Edited version of your written advice

Authorisation Number: 1013089259826

Date of advice: 13 September 2016

Ruling

Subject: Assessability of compensation payment

Question 1

Are the general damages awarded to you under the terms of settlement an employment termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997?

Answer

No

Question 2

Are the general damages that were awarded to you under the terms of settlement assessable income under section 6-5 of the Income Tax Assessment Act 1997?

Answer

No

Question 3

Is any capital gain arising from the general damages payment disregarded under section 118-37 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were employed by company (Employer) until the termination of your employment.

During your employment, you contended there were ongoing incidents involving discrimination, victimisation and bullying of yourself. Complaints were raised with supervisors but limited action was taken despite management's knowledge of the ongoing problems.

You submitted a Work Cover application citing anxiety and depression caused by psychological stress as a result of discrimination, victimisation and bullying. The claim was accepted for medical expenses and the like.

You submitted an application to the relevant authority. An offer was made to you, which was rejected and conciliation was deemed unsuccessful.

You then submitted an application to the relevant tribunal (Tribunal).

Following a hearing with the Tribunal, you and your Employer agreed, without admission or concession, to settle all matters, as per the terms of the Deed of Settlement and Release (Deed).

The Deed was signed by you and by a representative of your Employer at a later date.

Under the terms of the Deed it was agreed that your employment would cease.

Under the terms of the Deed, your Employer agreed to pay you an amount in general damages, along with your accrued leave entitlements.

The Deed refers to your application to the Tribunal which alleged sex discrimination, victimisation and inappropriate conduct against your Employer.

You provided a copy of your Tribunal application, which detailed incidents of alleged victimisation you were subjected to. In the application you advised that the incidents in your workplace caused you stress, anxiety, hurt, humiliation, pain and suffering.

Your Employer issued you with a PAYG Payment Summary - Employment Termination Payment for the relevant financial year representing the amount of your settlement payment and the tax they had withheld.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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 section 102-5

Income Tax Assessment Act 1997 paragraph 118-37(1)(a)

Reasons for decision

Question 1

Employment termination payment (ETP)

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.

To determine if a payment constitutes an ETP, 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 ETP.

Paid as a consequence of the termination of your employment

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.

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).

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.

In your case, the payment under the Deed received by you is not a payment that 'follows as an effect or result of the termination.' Rather, the payment is one that follows as an effect or result of several incidents of discrimination against you, since it was the discrimination, and not the termination, that gave cause to the claim in the Tribunal application.

In other words, as you were still employed at the time the Tribunal proceedings commenced, there is no causal connection between the Tribunal application and the termination of employment. Following on from this, as the Deed was entered into in settlement of the Tribunal application, there is similarly no causal connection between the payment under the Deed and the termination of employment.

As such, it is considered that the payment for general damages was not paid in consequence of the termination of your employment.

As this condition is not satisfied, there is no need to consider the other conditions under section 82-130 of the ITAA 1997. The payment received by you cannot be an ETP.

Question 2

Section 6-5 of the Income Tax Assessment Act 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income).

Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

• are earned

• are expected

• are relied upon

• have an element of periodicity, recurrence or regularity.

In your case, the payment was in lieu of a claim for discrimination. The amount paid is not income from rendering personal services, income from property or income from carrying on a business. The payment was not earned by you as it does not relate to services performed. The payment is also a one off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the pain and suffering resulting from the alleged discrimination, victimisation and inappropriate conduct, rather than from a relationship to personal services performed.

A compensation amount generally bears the character of that which it is designed to replace. If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

Taxation Ruling IT 2424 discusses compensation payments in respect of unlawful acts of discrimination, specifically under The Sex Discrimination Act (Commonwealth) 1984. At paragraph 8 it states: 

…a payment to compensate for personal injury, injury to feelings, humiliation, embarrassment, depression, anxiety, etc. is not liable for income tax. It is a payment of a capital nature. Nor is the payment liable to tax under the capital gains tax provisions by reason of the exemption provided in subsection 160ZB(1) [section 118-37 ITAA 1997] for compensation or damages paid for wrong or injury suffered by a taxpayer to his or person or in his or her profession or vocation.

The general damages component of your settlement is not a lump sum payment which substitutes for an income stream or a reimbursement of medical expenses. Accordingly, the lump sum amount for the general damages is a capital receipt and is not ordinary income. Accordingly, the lump sum payment for general damages is not ordinary income and is therefore, not assessable under section 6-5 of the ITAA 1997.

Question 3

Receipt of a lump sum payment may give rise to a capital gain. The net capital gain you make is then included in your assessable income under section 102-5 of the ITAA 1997 unless an exemption applies.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

As the amount you are to receive is not in respect of any underlying asset, the whole of the settlement amount for general damages is treated as capital proceeds from a CGT event (CGT event C2) happening to your right to seek compensation.

However, paragraph 118-37(1)(a) of the ITAA 1997 disregards a capital gain made from a CGT event where the amount relates to compensation or damages received for any wrong or injury you suffer in your occupation.

In your case, the Deed was entered into in settlement of the Tribunal application which alleged sex discrimination, victimisation and inappropriate conduct against your Employer. The general damages payment followed as a result of the incidents suffered by you.

Therefore, the capital gain made from the CGT event happening to your right to seek compensation is disregarded under paragraph 118-37(1)(a) of the ITAA 1997.

Conclusion

As the amount from the general damages is not assessable as an eligible termination payment, ordinary income or as a capital gain it is not assessable income.

Therefore the lump sum amount from the general damages payment will not be required to be included in your income tax return.