Edited version of private advice

Authorisation Number: 1051975267214

Date of advice: 5 May 2022

Ruling

Subject: Employment termination payment - settlement payment.

Question 1

Is the settlement payment from your former Employer an employment termination payment as per section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the settlement payment a redundancy payment in accordance with section 83-175 of the ITAA 1997)?

Answer

No.

Question 3

Are thelegal expenses relating to the settlement payment an allowable deduction under section 8-1 of the ITAA 1997?

Answer

No.

Relevant facts and circumstances

You were employed by the Employer.

In 20XX you were dismissed by the Employer.

You did not receive an employment termination payment (ETP).

You commenced proceedings alleging that your termination was in contravention of the general protection provisions of the Fair Work Act 2009 (Dispute) in the Federal Circuit Court of Australia.

You entered into a Deed of Settlement and Release (the Deed) with the Employer.

Without any admissions whatsoever, the parties have agreed to resolve the Dispute on the terms set out in the Deed.

The Settlement Sum was to be treated as general damages to be paid by the Employer to you in accordance with the Deed.

The following clauses are included in the Deed:

Payment to the Applicant

The Employer will pay the Applicant the Settlement Sum within 14 days of the date of this Deed.

Releases

Upon the execution of this Deed, the Respondents unconditionally and irrevocably releases and discharges the Applicant from the Claims.

Upon full payment by the Employer to the Applicant of the Settlement Sum, the Applicant will unconditionally and irrevocably release and discharge each of the Respondents from the Claims.

Costs

Each of the parties to this Deed will bear their own costs of and incidental to the negotiation, preparation and execution of this Deed.

The Employer failed to make the payment within 14 days as per the Deed.

You lodged a Court Order in relation to the non-payment.

An Instalment order and notice was issued advising that the Employer to make 12 monthly Instalments to total the full payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 section 83-175

We followed these ATO view documents

Taxation Ruling 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'

Taxation Ruling TR 2009/2: Income tax: genuine redundancy payments

Taxation Determination TD 93/29 Income tax: if an employee incurs legal expenses recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997?

Reasons for decision

ETP settlement payment

A payment is an ETP if it satisfies all the requirements in section 82-130 of the ITAA 1997 and is not specifically excluded under section 82-135 of the 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 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.

Paid 'in consequence' of the 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. Taking into account the courts decisions on the meaning of the phrase, the Commissioner's view on the meaning and application of the 'in consequence of' test are set out in Taxation Ruling 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).

Paragraphs 5 and 6 of TR 2003/13 state that:

5....the Commissioner considers that 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.

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 made in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

At paragraph 32 of TR 2003/13 the Commissioner considers payments from a former employer to settle litigation:

32. The Federal Court in Dibb v. FC of T adopted the approach of Goldberg J in Le Grand. At issue was whether a payment received by the taxpayer under a deed of release, following the settlement of Federal Court proceedings against his former employer, was an ETP. In deciding the payment was an ETP, Heery J held that the length of time between the termination of employment, the commencement of court proceedings and payment following settlement did not sever the causal connection between the termination and the payment. It was sufficient that the subject matter of the litigation was the termination. Heery J found at 296 that:

'The various causes of action whether breach of contract, conspiracy, breach of fiduciary duty or contravention of the Trade Practices Act were, as Goldberg J would say (Le Grand at [36]), 'interwoven and intertwined' with the termination. The payment was a consequence of the settlement, which was a consequence of the Federal Court proceeding, which in turn was a consequence of the termination.'

The payments in these cases were ETPs because there was a sequence of connected events following the termination which ultimately led to the payment. The payments would not have been made but for the termination.

In this case, after you were dismissed from your employment you filed an application with the Fair Work Act 2009 in the Federal Circuit Court of Australia to review your non-payment of an ETP. You and the Employer agreed, without any admissions whatsoever, to settle the claim and your differences under the terms of the Deed. You and the Employer unconditionally and irrevocably release and discharge each other from the claims.

While the settlement of the legal proceedings is a direct cause of the payment, the proceedings in respect of the claim were commenced by you as a result of the termination of your employment. That is, there was a sequence of events following the termination which had a relationship and connection which ultimately led to the settlement payment - the termination, claim for an ETP, legal proceedings and payment were all intertwined.

