Edited version of your written advice

Authorisation Number: 1013027355876

Date of advice: 9 June 2016

Ruling

Subject: Employment termination payment

Question

1. Is the payment of insurance proceeds from an employer (the Employer) to an employee (the Employee) an employment termination payment (ETP) under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

2. Is any portion of the payment to be paid to the Employee exempt from tax, as an invalidity segment of an ETP, in accordance with section 82-150 of the ITAA 1997?

3. Is the Employer required to withhold tax from the payment of insurance proceeds to the Employee?

Answer

1. Yes.

2. No.

3. Yes.

This ruling applies for the following periods:

Year ended 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

The Employee commenced employment with the Employer during the 20XX-XX income year.

As part of the Employee's Contract of Employment letter during the 20YY-YY income year, the Employee is eligible for cover under the Employer's, Care and Assurance Plan (the Plan). The Plan incorporates a Serious Illness policy, Income Protection Insurance and Death and Total and Permanent Disablement insurance. The Death and Total and & Permanent Disablement insurance (the Policy) is held by the Employer with an insurance company.

Cover under the Policy is usually inside a superannuation vehicle for most staff but senior employees can elect for the insurance to be outside of the fund. The Employee made such, an election.

The Employee suffers from a serious illness which has now reached the stage where the Employee was unable to return to work.

A medical certificate from a medical practitioner during the relevant income year stated that they did not believe the Employee is ever likely to resume work in their own or any other occupation.

A medical certificate from a second medical practitioner during the relevant income year advised that the Employee is unlikely to be able to continue work in their occupation due to excessive cognitive issues and fatigue, which are not able to be improved by retraining or rehabilitation.

A medical report from the second medical practitioner during the relevant income year also advised that the Employee's difficulty with maintaining their work capacity despite the reduction in responsibilities and hours over the last year shows the Employee is not capable of taking on a similar role in another company or a reduced level position.

The Australian Taxation Office requested additional medical certificates from the applicants. However, no additional medical certificates could be provided at this time.

The Employee was assessed by the Insurer and their initial date of disability was during the 20ZZ-ZZ income year.  From that date the Employee received a percentage of their salary under a separate salary continuance policy.  Due to the Employee's illness the Employee was unable to work full time so the Employee moved to less days per week. Under the policy, the insurer provided for a partial disability benefit where it tops up the employee's salary.

The Employee's employment was terminated during the relevant income year.

The Employee received their outstanding entitlements including a gratuitous payment on the termination of employment.

In addition to the payments to be received from Employer, the Employee is also to receive a payment under the Policy.

The Employee made a claim to the Insurer for Total and Permanent Disablement (TPD). According to a clause of the Executive Guide to the Plan, TPD Insurance provides a benefit if a person is unable to work as a result of accident or injury for six consecutive months and, at the end of six months, the Insurer is satisfied that the person is unlikely to resume their previous occupation and will be unable at any time in the future to perform any other occupation, on a part time or full time basis which the person is capable of performing by reasons of their education, training, experience.

The TPD claim was subsequently accepted by the Insurer during the relevant income year. Under the Policy the payment is made to the Employer. The Employer is then legally obligated under the terms of the employment contract and the Plan to pay the monies received from that insurance to the Employee.

Under a clause of the Executive Guide to the Plan the lump sum payment is calculated as a function of the Employee's remuneration and the Employee's age at the time of TPD. It is expressed as a multiple of the Employee's annual Remuneration Base.

The insurer paid out a lump sum benefit to the Employer. The Employer advised that the amount comprised a few years of annual salary.

The Employer will be making the payment to the Employee within 12 months of the Employee's termination of employment.

The Employee is under 60 Years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-130.

Income Tax Assessment Act 1997 Section 82-135.

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

Income Tax Assessment Act 1997 Section 82-150.

Income Tax Assessment Act 1997 Section 82-130.

Income Tax Assessment Act 1997 Section 118-20.

