Edited version of private advice

Authorisation Number: 1051981562137

Date of advice: 7 June 2022

Ruling

Subject: Employment termination payment

Question 1

Is the lump sum representing a payment at retirement from the Employer an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Does any part of the lump sum represent an invalidity segment under section 82-150 of the ITAA 1997?

Answer

Yes.

Relevant facts and circumstances

You commenced employment with the Employer.

You received a medical diagnosis of a disease.

You made an application for Voluntary Medical Retirement with the Employer. Enclosed with your application is a medical report completed providing details of your diagnosis and that you are unfit for work.

You were offered an arrangement to retire, which you accepted and then ceased full-time employment.

Two legally qualified medical practitioners provided signed medical certificates confirming that due to your diagnosis you are unlikely, because of the ill-health, to ever engage in gainful employment for which you are reasonable qualified by education, training or experience.

You received a lump sum from the Employer consisting of a taxable component and tax withheld.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 section 82-140

Income Tax Assessment Act 1997 section 82-150

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Employment termination payment

Section 995-1 of the ITAA 1997 states that:

employment termination payment has the meaning given by section 82-130 of the ITAA 1997.

Subsection 82-130(1) of the ITAA 1997 states that:

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 the lump sum paid to you constitutes an employment termination payment (ETP), all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

Failure to satisfy any of the conditions will result in the payment not being considered an employment termination payment. Furthermore, any termination payments received outside of the 12 months are taxed as ordinary income at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule.

Paid as a consequence of the termination of employment

It should be noted that the phrase in consequence of the termination of your employment is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase.

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) the Commissioner has considered the meaning of the phrase in consequence of.

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, as a result of a medical diagnoses you could no longer continue in your employment role.

You applied for voluntary medical retirement with your Employer, who offered you an arrangement to retire. This arrangement was accepted and you ceased employment.

In view of the above it is clear that the lump sum was made to you in consequence of termination of employment. Therefore, the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied.

The payment is received no later than 12 months after termination

The second condition for the payment to be an employment termination payment under paragraph 82-130(1)(b) of the ITAA 1997 is that the ETP is paid to the taxpayer no later than 12 months after the taxpayer's employment was terminated.

Your ETP was paid with 12 months.

Exclusions under section 82-135 of the ITAA 1997

Paragraph 82-130(c) of the ITAA 1997 specifies that one of the conditions for a payment to be an ETP is that it is not to be one of the types of payments mentioned in section 82-135 (payments that are not employment termination payments).

Section 82-135 of the ITAA 1997 includes payments such as pensions, foreign termination payments, unused annual leave and unused long service leave, a capital payment for personal injury and the tax-free part of genuine redundancy payments or early retirement scheme payments.

In your case consideration must be given as to whether the personal injury suffered by you is covered by the specific exemption for personal injury in paragraph 82-135(i) of the ITAA 1997. This subsection states that ETPs do not include:

(i) 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);

This exclusion is for a payment or benefit that compensates or reimburses the taxpayer for or in respect of a particular injury. Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the lump sum payment.

Therefore, the payment meets all the conditions in section 82-130 of the ITAA 1997 and is an ETP.

Invalidity segment

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 stops 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.

Section 995-1 of the ITAA 1997 defines being gainfully employed as follows:

gainfully employed means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment.

You were gainfully employed by the Employer.

Payment for stopping gainful employment

The payment was made to you because your employment with the Employer was terminated on medical grounds.

Your retirement on medical grounds was made by the Employer because you were medically unfit. In your application you provided the required medical reports, which confirmed you were unable to resume normal work due to your impairments. The subsequent incapacity payment received by you from your Employer would not have been approved and paid unless your employment with the Employer was terminated.

Accordingly, this requirement has been satisfied.

The employment termination occurred because of the ill-health of the taxpayer

The requirement under paragraph 82-150(1)(b) of the ITAA 1997 is that the termination of employment resulted from the taxpayer's ill health, that is, the ill health was the immediate cause for the termination of the taxpayer's employment.

In this case, the facts show the termination of employment occurred when your Employer offered you an arrangement to retire, which you accepted. This decision was based on result of your application where you provided evidence that due to your diagnosis, you are unlikely because of the ill-health, to ever engage in gainful employment for which you are reasonable qualified by education, training or experience.

This indicates that you were unable to resume your normal work duties due to your medical incapacity. Therefore, it is considered that this requirement has been satisfied.

The termination of employment of the taxpayer occurred before the last retirement date in relation to the employment

The third condition for a payment to qualify as an invalidity segment is that the termination of employment occurs before the taxpayer's last retirement day.

The term 'last retirement day' is defined in section 995-1 of the ITAA 1997 as follows:

last retirement day means:

(a) if an individual's employment or office would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be); or.

(b) in any other case - the day on which he or she would turn 65.

Your last day of service with the Employer was well before the normal retirement age of 65.

Therefore, the condition set out under paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied.

Certification from 2 legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed

In respect of this requirement, it must be demonstrated that the disability was such that it is unlikely that the person can ever be gainfully employed in a capacity for which he or she is reasonably qualified because of education, experience or training.

Therefore, paragraph 82-150(1)(d) of the ITAA 1997 requires that there must be the likelihood that the disability of the taxpayer will preclude the taxpayer from ever being employed in a role, for which the taxpayer is reasonably qualified.

Further, the requirement that the disability is likely to result in the taxpayer being unable ever to be employed in a capacity for which he or she is reasonably qualified extends to full-time employment, part-time or casual employment. A person who is not able to work full-time but can work part-time or casual in any employment for which the taxpayer is reasonably qualified will not receive the concessional component.

In your case, two qualified medical practitioners have certified that you are suffering from a medical condition, which in their opinion states that you are unable to return to work on a long term indefinite basis.

Therefore, after examining the contents of the medical reports provided it is considered the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997 is satisfied.

Tax exemption for an invalidity payment

Under section 82-140 of the ITAA 1997 the invalidity segment included in an ETP is tax free.

The taxable component of an ETP is the amount of the payment less the tax free component of the payment.

As you have satisfied the requirements for the payment of an invalidity payment, an element of the ETP received from the Employer will be tax free.

The amount of the invalidity segment is worked out by applying the formula in subsection 82-150(2) of the ITAA 1997:

Work out the amount of the invalidity segment by applying the following formula:

where:

days to retirement is the number of days from the day on which the person's employment was terminated to the last retirement day.

employment days is the number of days of employment to which the payment relates.

The $XXX invalidity segment included in the ETP is tax free. The remaining amount is a taxable component to be included in your income tax return for the 20XX-XX income year.