Therefore, it is considered that the settlement payment was received by you in consequence of the termination of your employment with the Employer as per paragraph 82-130(1)(a) of the ITAA 1997.

The payment is received no later than 12 months after termination

The Agreement stipulates that the Employer will pay you the settlement amount within fourteen days of receiving a duly executed copy of the Agreement, which was dated 15 June 2020.

If the payment is made within 12 months of the date that termination is effective, the requirement in paragraph 82-130(1)(b) of the ITAA 1997 will be satisfied. If the payment is not made within this time period, then the Commissioner may make a determination under subsection 82-130(5) that paragraph 82-130(1)(b) does not apply to you if the time between the employment termination and the payment is reasonable.

In this case, the Employer failed to make the ETP within the time frame of the Deed. In accordance with the subsequent Court Order, the ETP will be paid by instalments over a 12 month period. The Commissioner has determined that this is a reasonable period of time considering the circumstances.

Genuine redundancy

A payment made to an employee is a genuine redundancy payment if it satisfies all of the criteria set out in section 83-175 of the ITAA 1997.

In accordance with subsection 83-175(1) of the ITAA 1997, a genuine redundancy payment is so much of a payment received by an employee, who is dismissed from employment because the employee's position is genuinely redundant, as exceeds the amount that could reasonably be expected to be received by the employee in consequence of the voluntary termination of his or her employment at the time of the dismissal.

Paragraph 11 of Taxation Ruling TR 2009/2: Income tax: genuine redundancy payments (TR 2009/2), outlines the requirements to be satisfied under subsection 83-175(1) of the ITAA 1997. There are four necessary components within this requirement:

•         The payment being tested must be received in consequence of an employee's termination.

•         That termination must involve an employee being dismissed from employment.

•         That dismissal must be caused by the redundancy of the employee's position.

•         The redundancy payment must be made genuinely because of a redundancy.

The Commissioner's view is that a genuine redundancy payment can only arise where there is no suitable job available for the employee with the employer, meaning that he or she must therefore be dismissed. TR 2009/2 states:

25. An employee's position is redundant when an employer determines that it is superfluous to the employer's needs and the employer does not want the position to be occupied by anyone. Accordingly, it is fundamentally the employer's decision that a position is redundant. On occasion the decision may be unavoidable due to the circumstances surrounding the employer's operations.

Based on the information provided, the essential components of subsection 83-175(1) of the ITAA 1997 have not been satisfied, as no evidence has been provided that your position with the Employer was made redundant and will not to be occupied by anyone.

Therefore, your ETP will not be classed as a genuine redundancy payment and will be taxed concessionally in accordance with the ETP rates.

Legal expenses

You incurred legal expenses relating to the settlement agreement.

Apart from specific provisions, legal expenses are deductible under section 8-1 of the ITAA 1997 if incurred in gaining or producing assessable income, or if necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income.

In determining whether a deduction for legal expenses is allowed, 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 by employees and former employees if they arise out of:

•         recovering unpaid wages, unused annual leave and unused long service leave in accordance with the principles contained in Taxation Determination TD 93/29 Income tax: if an employee incurs legal expenses recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997?

•         instituting proceedings and settling disputes arising out of employment agreements, such as to enforce a contractual entitlement

•         preventing redundancy or dismissal

•         defending the manner in which employment duties are performed.

In contrast, legal expenses incurred in seeking compensation for loss of employment are not deductible. It is irrelevant if any amount awarded to the employee is calculated by reference to unpaid salary or lost income. As outlined at paragraph 5 of TD 93/29, legal expense relating to an action for damages for wrongful dismissal are not deductible as the claim is of a capital nature.

ETP's are subject to special tax treatment that may result in some or all of the amounts being included in assessable income. However, the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in assessable income.

As ETP's are capital in nature, any legal expenses associated with obtaining the ETP are also capital in nature and not deductible.

In your case, the settlement payment you received was an agreed amount to compensate you for the termination of your employment and to cease claims against your former Employer. The payment was not received for income contractually owed under your employment contract.

As your legal expenses related to an item which is capital in nature, the legal expenses are also capital in nature. Therefore, the legal expenses are not deductible under section 8-1 of the ITAA 1997.