the Employer under the Anti-Discrimination Act 1998 at the Anti-Discrimination office.

You state the Agreement was preceded by your complaint to the Anti-Discrimination Commissioner. This complaint regarding discrimination during your employment was accepted for investigation.

The parties to the Agreement were you, the Employer and another employee of the Employer (the Employee).

The Agreement stated in part that:

End of employment relationship

• as of the date of signing the Agreement you would no longer be employed by the Employer.

Payment

• the Employer would pay you the amount of $[amount], taxed according to law, which comprises the following:

Payment of X weeks' wages in lieu of notice $[amount]

Accrued long service leave $[amount]

Ex-gratia payment $[amount]

• The dollar amount specified the Agreement would be paid to you within a week of the Agreement being signed by the parties.

Statement of service

• The Employer would provide you a statement of service setting set out your length of service with the Employer, the roles you had with the Employer, the duties you performed in those roles, and that you resigned from your employment.

Release from liability

• On the Employer complying with the relevant paragraphs of the Agreement, you would release and forever discharge the Employer and the Employee from any liability past, present or future from all claims, suits, demands, actions or proceedings arising out of or connected with your employment with the Employer.

• On your complying with the relevant paragraph of the Agreement, the Employer and the Employee would release and forever discharge you from any liability past, present or future from all claims, suits, demands, actions or proceedings arising out of or connected with the your employment with the Employer.

• You agreed that compliance by the Employer and the Employee with the Agreement constitutes a full and final settlement of your complaint under the Act made to the Anti-Discrimination Commissioner and that the parties understood that this would result in the complaint being finalised by the Commissioner.

A pay slip dated several days after your termination of employment shows in part:

Leave Payment

Long Service Leave $[amount]

Lump Sum Payment

ETP Taxable (Post June 83) $[amount]

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 82-10(3)

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 82-135

Reasons for decision

Summary

The ex-gratia payment is a taxable component of an employment termination payment to be included in your assessable income for the relevant income year.

Detailed reasoning

Employment termination payment

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.

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.

To determine if the ex-gratia payment constitutes an employment termination payment, the following examination has been made to determine whether all the relevant conditions in section 82-130 of the ITAA 1997 have been satisfied.

Paid as a consequence of the termination of your employment

The phrase 'in consequence of the termination of your employment' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

In Taxation Ruling TR 2003/13 the Commissioner has considered the meaning of the phrase 'in consequence of'.

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) 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 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. 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'.

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.

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 the facts of this case, you were employed with the Employer many years until your resignation in the relevant income year.

In the Agreement signed on the date of resignation, it was agreed between both parties of the cessation of your employment with the Employer, and a settlement of all claims whatsoever arising out of, and in connection with, your employment and resignation.

Subject to the terms and conditions under the Agreement, the Employer agreed to pay you (less tax withheld):

Payment of X weeks' wages in lieu of notice $[amount]

Accrued long service leave $[amount]

Ex-gratia payment $[amount]

The Agreement stated the payment of these amounts would release and forever discharge the Employer from any liability and claims arising out of or connected to the employment. The payment of the amounts was also contingent on your resignation from employment with the Employer.

The facts provided show that the ex-gratia payment is made 'in consequence of the termination of employment'. The termination and the payment are intertwined and connected, and the payment would not have been made but for the termination of employment. 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 be an employment termination payment is that it must be received within 12 months of the termination of employment, (paragraph 82-130(1)(b) of the ITAA 1997), unless you are covered by a determination exempting you from the 12 month rule.

In your case, the payment was paid within a week following your termination from employment. Therefore, the ex-gratia payment satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997.

The final requirement under paragraph 82-130(1)(c) of the ITAA 1997 is that the payment is not a payment mentioned in section 82-135.

Exclusions under section 82-135 of the ITAA 1997

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

_ 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.

In this case, consideration must be given as to whether paragraph 82-135(i) of the ITAA 1997 will exclude the payment from being an employment termination payment. 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 the taxpayer for or in respect of a particular injury.

