Edited version of private advice

Authorisation Number: 1051623416276

Date of advice: 20 December 2019

Ruling

Subject: Income Tax - Compensation and Employment Termination Payment

Question 1

Is the proposed lump sum payment of arrears of weekly payments assessable as ordinary income?

Answer

Yes.

Question 2

Is the proposed lump sum payment for reasonable medical and like expenses to be made in accordance with the provisions of your States workers compensation legislation assessable income?

Answer

No.

Question 3

Is the portion of the lump sum payment that is not related to unused annual or long service leave, a payment, benefit or reimbursement for personal injury or a tax free component assessable as an employment termination payment in accordance with section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Financial year ending 30 June 2020

The scheme commences on:

1 July 2019

Relevant facts and circumstances

You suffered a compensable injury.

As a result you made a claim for compensation under your states workers compensation legislation.

The self-insured employer rejected you claim.

You made an application for review in your states Employment Tribunal (ET) to have the decision reviewed.

The application for the review was resolved under a standard form of Order.

You were found to be entitled to payment of arrears of weekly payments as a consequence of the Orders.

You were found to be entitled to payment of reasonable medical and like expenses.

On a commercial basis and without admission of liability by the employer or obligation to do so, the employer and yourself have agreed to settle all matters relation to your employment on the terms contained in the Deed of Settlement (Deed).

You will receive a lump sum settlement sum.

You will resign from your employment on the date the Deed is signed.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 6-5

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

Income Tax Assessment Act 1997 subsection 6-5(4)

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 82-10

Income Tax Assessment Act 1997 subsection 82-10(1)

Income Tax Assessment Act 1997 subsection 82-10(2)

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 paragraph 82-130(1)(b)

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

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 paragraph 82-135(i)

Income Tax Assessment Act 1997 section 82-140

Income Tax Assessment Act 1997 section 82-145

Income Tax Assessment Act 1997 section 82-150

Income Tax Assessment Act 1997 subsection 82-150(1)

Income Tax Assessment Act 1997 subsection 82-150(2)

Income Tax Assessment Act 1997 section 82-155

Reasons for decision

Weekly payments of arrears

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the income year.

Workers compensation policies provide for periodic payments in the event of loss of income caused by a work related injury or illness. These payments are assessable as income under section 6-5 of the ITAA 1997, as they are paid to take the place of lost earnings.

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings deals with the derivation of ordinary income and states that the general rule with non-trading income is that it is derived when it is received.

Subsection 6-5(4) of the ITAA 1997 provides that in working out whether a taxpayer has derived an amount of ordinary income and when it is derived, the taxpayer is taken to have received the amount when it is applied or dealt with in anyway on the taxpayer's behalf or as the taxpayer directs.

In your case, the lump sum you will receive for your entitlement to payment of weekly payments, is a payment for loss of earnings and subsequently will need to be included as part of your assessable income in the financial year in which it is received.

Medical expenses

You have also been awarded payment of reasonable medical and like expenses in accordance with the States workers compensation legislation as a consequence of psychiatric injury that was accepted as compensable by the Orders.

Amounts identifiable as a payment for or reimbursement of, medical and like expenses are private and personal in nature are not taxable.

Employment Termination payment

Your assessable income also includes statutory income amounts which are not ordinary income but are included in your assessable income by another provision of the tax law (section 6-10 of the ITAA 1997).

Section 10-5 of the ITAA 1997 lists those provisions. Included in this list is section 82-10 which deals with ETP's

For the lump sum payment to be considered an ETP, the payment must satisfy the definition of an ETP set out in subsection 82-130(1) of the Income Tax Assessment Act 1997 (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 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.

In consequence of the termination of your employment

The Commissioner's view on the meaning of the phrase 'in consequence of; in the context of termination of employment is set out in 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'.

In paragraph 5 and 6 of TR 2013/13, the Commissioner states;

5. ..... payment is received by a taxpayer in consequence of the termination of the taxpayer's employment 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 received by 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 received in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

Based on the information you have provided, you propose to sign the Deed and the employer agrees to pay you a lump sum on the date the Deed is signed.

Applying the Commissioner's view to your situation, it is clear that a connection between the payment of the lump sum and the termination of your employment exists. This is because the Deed requires you to terminate you employment on the date you sign the Deed.

