Edited version of private advice

Authorisation Number: 1051700260156

Date of advice: 1 July 2020

Ruling

Subject: Assessability of ex-gratia payment

Question 1

Is the ex-gratia payment made to you by your former employer considered to be an employment termination payment as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the ex-gratia payment made to you by your former employer assessable under section 15-2 of the ITAA 1997?

Answer

No

Question 3

Is the ex-gratia payment made to you by your former employer when you accepted the terms of the Deed of Release considered a Capital Gain?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You commenced full-time employment with your Former Employer as a Research Associate. The appointment was for a fixed term period.

The latter position was funded from a grant made for research purposes and the Former Employer was unable to contribute funds from other sources towards the appointment. Your appointment was contingent upon the continuing provision of funding for your specified research project. Should the funding be withdrawn for any reason during the fixed term, your appointment would have terminated with immediate effect.

When the term of the contract ended your full-time employment with the Former Employer (to continue research) was renewed as a Research Associate.

Your full-time employment with the Former Employer (to continue research) was again renewed for another period of time as a Research Associate.

During the last period of your employment you were advised that your contract would not be renewed for the next year due to limited funding and asked to take your remaining leave starting within the coming days.

You lodged a complaint a few weeks later with the Former Employer. The complaint broadly identified three matters that you sought consideration of:

·         Possible research misconduct by a colleague;

·         An inappropriate and inadequate internal review (the Review) by an affiliated organisation into the possible research misconduct; and

·         Adverse personal and professional impacts as a result of the above two matters.

At the end of the last contract period your employment with the Former Employer ended.

During the following year you commenced employment with another employer as a Research Officer.

Later that same year the Former Employer wrote to you in response to a request from you for an update to your complaint. The Former Employer apologised for the lack of contact in providing you with case updates and stated:

a) I have been closely following the progress of the inquiry (which arose from your complaint);

b) I am aware of the various reasons which have contributed to the time it is taking to complete the enquiry;

c) I am considerate of how the complaint process may have negatively impacted on you; and

d) A full review of this case will be undertaken at its conclusion for the purposes of continuous improvement at both this centre and its affiliated organisations.

With regard to "c)" the author stated that another colleague...provided you with a written reference...I hope this goes some way towards remedying this situation for you.

Early in the following year the Former Employer wrote to you in relation the "complaint outcome". The letter formally advised you of the findings and outcomes and provided you with the Notice of Findings. In summary, the findings were:

·         On the balance of probabilities, it is most likely that in relation to the disputed data, data fabrication most likely occurred and that the allegation of research misconduct had been substantiated;

·         That your concern regarding the Review was substantiated;

·         Recognition that this situation has 'adversely' impacted on your development as an early career researcher and that they will 'work with you to identify options aimed at restoring your research career progression'.

Later that year the Former Employer wrote to you in relation to 'Complaint Findings and Outcome", reiterating that one of the mattes were substantiated and the two other matters were partially substantiated. The letter stated (amongst other matters):

As the Former Employer has found your complaint to be partly justified, I am also writing to propose a resolution.

A colleague was responsible for providing you with support to assist you to produce a publication prior to the end of your contract.

Your employment ended because there were no funds available. The colleague invested significant energy in trying to find you a viable, manageable project in their laboratory.

The events at the second research centre and duration of the investigation processes have impacted not only on you personally but also on your career progression.

The Former Employer acknowledges your view that you formed an honest belief that the end of your contract was directly related to your allegation of research misconduct.

In light of the above the Former Employer proposes what it considers to be an appropriate remedy for you: They would like to offer you a two-year contract commencing at a certain level. This contract will enable you to undertake further research and receive research mentoring with another colleague. The Complaint Resolution Unit will be able to provide you with a Deed of Settlement to formalise this offer should you choose to accept it and to discuss any concerns you may have regarding the offer and/or deed.

In a later email, the Former Employer agreed to a letter, 'as per your request to be provided in order to support your future career endeavours'.