In Commissioner of Taxation (Cth) v. Scully (2000) 201 CLR 148; [2000] HCA 6; (2000) 2000 ATC 4111; (2000) 43 ATR 718 (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 Income Tax Assessment Act 1936 (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.

The Administrative Appeals Tribunal (AAT) considered the meaning of personal injury for the purposes of the former paragraph (n) exclusion in AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258, McMahon v Commissioner of Taxation (Cth) [1999] AATA 5; (1999) 41 ATR 1056; (1999) 99 ATC 2025 (McMahon) and, more recently, in Re Applicant and Federal Commissioner of Taxation [2005] AATA 583; (2005) 2005 ATC 162; [2006] ALMD 8399; (2005) 59 ATR 1161. In these cases, the decision by the Victorian Supreme Court in Graham v Robinson [1992] 1 VR 279 (Graham v. Robinson) was cited and in each case it was held that personal injury does not extend beyond physical injury or mental illness.

In Graham v. Robinson 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 that case 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 former paragraph (n) exclusion.

The decision in Graham v. Robinson was applied in McMahon in relation to a payment for alleged damage to a taxpayer's 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:

26 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.

27 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 former paragraph (n), there must be a behavioural type personal injury.

From 1 July 2007, former paragraph (n) was replaced by paragraph 82-135(i) of the ITAA 1997 (the new provision).

Whilst the wording of the new provision differs slightly from the wording contained in former paragraph (n), the operation of the new provision remains the same. This is illustrated by the following statement made in the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006, in relation to section 82-135 of the ITAA 1997:

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

Further, section 1-3 of the ITAA 1997 states:

(1) This Act contains provisions of the Income Tax Assessment Act 1936 in a rewritten form.

(2) If:

(a) that Act expressed an idea in a particular form of words; and

(b) this Act appears to have expressed the same idea in a different form of words in order to use a clearer or simpler style;

the ideas are not to be taken to be different just because different forms of words were used.

In light of the foregoing it is clear that cases that refer to the previous legislation can be cited with approval in relation to the new provisions.

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.

From the foregoing it is apparent that for an amount to be excluded under paragraph 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 this case, you were in receipt of the ex-gratia payment. You agreed to the terms and conditions set out in the Agreement to settle all claims which you have or may have had against the Employer in connection with, or relating to, the employment and the resignation on the terms set out in the Agreement.

The amount made to you is a single undissected lump sum payment and was not calculated by reference to the nature and extent of injuries or its likely effect on your capacity to derive income from personal exertion. No consideration was given to injuries in determining the level of payment. In other words, the payment was to settle all claims you may have had against the Employer and terminate employment, rather than to compensate for injuries and any subsequent loss of earning capacity.

The payment is clearly not for, or in respect of, personal injury.

Therefore, as paragraph 82-135(i) of the ITAA 1997 does not apply, the requirement in paragraph 82-130(1)(c) is satisfied.

Consequently, the ex-gratia payment is considered to be an employment termination payment as the payment satisfies all the requirements in section 82-130 of the ITAA 1997, and is not specifically excluded under section 82-135.

Tax treatment of an employment termination payment

An employment termination payment may comprise of the following components:

_ Tax fee component - this includes the post-June 1994 invalidity or pre-July 83 component (if any); and

_ Taxable component - the amount remaining after deducting the tax free component from the total payment.

In your case, as the period of employment to which the payment relates commenced after 1 July 1983, the payment does not have a pre-July 83 segment.

In addition, as the payment was not made by reason of you ceasing gainful employment as a result of suffering from ill-health, there is no invalidity segment for the purposes of section 82-150 of the ITAA 1997.

Accordingly, the ex-gratia payment is a taxable component of an employment termination payment to be included in your assessable income for the relevant income year.

As you were under your preservation age when the payment was made, and the payment is under the employment termination payment cap of $X (for the relevant income year), you are entitled to a tax offset that ensures that the rate of income tax on the ex-gratia amount does not exceed 30% in accordance with subsection 82-10(3) of the ITAA 1997. In addition, the Medicare levy may apply.