Income Tax Assessment Act 1997 Section 118-37.

Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision

Summary

The payment of insurance proceeds from the Employer the Employee is an employment termination payment (ETP) under section 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997). The payment is an ETP as:

• it is made in consequence of the termination of the Employee's employment;

• it will be made within 12 months of termination of the Employee's employment; and

• it is not payment which is excluded from being an ETP.

The payment is not exempt from being an ETP as a payment for personal injury.

The payment is not subject to capital gains tax.

Based on the facts provided in the application, no portion of the payment to be paid to the Employee is exempt from tax, as an invalidity segment of an ETP, in accordance with section 82-150 of the ITAA 1997.

As the payment has been determined as an ETP, the Employer is required to withhold tax from the payment to the Employee.

Detailed reasoning

Employment termination payment

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

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 ETPs. These include (among others):

• unused annual leave or long service leave payments which are covered by Subdivision 83-A and Subdivsion 83-B respectively;

• Superannuation benefits which are covered by Divisions 301-307;

• the tax-free part of a genuine redundancy payment or an early retirement scheme payment worked out under section 83-170; and

• certain capital payments for personal injury.

Paid as a 'consequence of' the termination of your employment

For a payment to be treated as an ETP, the first condition that must be met is that the payment is made in 'consequence of' the termination of employment of the taxpayer.

It should be noted that 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 light of these decisions, the Commissioner discusses the meaning of the phrase in Taxation Ruling TR 2003/13 titled 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).

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)  133 CLR 45 (Reseck) and the Full Federal Court in McIntosh v. Federal Commissioner of Taxation (1979) 25 ALR 557 (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 in my opinion necessary that the termination of the services should be the dominant cause of the payment...

In the same case Jacobs J 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; (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. True it is that the payment was made not only to settle the applicant's claim for common law damages for breach of the employment agreement but also for statutory damages...

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 of 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 termination of the payment need not be the sole or dominant cause of the payment.

The above views were referred to, and relied upon by the AAT in Seabright v FC of T 99 ATC 2011 (Seabright), where it was held that a payment arising from a commutation of a pension that started to be paid more than 10 years earlier was made in consequence of the termination of employment.

In Seabright, the taxpayer's entitlement to the pension arose as a consequence of the termination of her employment, and the payment of the commuted amount simply changed one form of payment into another. The gap of over 10 years between the termination of employment in October 1984 and the offer to commute the pension in May 1995 did not destroy the connection between the termination of employment and the payment.

In arriving at this decision, Senior Member Pascoe stated:

...The question is whether the payment, however it came about, could be said to have followed on termination of the applicant's employment...in 1984. In my view it could. The payment of the commuted amount was simply to change one form of payment, a pension, into another, a lump sum. The entitlement to the pension arose as a consequence of termination of employment in 1984. Termination was a prerequisite to payment of the pension which, in turn, was a prerequisite to the right to receive a lump sum in lieu of the pension. The gap of more than ten years between the two events does not, in my view, destroy the connection between termination of employment and the payment. They remain inextricably linked. The statement by Toohey J in McIntosh's case that "a short period of one month might be thought to strengthen" the connection does not, in my view, necessarily suggest that the longer the period the weaker the connection. If the termination of employment can be seen as either a cause or an antecedent of the payment of the lump sum it can be said that the payment is made in consequence of that termination (Emphasis added).

The Commissioner does not accept that a payment will be made in consequence of termination simply because the termination of employment was antecedent to the payment. There must be a causal connection between the termination and the payment. In Seabright the termination was a cause of the payment of the commuted lump sum amount and the causal connection was sufficient for a finding that the payment was made in consequence of the termination of employment. The facts in Seabright show that but for the termination of employment the taxpayer would not have received the commuted lump sum payment (paragraph 39 of TR 2003/13).

Accordingly, it must be demonstrated that, but for the termination of employment, the payment would not have been made.

