Edited version of your written advice

Authorisation Number: 1051390460966

Date of advice: 26 June 2018

Ruling

Subject: Eligible termination payments

Question

Are the payments which you received from your previous employer in Australia as a result of your court settlement taxable in Australia?

Answer

Yes

Question

Are any of the payments received by your employer classified as employment termination payments under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question

Does the payment received under a deed of release and settlement form part of capital proceeds for capital gains tax purposes?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You commenced employment with your employer in Spring 20AA

You terminated your employment in Autumn 20BB on the grounds of voluntary resignation.

After you terminated your employment, you left Australia for Country A, where you have lived since.

You had a dispute with your employer about incorrect payment of wages. You attempted to contact your employer’s HR staff and other relevant people to have these issues resolved.

However, over a number of years you have felt that HR did not process these issues effectively.

You lodged a complaint with the Fair Work Ombudsman in Summer 20CC.

The Fair Work Ombudsman responded to this complaint by stating that you may wish to seek independent legal advice.

During the period between Autumn 20BB and Summer 20CC, you were undertaking mediation actions through a local Community Justice Centre (CJC). From here the CJC advised you to continue to the court in order to solve your matter.

You launched a case at the CJC based on the advice given to you by the CJC. After taking this action, you received a gross payment from your employer in Autumn 20DD of $X. From this payment, $Y was withheld for tax.

However, the payment mentioned above did not cover the full obligation of your employer leading you to start a case with the Local Court in Spring 20DD.

As a result of the case launched with the Local Court, you received a gross payment from your employer on Autumn 20EE of $X. From this payment, $Y was withheld for tax.

Your employer has stated the amounts paid to you as employment termination payments (ETP). However you don’t believe that this is correct due to the payment being made as a result of the court cases as opposed to the termination of employment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(2)

International Tax Agreements Act 1953 Section 4

International Tax Agreements Act 1953 Section 5

Income Tax Assessment Act 1936

Agreement between Australia and Country A for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income

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 Paragraph 82-130(1)(b)

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

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

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

Income Tax Assessment Act 1997 Section 82-135

Reasons for decision – taxable in Australia

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

In determining your liability to pay tax in Australia it is necessary to consider not only the domestic income tax laws but also any applicable double tax agreements (DTA).

Section 4 of the International Tax Agreements Act 1953 (Agreements Act) incorporates that Act with the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997 so that all three Acts are read as one. The Agreements Act overrides both the ITAA 1936 and ITAA 1997 where there are inconsistent provisions (except in some limited situations).

Section 5 of the Agreements Act states that, subject to the provisions of the Agreements Act, any provision in an Agreement listed in section 5 has the force of law. The Country A Agreement is listed in section 5 of the Agreements Act and is called the Agreement Between Australian and Country A for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income.

This Agreement operates to avoid the double taxation of income received by residents of Australia and Country A.

The Agreement states at Article M, paragraph N:

(2) Notwithstanding the provisions of paragraph (1), remuneration derived by an individual who is a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first mentioned State if:

(a) the recipient is present in that other State for a period or periods not exceeding in the aggregate 183 days in the year of income of that other State;

(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of that other State; and

(c) the remuneration is not borne by a permanent establishment or a fixed base which the employer has in that other State.

It is clear that the remuneration you received is assessable in Australia as while you were not in Australia for more than 183 days in the year of payment, your employer was not a non-resident of Australia.

In your situation Australian tax has been deducted and this tax may well be covered by Article O of the agreement. This article operates to eliminate double taxation and says you may be able to claim a credit for taxes paid in Australia against any tax payable in Country A.

Reasons for decision – Eligible Termination Payment (ETP)?

Summary

The payments received from your employer are not employment termination payments (ETP) as you commenced legal action more than 12 months after you terminated employment.

Detailed reasoning

For payments received from your employer to be considered an ETP under section 82-130 of the ITAA 1997, they would need to satisfy the definition of an ETP and the associated criteria set out in subsection 82-130(1) of the ITAA 1997.

Subsection 82-130(1) states that a payment is considered as an ETP if:

● it is received by you:

● in consequence of the termination of your employment; or

● after another person’s death, in consequence of the termination of the other person’s employment; and

● it is received no later than 12 months after termination (except for situations mentioned in subsection (4)); and

● it is not a payment mentioned in section 82-135 “In consequence of the termination of your employment”.

Taxation Ruling TR 2003/13 Income tax: employment termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase ‘in consequence of’ (TR 2003/13) explains what is meant by the phrase ‘in consequence or the termination of any employment’.

Paragraph 6 of TR 2003/13 states that the phrase ‘in consequence of’ requires a connection between the termination and the payment, although the termination may not need to be the dominant cause.

Based on the information you have provided, the payment was received from the employer as part of a settlement deed signed with your employer.

Paragraphs 31 and 32 of TR 2003/13 refer to how payments arising from litigation settlements can be made in consequence of termination of employment if the litigation proceedings arose as a result of the employer terminating your employment and related to an issue regarding your employment.

‘Received no later than 12 months after termination’

This phrase relates to the time period between the termination of employment and the receipt of the payment being less than 12 months apart.

From the information you have provided, these payments were made to you more than 12 months after you terminated your employment.

Since both these payments were made more than 12 months after the termination of employment, the condition at paragraph 82-130(1)(b) has not been satisfied.

