Edited version of your written advice

Authorisation Number: 1013035395613

Date of advice: 21 June 2016

Ruling

Subject: Employment termination payment.

Question 1

Is the lump sum payment, or any part of it, paid to your client by their former employer in settlement of litigation proceedings in consequence of the termination of your client's employment?

Answer

Yes.

Question 2

Is the lump sum payment, or any part of it, paid to your client by their former employer in settlement of litigation proceedings an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 3

Is the lump sum payment, or any part of it, paid to your client by their former employer in settlement of litigation proceedings a capital payment in respect of which the capital gain is disregarded under section 118-37 of the ITAA 1997?

Answer

No.

Question 4

Had the lump sum payment paid to your client by their former employer in settlement of litigation proceedings been made within 12 months of your client's termination of employment, would that lump sum payment, or any part of it, have been an employment termination payment in accordance with subsection 82-130(1) of the ITAA 1997?

Answer

Yes.

Question 5

If the answer to Question 4 is yes, is any part of the lump sum payment paid to your client by their former employer in settlement of litigation proceedings excluded from being an employment termination payment as a 'capital payment for, or in respect of, personal injury…', in accordance with paragraph 82-135(i) of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances

Your Client commenced employment with the Former Employer effective more than 10 years ago.

Your Client lodged a formal grievance against the Former Employer, which was resolved by the Former Employer. The Former Employer however, also made counter allegations, including serious misconduct, against Your Client.

Your Client lodged a dispute application with Fair Work Australia (FWA). During the relevant period the FWA found in favour of the Former Employer, and concluded that it was appropriate for the Former Employer to further investigate the misconduct allegations pursuant to their disputes process.

Your Client lodged an appeal against the latter decision.

The FWA dismissed the appeal.

In accordance with the Former Employer's disputes process, the disputes committee concluded its investigation, finding that there were some instances of misconduct.

In the 20XX-XX income year, the Former Employer wrote to Your Client, concluding that Your Client's actions and behaviours amounted to serious misconduct and decided to terminate Your Client's employment.

In the 20XX-XX income year, Your Client's solicitors sent a letter to the Former Employer indicating that the decision by the Former Employer to terminate Your Client's employment was indefensible and are instructed by Your Client to commence legal proceedings for breach and ultimately the wrongful termination of Your Client's employment contract. Your Client also invited The Former Employer to engage in bona fide settlement discussions to avoid further litigation and indicated that should the Former Employer not be willing to engage in settlement discussions, legal proceedings would commence.

As the settlement discussions between Your Client and the Former Employer failed to produce a suitable outcome for Your Client, Your Client commenced proceedings against the Former Employer in the relevant Commonwealth Court in the 20YY-YY income year.

A copy of the Further Amended Statement of Claim was provided to the Australia Taxation Office.

In the 20ZZ-ZZ income year, Your Client and the Former Employer entered into a Deed of Settlement and Release (the Deed) in which the Former Employer agreed to pay a settlement sum to Your Client in full and final settlement of the court proceedings.

The settlement sum comprised an amount for legal costs, non-economic loss (reflecting loss of self-esteem, injury to feelings, hurt, humiliation suffered by Your Client) and an amount for loss of earning capacity.

The Deed stipulated that the settlement sum was to be paid in two instalments, over two income years.

Your client advised in the 2015-16 income year that they did not wish for the Commissioner to make a determination under subsection 82-130(5) of the ITAA 1997 in relation to the application of paragraph 82-130(1)(b) of the ITAA 1997 to their circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Subsection 82-130(1)

Income Tax Assessment Act 1997 Subparagraph 82-130(1)(a)(i)

Income Tax Assessment Act 1997 Subparagraph 82-130(1)(b)

Income Tax Assessment Act 1997 Subparagraph 82-130(1)(c)

Income Tax Assessment Act 1997 Subsection 82-130(4)

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

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 Section 83-295

Income Tax Assessment Act 1997 Subdivision 118-A

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 118-37

Income Tax Assessment Act 1936 Subsection 6(1)

All references are to the ITAA 1997 unless otherwise indicated.