Consequently, you will receive the lump sum 'in consequence of' terminating your employment.

The 12 month rule set out in paragraph 82-130(1)(b) of the ITAA 1997

Paragraph 82-130(1)(b) of the ITAA 1997 specifies that the payment must be received within 12 months of the employee's termination of employment, unless they are covered by a determination exempting them from the '12 month rule'.

As per the facts of this case, you have not yet signed the Deed proposed to you by the employer and the Deed requires you to terminate your employment on the date you sign the Deed.

For this payment to meet the 12 month rule, the payment will need to be received by you within 12 months from termination. In this case, the termination date will be when you sign the Deed.

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

Paragraph 82-130(1)(c) of the ITAA 1997 provides that any payments listed in section 82-135 of the ITAA 1997 are not classified as ETPs.

Section 82-135 of the ITAA 1997 lists examples of payments which are not ETPs.

In this case, the lump sum which you will receive for your employer includes amounts relating to your entitlements around unused annual leave and unused long service leave.

Hence, payments relating to unused annual and long service leave are not considered to be ETPs as they are covered under paragraphs (c) and (d) of section 82-135 of the ITAA 1997.

Also, based on the nature of the injuries you suffered when working with the employer, we must give consideration to whether or not any part of the lump sum you will receive contains a reasonable capital payment for personal injury as per subsection 82-135(i) of the ITAA 1997.

Paragraph 82-135(i) of the ITAA 1997 states that an employment termination payment does not include:

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);

Payments that fall within this exclusion are payments or benefits that compensate or reimburse the person for or in respect of the particular injury.

Hence, if any part of the lump sum you will receive consists of payments, benefits or reimbursements for personal injury, the amounts relating to such payments are not considered to be ETPs.

Application of section 82-130 of the ITAA 1997 to the payment that you will receive from the employer

Based on the above criteria, the lump sum you will receive for the employer will be considered an ETP, This is provided that you terminate your employment with the employer on the date you sign the Deed and you receive the lump sum within 12 months of termination.

However, the part of the lump sum which includes amounts relating to unused annual leave, unused long service leave and, if applicable, any payments, benefits or reimbursements for personal injury will not be classifies as an ETP.

Therefore, the amount of the lump sum payment which will be considered an ETP is $xx,xxx less any amounts relating to unused annual leave, annual leave, unused long service leave and, if applicable any payments, benefits or reimbursements for personal injury.

Taxation of employment termination payments

An ETP made may be comprised of the following components:

·        the tax free component; and

·        the taxable component

Subsection 82-10(1) of the ITAA 1997, states that the 'tax free component' of a life benefit termination payment is not assessable and is not exempt income.

Tax free component is defined in section 82-140 of the ITAA 1997 as so much of the ETP as consists of the following:

(a)   the invalidity segment of the payment with the meaning of section 82-150 of the ITAA 1997;

(b)   the pre-July 83 segment of the payment within the meaning of section 82-155 of the ITAA 1997.

Based on the information you have provided, the ETP portion of the lump sum you will receive may have an invalidity segment under section 82-150 of the ITAA 1997.

Subsection 82-150(1) of the ITAA 1997 states that:

An employment termination payment includes an invalidity segment if:

(a)   the payment was made to a person because he or she stopes 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.

*       the definition of terms 'gainfully employed' and 'last retirement day' can be found under subsection 995-1(1) of the ITAA 1997.

In your case, if the ETP portion of the lump sum you receive satisfies all the conditions stated above, it will contain an invalidity segment. The amount of this segment can be worked out be using the formula prescribed under subsection 82-150(2) of the ITAA 1997.

However, if the lump sum you receive does not satisfy the conditions outlined in subsection 82-150(1), then the EPT portion of you lump sum will not include any tax free components.

Taxable component

Pursuant to section 82-10(2) of the ITAA 1997, the taxable component of a life benefit ETP is assessable income.

In accordance with section 82-145 of the ITAA 1997, the taxable component of an ETP is taxed at 30% for amounts below the ETP cap amount ($210,000 for the 2019-20 income year), and at the top marginal rate for amounts above the cap (subsection 82-10(3) of the ITAA 1997).