The Former Employer provided a reference for you which provided details of your academic record, details of your project whilst employed with the Former Employer, as well as stating that there was an issue which adversely impacted on your ability to achieve a 'publishable output' during your employment. The Former Employer stated:

'Following an investigation, the Former Employer had been provided fabricated data by an external contractor.'

Sometime after this, you and the Former Employer commenced negotiations around your entitlement to and quantum of an ex gratia payment as well as other matters around the report and the final form of the Deed.

Subsequently, you and the Former Employer agreed to settle the Complaint and all matters between you arising out of the Employment and the termination of the Employment, in accordance with the terms of the Deed of Settlement and release (the Deed) without any admission as to liability (Recital 4).

During the 20XX-20XX income year you executed the deed.

The Deed provides, in part, that:

(a) Your termination date, and

(b) You commenced the Complaint (Recital 3).

(c) The parties agreed to settle the complaint, which was defined as a series of complaints lodged with the Former Employer about your employment with their affiliate.

(d) You were to be paid a 'Settlement Sum' in accordance with clause 2.1(a).

(e) Settlement Sum under clause 2.1(a) is defined as the Former Employer paying you an ex-gratia payment on the basis that the payment is not compensation and is not income-related.

(f) The Settlement Sum will be paid by the Former Employer within 14 days of both parties executing this Deed, in full satisfaction of all obligations of the Former Employer towards you and is made without any admission of liability by the Former Employer.

(g) The Former Employer makes no representations in relation to your tax liability in relation to the Settlement Sum.

(h) Each party must pay its own legal costs and expenses in respect of the negotiation, preparation and completion of the Deed.

The Former Employer provided a reference for you which included (amongst other things) the following:

·         conformation that you are presently employed by as a Research Officer;

·         details of your employment as a Research Associate with the Former Employer and the research project you were focussed on;

·         confirmation that while you were employed with the Former Employer an issue arose during your employment which adversely impacted on your ability to achieve 'a publishable output';

·         confirmation that following an investigation, the Former Employer found that you were provided with fabricated data by an external contractor.

The Deed of Release has been fully executed and you received the ex-gratia payment within the timeframe agreed to in the deed.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 subsection 102-5(1)

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 15-2

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 104-25(2)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 Division 82

Income Tax Assessment Act 1997 Section 82-130

Income Tax Assessment Act 1997 Section 82-135

Income Tax Assessment Act 1997 section 116-20

Reasons for decision

Summary

The ex-gratia payment is not an employment termination payment (ETP).

The ex-gratia payment is not assessable ordinary income.

The lump sum compensation payment will be assessable under the capital gains tax provisions.

CGT event C2 happened when you accepted the offer of compensation and entered into a Deed of Settlement and Release.

The 50% general discount will apply to the capital gain you made as a result of CGT event C2 happening.

Detailed reasoning

Employment termination payment

Division 82 sets out how ETPs are treated for income tax purposes.

A payment is an ETP if it satisfies all the requirements in section 82-130 and is not specifically excluded under section 82-135.

Subsection 82-130(1) 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 that termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135.

Section 82-135 provides that certain payments are not employer termination payments. Relevantly, these include (among others):

·         unused annual leave or long service leave payments; and

·         reasonable capital payments for, or in respect of, personal injury.

In consequence of termination of employment

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 contains references to repealed provisions, some of which may have been rewritten, the ruling still has effect 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 paragraphs 5 and 6 of TR 2003/13 the Commissioner states:

5. ... a 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.

In your case, you were employed on a full-time basis with the Former Employer on fixed term contracts as a Research Associate.

You were later advised that your contract would not be renewed for the following year due to limited funding. Your employment subsequently terminated.

The reason for the non-renewal of your fixed term contract was again reiterated in a letter in which the Former Employer stated that 'your employment ended because there were no funds available'.

Eventually, you executed the Deed in which it was agreed that you would receive an ex-gratia payment from the Former Employer within 14 days of both parties executing the Deed in full and final settlement of the complaint (lodged with the Former Employer) without any admission as to liability.