Reasons for decision

Summary

The entire settlement sum amount paid to Your Client by the Former Employer in settlement of litigation proceedings is not an employment termination payment.

A portion of the settlement sum, that is, the amount representing compensation for non-economic loss and loss of earning capacity is assessable income.

A portion of the settlement sum amount, that is, the amount representing a reimbursement of legal costs and disbursements is not assessable income.

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 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.

Paid 'in consequence' of the termination of your employment

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, at paragraphs 5 and 6 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 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.

While TR 2003/13 contains references to repealed provisions, some of which may have been rewritten, the ruling still has effect.

Whether payments made in respect of a taxpayer as a result of settlement of litigation arising out of the termination of the taxpayer's employment, is made 'in consequence of' the termination of employment is specifically addressed in TR 2003/13. According to paragraph 31 of TR 2003/13:

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 FWA made a decision in relation to Your Client's grievance finding in favour of the Former Employer. The FWA concluded that it was considered appropriate that some of the issues raised be the subject of further investigation by the Former Employer pursuant to their disputes process. Your Client lodged an appeal against this decision and the FWA subsequently dismissed that appeal.

As a result of the findings by the dispute committee, the Former Employer concluded that Your Client's actions and behaviours amounted to serious misconduct and made the decision to terminate Your Client's employment. Your Client's employment was consequently terminated in the 20XX-XX income year.

The matter before the FWA and the disputes committee had clearly concluded prior to Your Client's termination of employment.

After the termination of Your Client's employment, Your Client's solicitors wrote to the Former Employer indicating the termination was 'wrongful' and invited the Former Employer to enter into bona fide settlement discussions in order to avoid legal proceedings.

As the settlement discussions between Your Client and the Former Employer failed to produce a suitable outcome for Your Client, Your Client commenced proceedings in the relevant Commonwealth Court the 20YY-YY income year. The court proceedings were a separate action against the Former Employer as a result of the termination of Your Client's employment and the failure of settlement discussions between the relevant parties.

The subject of Your Client's Further Amended Statement of Claim deals with Your Client's claim, (among other issues), against the Former Employer for unlawfully terminating Your Client's employment contract and how their ultimate termination deprived them of future promotion and income. Your Client argued that their employment could not be terminated for serious misconduct unless the relevant terms of the applicable industrial instruments had first been complied with. Whilst the argument may have centred on whether their termination was lawful, it was the ultimate termination of Your Client's employment that was at issue.

Your Client and the Former Employer then entered into a Deed in the 20ZZ-ZZ income year in which the Former Employer agreed to pay a settlement sum to Your Client in full and final settlement of the Federal Court proceedings.

The cause of action, whether there was a breach of contract or not, was connected to the termination. The payment of the settlement sum was made 'in consequence of' the termination of Your Client's employment. 'In consequence of the termination' requires that termination be a cause, but not necessarily a dominant cause of a payment. There is a causal connection between the termination and the payment of the settlement sum. The termination, the legal proceedings and the payment are intertwined; but for the termination, the payment of the settlement sum would have not been made.

Legal Costs

The settlement sum however, includes an amount for legal costs and disbursements. As this amount has been clearly identified in the Deed as relating specifically to the reimbursement of legal costs and disbursements, this amount is not 'in consequence of the termination' of Your Client's employment. As the amount for legal costs and disbursements is not in consequence of the termination of Your Client's employment, that amount is therefore not an employment termination payment, having failed to satisfy subparagraph 82-130(1)(a)(i) of the ITAA 1997.

This is reiterated in paragraph 4 of Taxation Ruling TR 2012/8 Income tax and fringe benefits tax: assessability of amounts received to reimburse legal costs incurred in disputes concerning termination of employment, which provides that an amount received in relation to a dispute concerning termination of employment is not an employment termination payment, nor forms part of an employment termination payment, where the amount is capable of being identified as relating specifically to the reimbursement of legal costs.