Determination under section 82-130(7) of the ITAA 1997

However, subsection 82-130(4) states that you can be exempt from the 12 month period requirement stated in paragraph 82-130(1)(b) 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

Subsection 82-130(7) of the ITAA 1997 states that the Commissioner can make a legislative determination that paragraph 82-170(1)(b) of the ITAA 1997 does not apply to either:

● A class of payments;

● A class of recipients of payments

On 7 December 2017 the Commissioner issued Income Tax Employment Termination Payments (12 month rule) Determination 2018 (ETP 2018/1) which states that paragraph 82-130(1)(b) of the ITAA 1997 does not apply to a late termination where the payment is received more than 12 months after the termination of a person's employment, and the legal action regarding the persons entitlement to the payment or the amount of their payment was commenced within 12 months of the termination of employment; or the payment was made by a liquidator, receiver or trustee in bankruptcy of an entity that is otherwise liable to make the payment, where that liquidator, receiver or trustee is appointed no later than 12 months after the termination of employment.

From the information you have provided, you commenced your legal action more than 12 months since you terminated your employment. Therefore ETP 2018/1 does not apply in your circumstances.

Type of payment not mentioned in section 82-135

This phrase relates to types of payments listed in section 82-135 of the ITAA 1997. These payments include unused annul leave payments or unused long service leave and are not classified as employment termination payments.

Since your payments relate to the payment of outstanding wages, they are not a type of payment which is listed under section 82-135.

Application of section 82-130 to the payments you received from your employer

Therefore it is considered that the payments you received from your employer are not classified as ETP’s under section 82-130 of the ITAA 1997 as you commenced legal action more than 12 months after you terminated employment.

Reasons for decision – capital proceeds

Ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes the ordinary income they derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

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, and

● have an element of periodicity, recurrence or regularity.

For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433).

On the other hand, 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. Damages awarded for past or future loss or impairment of earning capacity is not ordinary income (Groves v. United Pacific Transport Pty Ltd [1965] Qd R 62).

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? explains the circumstances in which a lump sum compensation/settlement payment is assessable, and states that such a payment is assessable income:

● if the payment is compensation for loss of income only (even when the basis of the calculation of the lump sum cannot be determined), or

● to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature.

In your case, you sought compensation for lost income as well as other things. However, there is no identifiable portion of your payment that relates to your loss of income. The payment you received is not compensation for loss of income only and it does not relate to services performed. Rather the payment was received on the finalisation of a dispute you had with your previous employer. The payment is a one-off payment and thus does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation does not arise from any personal services performed.

The payment is not regarded as ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997.

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income and are also included in assessable income.

The other relevant provisions are discussed below.

Employment termination payment

A payment is an employment termination payment (ETP) if it satisfies all the requirements in section 82-130 of ITAA 1997.

Subsection 82-130(1) of the ITAA 1997 states that a payment is an ETP 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.

To find that a payment is an ETP, all the conditions in subsection 82-130(1) of the ITAA 1997 must be satisfied. Failure to satisfy any of one the three conditions will result in the payment not being considered an ETP.

Conclusion

The payment is not an ETP in accordance section 82-130 of ITAA 1997, as noted earlier in this ruling.

Capital gains tax provisions

Amounts received as a lump sum are generally capital in nature and are potentially taxable as statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

You make a capital gain (or loss) as a result of a CGT event happening (section 102-20 of the ITAA 1997).

A CGT asset is any kind of property or a legal or equitable right that is not property (section 108-5 of the ITAA 1997).

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts considers the CGT consequences for compensation payments.

In your case, your right to seek compensation is an intangible CGT asset (acquired at the time of the compensable wrong) and your ownership of that asset ended when you accepted the settlement sum. At that time CGT event C2 happened (section 104-25 of the ITAA 1997).

The capital proceeds from a CGT event are the total of the money you have received, or are entitled to receive, in respect of the event happening, and the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event) (section 116-20 of the ITAA 1997).

In your case, the capital proceeds will include the settlement payment paid.

As you acquired your right to seek compensation more than 12 months before the CGT event, you are able to apply the 50% general discount to your capital gain.

Allowable deductions

Section 8-1 of the ITAA 1997 allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, in determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).

In your case, the legal costs were not incurred in relation to the way you carried on your day to day income earning activities or the performance of your employment duties.

Your legal costs were incurred in relation to you resolving various disputes with your employer. Resolving these disputes would provide you with an enduring benefit.

An expense will usually be capital in nature where it is incurred with the intention to create an asset or advantage of a lasting and enduring nature. (British Insulated & Helsby Cables Ltd v. Atherton (1926) AC 205) The nature of the advantage sought by the taxpayer is therefore relevant.

The enduring benefit test was adopted and expanded by Dixon J in Sun Newspapers Limited v. FC of T (1938) 61 CLR 337 when expenditure is made once, with a view to bringing into existence an asset or advantage for the enduring benefit of the business, and absent of special circumstances leading to the opposite conclusion, this expenditure would be properly classified as capital.

In your case, resolving these employment disputes would have provided you with lasting advantages. Such advantages and enduring benefits are capital or of a capital nature.

As outlined above, the payment you received is capital in nature. It follows that the expenses incurred in pursuing the action and obtaining the payment are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses you incurred.

Please note that the legal expenses incurred form part of the cost base for CGT purposes (section 110-25 of the ITAA 1997).