Based on the Commissioner's views expressed in TR 2003/13, 'in consequence of the termination' requires that termination be a cause, but not necessarily a dominant cause of the payment.

As per the facts of your case, the ex-gratia payment you received was not connected to your termination. Your termination was not the cause of the ex-gratia payment made to you.

Further, it cannot be argued that the ex-gratia payment followed 'as an effect or result of' your termination, or that 'but for the termination' of your employment the ex-gratia payment would not have been made to you. There is no causal connection between the termination of your employment and the payment of the ex-gratia amount in the 2019-20 income year.

Whilst settlement of your complaint and the payment of the ex-gratia amount in early 2020, happens to be after the termination of your employment, the connection to the termination of your employment is temporal.

The dominant cause of the ex-gratia payment was to settle the complaint/claims you initiated against the Former Employer, which pre-dated your dismissal and were unrelated to the termination of your employment. The requisite causal connection between your termination of employment and the ex-gratia amount paid is absent.

As the ex-gratia payment (Settlement Sum) is not 'in consequence of' the termination of your employment with the Former Employer, that amount is therefore not an ETP.

Accordingly, subparagraph 82-130(1)(a)(i) is not satisfied.

Assessable ordinary income

SECTION 15-2 outlines allowances and other things provided in respect of employment or services

15-2(1)Your assessable income includes the value to you of all allowances, gratuities, compensation, benefits, bonuses and premiums *provided to you in respect of, or for or in relation directly or indirectly to, any employment of or services rendered by you (including any service as a member of the Defence Force).

15-2(2) This is so whether the things were *provided in money or in any other form.

The ex-gratia payment you received was compensation for the potential damage to your reputation and was not related to your employment services. Accordingly the payment is not considered ordinary income and therefore is not assessable.

Capital Gains Tax

Your assessable income includes your net capital gain for the income year (subsection 102-5(1) 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).

CGT event C2 happens if your ownership of an intangible CGT asset ends in certain ways, including being released or cancelled (subsection 104-25(1) of the ITAA 1997). The time of the event is when you enter into the contract that results in the asset ending, or if there is no contract, when the asset ends (subsection 104-25(2) 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).

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 entered into the Deed of Settlement and Release with the Former Employer). At that time CGT event C2 happened.

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 include the lump sum payment you received under the Deed of Settlement and Release.

You will make a capital gain if those proceeds are more than the right's cost base.

The cost base of the right to seek compensation is determined in accordance with the provisions of section 110-25 of the ITAA 1997. The cost base of a CGT asset consists of 5 elements (subsection 110-25(1) of the ITAA 1997).

The first element includes in the cost base any consideration in respect of the acquisition of the right to seek compensation (subsection 110-25(2) of the ITAA 1997). As a general rule, a taxpayer does not pay or give any money or property to acquire the right to seek compensation.

The second element is the incidental costs you incur to acquire a CGT asset or that relate to a CGT event (subsection 110-25(3) of the ITAA 1997). Incidental costs include remuneration for the services of accountants, financial advisers and legal advisers (subsection 110-35(2) of the ITAA 1997). However, expenditure does not form part of the second element of the cost base to the extent that you have deducted it or can deduct it (subsection 110-45(1B) of the ITAA 1997).

The other three elements are not relevant to your circumstances.

50% general CGT discount

Section 115-25 of the ITAA 1997 generally allows any individual to apply a 50% discount to any capital gain provided that the CGT event to which the capital gain relates occurs at least 12 months after the asset is acquired.

You acquired the right to seek compensation when you commenced employment. You disposed of this right when you enter into the Deed of Release in 2020.

As your right to seek compensation was acquired more than 12 months before the disposal will occur, you can apply the 50% general discount to the capital gain you will make from CGT event C2 happening.

Application to your case

The lump sum payment you received for entering into the Deed of Settlement will be capital proceeds from CGT event C2 happening. As you acquired the right to seek compensation more than 12 months before the disposal will occur, you can apply the 50% general discount to your capital gain.