Further, a reimbursement of legal costs does not have the characteristics of ordinary income. Therefore, the amount representing a reimbursement of legal costs does not give rise to ordinary assessable income.

Therefore, a portion of the settlement sum, that is, the settlement sum less the amount for legal costs and disbursements, was made in consequence of the termination of Your Client's employment as defined in subparagraph 82-130(1)(a)(i) of the ITAA 1997.

Payment must be received no later than 12 months after termination

As it has been determined that a portion of the settlement sum, was received in consequence of Your Client's termination of employment, paragraph 82-130(1)(b) of the ITAA 1997 of the definition of employment termination payment also requires that the amount is paid to Your Client within 12 months of their termination.

Your Client's employment was terminated in the 20XX-XX income year and a settlement sum as stipulated under the Deed was to be paid to Your Client in instalments over the relevant income years.

As the settlement sum was not paid within 12 months of Your Client's termination, paragraph 82-130(1)(b) of the ITAA 1997 is not satisfied.

Subsection 82-130(4) of the ITAA 1997 however, provides an exemption from the application of paragraph 82-130(1)(b) of the ITAA 1997, (the 12 month rule), if:

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

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

You advised in the 2015-16 income year that Your Client did not wish for the Commissioner to make a determination under subsection 82-130(5) of the ITAA 1997 in relation to the application of paragraph 82-130(1)(b) to Your Client's circumstances. Furthermore, Your Client is not covered by a legislative instrument under subsection 82-130(7), such as SPR 2007/1 Employment Termination Payments (12 months rule) Determination 2007, which requires legal action to be commenced within 12 months of the termination of employment.

Accordingly, the requirement under paragraph 82-130(1)(b) applies to Your Client and has not been satisfied.

Subparagraph 82-130(1)(c) of the ITAA 1997 regarding the definition of employment termination payment also requires that the payment in question is not a payment mentioned in section 82-135 of the ITAA 1997.

Exclusions under section 82-135 of the ITAA 1997

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

• unused annual leave and unused long service leave payments; and

• 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).

A portion of Your Client's settlement sum was comprised of: the non-economic loss component, representative of compensation received for injury to feelings, loss of self-esteem, hurt and humiliation; and a component for loss of earning capacity component, representative of compensation for loss of professional reputation and loss of ability to earn income and wages.

The term 'personal injury' means physical injury and does not extend to emotional hurt, humiliation, loss of self-esteem etc. or to loss of professional reputation [Graham v Robinson (1992) 1 VR 279; McMahon v Commissioner of Taxation 99 ATC 2025; [1999] 41 ATR 1056].

Further, the statutory requirement that the payment must be considered 'reasonable' having regard to its impact on an individual's capacity to earn income from 'personal exertion' means that the injury must have an assessable and identifiable impact on the capacity of the individual to earn income.

Therefore, this portion of the settlement sum is not an employment termination payment by reason of paragraph 82-130(1)(b) only. As explained above, the settlement sum is not a payment that falls within any of the exceptions in section 82-135.

Accordingly, this amount is assessable income in accordance with section 83-295 of the ITAA 1997, to be included in Your Client's assessable income for the relevant income years.

Section 83-295 of the ITAA 1997 provides:

A payment received by you that would be an *employment termination payment but for paragraph 82-130(1)(b) is assessable income.

Capital gains tax

The general capital gains tax (CGT) exemptions provisions are found in subdivision 118-A of the ITAA 1997. Included amongst them is an anti-overlap provision, section 118-20 of the ITAA 1997, 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.

Section 118-37 of the ITAA 1997 deals with exemptions from capital gains of 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 83-295 of the ITAA 1997 (a 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 83-295 of the ITAA 1997.

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, this portion of the settlement sum is excluded from the capital gains tax provisions and as explained above, included in Your Client's assessable income and subject to marginal tax rates.