The question of whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case.

In this case the Employee is covered by the Policy under the Plan. The Policy provides a lump sum benefit if disablement is total and permanent.

The Employee suffers from a serious illness and was at the stage where the Employee was unable to return to work. As a result of their illness the Employee's employment with the Employer was terminated during the relevant income year. In addition, the Employee made a claim to the Insurer for TPD. Under a clause of the Executive Guide to the Plan, the Insurer will only pay a TPD if the insured person is unable to work as a result of accident or injury for six consecutive months and, at the end of six months the Insurer is satisfied that the insured person is unlikely to resume their previous occupation and will be unable at any time in the future to perform any other occupation, on a part time or full time basis which they are capable of performing by reasons of their education, training, experience.

The Employee's claim for TPD was accepted by the insurer during the relevant income year and an insurance payment was made to the Employer. The Employer will be making the payment to the Employee within 12 months of the Employee's termination of employment.

Applying the principles expressed in Reseck, McIntosh and Seabright, the payment to be made from the Employer to the Employee is considered to be made 'in consequence' of the termination of employment. The payment followed on as an effect or result of the Employee's termination of employment. Although the termination was not the dominant cause of the payment, there was a causal nexus between the termination and payment. The Employee's employment must be terminated before the TPD claim could be accepted by and paid out by the Insurer because the Insurer had to be satisfied that the insured person is unlikely to resume their previous occupation and will be unable at any time in the future to perform any other occupation, on a part time or full time basis which they are capable of performing by reasons of their education, training, experience.

In other words, the mere fact of the Employee's disablement is not enough for a successful claim under the Policy. Instead, there is a fundamental link between the condition for payment under the Policy and the degree of the Employee's disablement. The Employee's disablement must be such that they are unable to work in their previous occupation or any other occupation. Therefore the insurance claim for TPD, the termination and the payment are all intertwined because but for the termination of employment, the Employee would not have satisfied the criteria under the Policy and been entitled to the payment.

From the above discussion, as the payment followed on as an effect or result of the Employee's termination of employment and would not have been made but for the termination of employment, the payment is considered to be made in consequence of the termination of employment. Therefore the condition in subparagraph 82-130(1)(a)(i) of the ITAA 1997 is met.

Payment is received no later than 12 months after the termination

The Employee terminated employment during the relevant income year. The Employer will make the payment to the Employee within 12 months of the termination of the Employee's employment. Therefore this condition is satisfied.

Exclusions under section 82-135 of the ITAA 1997

As mentioned above, 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, among others, include:

_ accrued annual leave and long service leave payments which are covered by Subdivision 83-A and Subdivision 83-B respectively

_ superannuation benefits which are covered by Divisions 301 to 307

_ the tax-free parts of a genuine redundancy payment or an early retirement scheme payment worked out under section 83-170; and

_ certain capital payments for personal injury.

The payment does not fall within the various exclusions under section 82-135 of the ITAA 1997 except possibly a payment for personal injury. We will now consider whether the payment is a capital payment for personal injury.

Paragraph 82-135(i) of the ITAA 1997 specifically excludes from being an employment termination payment:

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 a person for, or in respect of, the particular injury.

From the facts, the Employee suffers from a serious illness and is unable to return to work.

The principal question for determination therefore is whether the payment can be characterised as 'a capital payment for, or in respect of, a 'personal injury'. The words require a relationship between the injury and payment.

The Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 stated, in relation to section 82-135 of the ITAA 1997, that:

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

In accordance with section 1-3 of the ITAA 1997, provisions in the Income Tax Assessment Act 1936 (ITAA 1936) which have been rewritten in the ITAA 1997 will have the same meaning where they express the same idea, even if the words used are different. It is therefore appropriate to cite cases that refer to paragraph 27A(1)(n) of the ITAA 1936.

