Edited version of your written advice

Authorisation Number: 1013040810889

Date of advice: 24 June 2016

Ruling

Subject: Compensation payment for unfair dismissal

Question

Is the payment awarded under the terms of settlement an employment termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following periods:

Income year ending 30 June 20yy

Income year ending 30 June 20zz

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

The Taxpayer is over their preservation age.

The Taxpayer was terminated from their employment on XX/XX/XXXX.

The Taxpayer commenced proceedings for unfair dismissal.

The Taxpayer and the Employer entered into mediation and agreed to settle all matters between them in accordance with terms of settlement outlined in a discharge and release document.

Under the terms of settlement, the Employer agreed to pay the Taxpayer a gross sum of $XX,XXX, yet to be paid pending the dismissal of a separate workers compensation claim. The payment is expected to be paid on XX/XX/XXXX.

Assumptions

The payment will be received no later than 12 months after the termination of employment.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 82-10

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

Income Tax Assessment Act 1997 section 82-130

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

Income Tax Assessment Act 1997 subsection 82-130(7)

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 section 82-140

Superannuation Industry (Supervision) Regulations 1994 subregulation 6.01(2)

Reasons for decision

Summary

1. The payment awarded to the Taxpayer under the terms of settlement is an employment termination payment.

Detailed reasoning

Employment termination payment (ETP)

2. A payment made to an employee is an 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.

3. To determine if a payment constitutes an ETP, all the conditions in section 82-130 of the ITAA 1997 must be satisfied.

4. 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 ETP.

Paid as a consequence of the termination of your employment

5. For a payment to be treated as an ETP, there must be a payment that is made in consequence of the termination of employment of the taxpayer, according to subparagraph 82-130(1)(a)(i) of the ITAA 1997.

6. The phrase 'in consequence of' is not defined in the ITAA 1997. However, the courts have interpreted the phrase in a number of cases. Whilst the courts have divergent views 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).

7. 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.

8. 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.

9. 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.

10. In this case, the Employer terminated the Taxpayer's employment on XX/XXX/XXXX and as a result, a settlement was reached by the two parties after a dispute regarding the termination. As such, it can be said that but for the termination of employment, the $XX,XXX compensation would not have been made to the Taxpayer.

11. Therefore, it is considered that the above payment was made in consequence of the termination of the Taxpayer's employment.

Payment is received no later than 12 months after termination

12. In this case, the Taxpayer's employment was terminated on XX/XX/XXXX and the Taxpayer initiated their action against their Employer on XX/XX/XXXX, resulting in the award of compensation.

13. As the compensation payment has not yet been made, this condition is not considered satisfied. However, as the 12 month period has not yet elapsed and the payment is expected on XX/XX/XXXX, this condition may still be satisfied.

14. If the payment under the terms of settlement is not made within 12 months after termination, then the payment will not satisfy paragraph 82-130(1)(b) of the ITAA 1997. However, subsection 82-130(4) of the ITAA 1997 provides that the requirement under paragraph 82-130(1)(b) of the ITAA 1997 will not apply if you are covered by a determination under subsection 82-130(5) or 82-130(7) of the ITAA 1997. The Taxpayer may apply for such a determination from the Commissioner if the payment is not made by XX/XX/XXXX.

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

15. Section 82-135 of the ITAA 1997 provides a list of certain payments that are not ETPs.

16. As the amount awarded to the Taxpayer is not excluded from being an ETP, this condition is satisfied.

Taxation of ETP

17. An ETP may be made up of two components: the 'tax-free component' and the 'taxable component'.

18. In accordance with section 82-10 of the ITAA 1997, the tax-free component of an ETP is not assessable income and is not exempt income. That is, it is tax-free.

19. However, under section 82-140 of the ITAA 1997, the tax-free component of an ETP consists of the invalidity segment of the payment and the pre-July 83 segment of the payment. Hence, there is no applicable tax-free component, in this case.

20. The taxable component of the ETP is assessable, however a tax offset, which depends on a person's age, applies.

21. If a person is over their 'preservation age', subsection 82-10(3) of the ITAA 1997 applies to ensure that the rate of tax payable on the taxable component does not exceed 15% (plus Medicare levy).

22. In this case, the relevant cap amount is the ETP cap, which is $195,000 in both the 20xx-yy income year and the 20yy-zz income year.

23. Preservation age is defined in regulation 6.01(2) of the Superannuation Industry (Supervision) Regulations 1994 and, for a person born before 1 July 1960, is 55 years. The Taxpayer is over their preservation age in this case.