The term 'personal injury' is not defined in the ITAA 1936 or in the ITAA 1997. Justice Smith of the Victorian Supreme Court considered the meaning of the term, in Graham v Robinson [1992] 1 VR 279, (Graham v Robinson) and 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.

In Dibb v. Commissioner of Taxation (2003) 53 ATR 290 Justice Heerey stated that personal injury encompasses injury or disease of a physical or psychological nature. However it would not extend to anguish, distress or embarrassment of the kind traditionally taken into account in assessing damages for defamation.

In Commissioner of Taxation v. Scully (2000) 201 CLR 148 (Scully) the High Court, in considering former paragraph 27A(1)(n) of the ITAA 1936, held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

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.

Therefore for an amount to meet the requirements of paragraph 82-135(i) of the ITAA 1997, the payment must be for, or in respect of, personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

In Purvis and Ors v. Federal Commissioner of Taxation (2013)  AATA 58 (Purvis) the Administrative Appeals Tribunal held that the payment was not compensation for personal injury as the injury was not a factor in determining the amount of the payment.

In this case, the Employer took out an insurance policy for the Employee which includes TPD. The Employee suffers from a serious illness and was unable to return to work. The Employee terminated employment during the relevant income year. The Employee lodged a claim with the Insurer for TPD.

Under a clause of Executive Guide to the Plan an Insurer can pay out a TPD claim if the insurer is satisfied that the insured person is unlikely to resume their previous occupation and will be unable at any time in the future to perform any other occupation, on a part time or full time basis which the insured person is capable of performing by reasons of their education, training, experience.

The insurance claim for TPD was accepted by the Insurer during the relevant income year and a benefit was paid to the Employer. The Employer will make the payment to the Employee when the private ruling is issued. Under a clause of the Executive Guide to the Plan the lump sum payment is calculated as a function of the Employee's remuneration and the Employee's age at the time of Total and Permanent Disablement (TPD). It is expressed as a multiple of the employee's annual Remuneration Base. Therefore the calculation of the benefit is not made by reference to the Employee's injury. It was also advised that the amount of the insurance payment comprised a few years of annual salary. In this respect, this case is analogous to the circumstances in Scully, where the payment was also calculated as a function of salary. In either case, there is no correspondence between the amount of the payment and the value of the injury sustained by the Employee.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not exclude the lump sum payment from being an ETP. As the payment is not a payment mentioned in section 82-135 of the ITAA 1997, paragraph 82-130(1)(c) of the ITAA 1997 is satisfied.

As discussed above, all the conditions of subsection 82-130(1) of the ITAA 1997 will be met as the payment is considered to be a payment received in consequence of the termination of employment, is not a payment mentioned in section 82-135 of the ITAA 1997; and will be paid within 12 months of termination, Therefore, the payment is considered to be an ETP.

Invalidity Segment of ETP

Under subsection 82-130(1) of the ITAA 1997 where a person's employment is terminated because of ill-health and the person receives an employment termination payment part of the payment may be tax free. This component is called an invalidity segment (subsection 82-150(1) of the ITAA 1997).

In this case, the Employee's employment was terminated because of ill-health. As mentioned above, the lump sum payment (the Payment) the Employee will receive from the Employer as proceeds from an insurance policy for TPD is an ETP.

In relation to whether any part of the Payment includes an invalidity segment it must satisfy subsection 82-150(1) of the ITAA 1997 which states:

An employment termination payment 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 the 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.

Gainful employment

Section 995-1 of the ITAA 1997 defines being 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.

The Employee was employed on a full-time basis with the Employer until the Employee became ill.

Payment for stopping gainful employment

As stated above the Payment is considered to be a payment made on the termination of the Employee's employment.

Employment termination occurred because of ill-health

The requirement under paragraph 82-150(1)(b) of the ITAA 1997 is 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.

In this case, the facts show the termination of employment during the relevant income year occurred after the Employee suffered from the serious illness and was unable to return to work. The Employee lodged a claim with the insurer for TPD. The claim for TPD was accepted by the insurer during the relevant income year. Therefore, it is considered that this requirement is satisfied.

Termination of employment occurred before last retirement date

The third condition for a payment to qualify as an invalidity component is that it was made before the taxpayer's last retirement date. The payment will be made during the relevant income year when the Employee is 54 years of age, well before the normal retirement age of 65. Therefore, the condition of paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied.

Certification from 2 legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed.

In respect of the final requirement, it must be demonstrated that the disability at the time of termination was such that:

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.

Therefore, paragraph 82-150(1)(d) of the ITAA 1997 requires that there must be the likelihood that the disability of the taxpayer will preclude the taxpayer from ever being employed in a role, for which the taxpayer is reasonably qualified.

A medical certificate from a medical practitioner during the relevant income year stated that the medical practitioner did not believe the Employee is ever likely to resume work in their own or any other occupation.

It is considered that the medical certificate from the medical practitioner satisfies the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997.

A medical certificate from a second medical practitioner during the relevant income year advised that the Employee is unlikely to be able to continue work in their occupation due to excessive cognitive issues and fatigue, which are not able to be improved by retraining or rehabilitation.

A medical report from the second medical practitioner during the relevant income year also advised that the Employee's difficulty with maintaining their work capacity despite the reduction in responsibilities and hours over the last year shows the Employee is not capable of taking on a similar role in another company or a reduced level position.

It is considered that the medical certificate and medical report from second medical practitioner during the relevant income year does not satisfy the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997 as they should consider not only the Employee's role with the Employer, but any other role the taxpayer is reasonably qualified because of education, training or experience.

Based on the information provided in this case, only one medical practitioner has provided a certificate that attest to the Employee being unable to ever be employed in a capacity for which the Employee is reasonably qualified because of education, training or experience. This is not sufficient to satisfy the final condition of subsection 82-150(1) of the ITAA 1997.

As mentioned above all conditions under section subsection 82-150(1) of the ITAA 1997 must be satisfied before a part of the payment can be treated as an invalidity segment of the ETP. As one of the conditions under subsection 82-150(1) of the ITAA 1997 is not satisfied, no part of the ETP payment contains an invalidity segment.

If the Employee is able to locate or produce a second medical certificate that would allow him to satisfy the final condition in paragraph 82-150(1)(d) of the ITAA 1997, the Employee may request for a private ruling to recalculate the taxable and tax-free components of the ETP.

The tax-free component of an ETP containing an invalidity segment is calculated using the following formula:

Amount of employment days to retirement

Termination payment x Employment days + Days to retirement

where:

days to retirement is the number of days from the day on which the person's employment was terminated to the last retirement day.

employment days is the number of days of employment to which the payment relates.

Tax treatment of the employment termination payment

An ETP may comprise of the following components:

_ Tax free 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.

An Employer does not withhold tax from the tax free component.

An Employer withholds tax from a taxable component.

In the Employee's 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. As discussed above, based on the information provided, the ETP does not include an invalidity segment. Therefore the ETP does not contain a tax free component.

Accordingly, the whole payment of $X is a taxable component of an ETP.

However, an ETP is taxed at a lower (concessional) rate, in accordance with subsection 82-10(3) of the ITAA 1997, up to a certain 'cap' amount. Subsection 82-10(3) of the ITAA 1997 states:

You are entitled to a * tax offset that ensures that the rate of income tax on the amount mentioned in subsection (4) does not exceed:

(a) if you are your * preservation age or older on the last day of the income year in which you receive the payment--15%; or

(b) otherwise--30%.

*To find definitions of asterisked terms, see the Dictionary, starting at section 995-1

In this case, the Employee is under their preservation age.

Subsections 82-10(4) and (5) of the ITAA 1997 outline how the 'cap' amount is worked out. According to these subsections, the 'cap' amount is either:

a. the ETP cap amount (reduced by the amount of any earlier ETPs received in the same income year), or

b. the lesser of:

i. the ETP cap amount (reduced by the amount of any earlier ETPs received in the same income year); and

ii. the whole-of-income cap amount (being $180,000 minus other taxable income earned throughout the year).

According to paragraph 82-10(6)(d) of the ITAA 1997, for certain specified ETPs, only the ETP cap will apply (as opposed to the lesser of the ETP amount and the whole-of-income cap amount). These ETPs are known as 'excluded payments' and include payments that:

(a) that are * genuine redundancy payments, or that would be genuine redundancy payments but for paragraph 83-175(2)(a); or

(b) that are * early retirement scheme payments; or

(c) that include * invalidity segments, or what would be invalidity segments included in such payments but for paragraph 82-150(1)(c); or

(d) that:

(i) are paid in connection with a genuine dispute; and

(ii) are principally compensation for personal injury, unfair dismissal, harassment, discrimination or a matter prescribed by the regulations; and

(iii) exceed the amount that could, at the time of the termination of your employment, reasonably be expected to be received by you in consequence of the voluntary termination of your employment.

As this ETP is not an excluded payment mentioned above, the relevant cap is the lesser of the whole-of-income cap and the ETP cap.

The ETP cap in the relevant income year is $195,000. The whole-of-income cap is $180,000 reduced by any other taxable income earned in the income year before or after receiving the ETP.

The rate of tax that an Employer withholds from a payment will depend on the person's preservation age. As the Employee is below the preservation age of 57, the Employer should withhold tax at the rate of 32% from the taxable component for amounts below the smaller of the ETP cap and the whole-of-income cap. For the remainder of the amount, being the amount above the whole-of-income cap, the Employer should withhold tax at the rate of 49%.

Capital gains tax (CGT)

The general CGT exemptions provisions are found in subdivision 118-A of the ITAA 1997. Included amongst them is an anti-overlap provision, section 118-20, which ensures that an amount cannot be assessable under both the CGT provisions and non CGT provisions. The effect of the anti-overlap provision is to reduce the amount of any assessable capital gain by any amount which is also assessable under non CGT provisions and by amounts which are exempt income.

In your ruling application you stated any capital gain made from a CGT event happening in respect to the compensation is disregarded under paragraph 118-37(1)(a) of the ITAA 1997.

However, the payment is assessable under section 82-130 of the ITAA 1997 as explained above. The combined effect of section 118-20 and section 82-130 is that where a capital payment is assessable under a non-CGT provision, then it is treated as being assessable under that non-CGT provision.

In this regard, it is relevant to note the following comment made by Senior Member Dwyer of the Administrative Appeals Tribunal (AAT) in AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258 at paragraph 31:

I accept Mr Gibb's submission that if the payment is caught, as I am satisfied it is, by s 27A(1), there is no advantage to the applicant in the fact that it would have been exempt by virtue of s 160ZB(1), if it were not so caught. …

The above was in respect of the eligible termination payment provisions which, prior to 1 July 2007, were contained in the ITAA 1936. The term 'eligible termination payment' was defined in former subsection 27A(1) in the ITAA 1936 and included any payments made in consequence of the termination of employment. Subsection 160ZB(1) of the ITAA 1936 was replaced by section 118-37 of the ITAA 1997 for the 1998-99 and later income years.

Section 118-37 of the ITAA 1997 deals with exemptions from capital gains for compensation or damages for wrong or injury suffered by a taxpayer.

However, as the settlement sum is to be included as assessable income under section 82-130 of the ITAA 1997 (the non CGT provision) any capital gain made is to be reduced under section 118-20 of the ITAA 1997 by the amount assessable under section 83-130. The fact that the payment may also be assessable as a capital gain does not change the fact that it is assessable under another provision of the ITAA 1997.

Accordingly, the payment is excluded from the CGT provisions. Consequently, as explained above, the payment is assessable as an ETP and taxed as explained above.