Edited version of private advice

Authorisation Number: 1052037653817

Date of advice: 13 December 2022

Ruling

Subject: Employment termination payments

Question 1

Is the settlement amount for general damages ("Amount 1") paid to you included in your assessable income as ordinary income?

Answer

No.

Question 2

Is Amount 1 paid to you included in your assessable income as an employment termination payment?

Answer

Yes.

Question 3

Is Amount 1 paid to you included in your assessable income as a capital gain?

Answer

No.

Question 4

Is the settlement amount for legal costs ("Amount 2") paid to your solicitor included in your assessable income as ordinary income?

Answer

Yes.

Question 5

Is Amount 2 paid to your solicitor included in your assessable income as an employment termination payment?

Answer

No.

This ruling applies for the following period:

30 June 20YY.

The scheme commences on:

1 July 20YY.

Relevant facts and circumstances

You have advised that you were employed with a company ("the Previous Employer") from mid-YYYY to mid-YYYY.

You advised that you commenced employment with another company ("the Current Employer") in mid-YYYY. The director for the Previous Employer and the Current Employer is the same individual ("the Director").

You provided a copy of a document dated early YYYY, which details a psychiatric assessment that took place in early YYYY. This psychiatric assessment stated that you had been suffering from various physical and mental symptoms due to the ongoing bullying and harassment you underwent at your workplace, which worsened in the last X months of YYYY and culminated in an event in early YYYY.

The psychiatric assessment concluded that you had been suffering from a psychiatric illness and that this illness had 'come about as a result of the way [you were] treated at work'.

The psychiatric assessment stated that you stopped working for the Current Employer in early YYYY. You advised that this was the last day that you physically worked for the employer, and that you were on leave from that date onwards while the insurer's investigation and related legal procedures were undertaken.

The psychiatric assessment stated that you hadn't gone back to work from early YYYY to the date of the assessment. The assessment stated that you had visited an employment agency to attempt to return to work, but had been informed by an individual there that you were not ready to get another job. The assessment also stated that, at the date of the assessment, you felt ready to go back to work but did not feel that you would ever be able to work for the Director.

You advised that, in early YYYY, you filed a workers' compensation claim ("Workers' Compensation claim") alleging that you had suffered an injury due to ongoing harassment and bullying by the Director during your employment.

You further advised that the investigation into the Workers' Compensation claim by the insurer commencing and concluding in early YYYY.

You have provided a copy of a document dated mid-YYYY from an insurance company. This document stated that your Workers' Compensation claim for your psychiatric injury sustained in early YYYY was accepted by the insurance company in early YYYY.

In early YYYY, you lodged a claim in an employment tribunal in relation to underpayment from the Previous Employer from mid-YYYY to mid-YYYY. You advised that this claim was for the underpayment of wages and leave entitlements, and that you were claiming that you were a full-time employee whereas the Previous Employer was claiming that you were a casual employee.

You advised that you returned your tools and equipment to your employer in mid-YYYY. In an email to the case officer in late YYYY, you stated that the investigation made it obvious that you would be unable to return to your previous employment.

In mid-YYYY, the Current Employer lodged an application to commence proceedings in the employment tribunal in response to the Workers' Compensation claim. These proceedings were scheduled to commence in mid-YYYY, but were formally concluded upon the signing of the Deed of Settlement ("the Deed") between you, the Current Employer and the Previous Employer in late YYYY.

You provided a copy of this Deed.

Paragraph F of the Recitals to the Deed stated that you ceased work with the Current Employer on a stated date in early YYYY.

The phrase 'The Termination date' is defined in paragraph 2 of the Deed as the abovementioned stated date in early YYYY.

Clause 4 of the Deed stated that you would be paid two settlement amounts 'in consideration of the releases provided in this document'.

Clause 4(a) of the Deed stated that you would be paid a stated amount as 'payment in respect to general damages' ("Amount 1").

You advised that you received Amount 1 directly in late YYYY.

Clause 4(b) of the Deed stated that you would be paid another stated amount as 'payment in respect to the Employee's legal costs'. ("Amount 2").

You advised that Amount 2 was received by your solicitor directly in late YYYY.

You have provided a copy of communication from your solicitor, dated late YYYY, where your solicitor states that Amounts 1 and 2 did not relate to income or wages. In this communication, your solicitor stated that the deed made reference to your Workers' Compensation claim and the 's18 release of your employer', which the payments would be in reference to.

You have advised that the 's 18 release' refers to section 18 of the Return to Work Act 2014 (SA).

The communication from your solicitor also stated that clause 9 of the Deed confirmed that you would discontinue your Workers' Compensation claim in exchange for the Current Employer's compliance with their obligations under the Deed.

Clause 6 of the Deed ("the Release clause") stated that you would release the Previous Employer, the Current Employer and the Director of all claims made against them in exchange for their compliance with their obligations under the Deed.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5.

Income Tax Assessment Act 1997 subsection 6-5(1).

Income Tax Assessment Act 1997 section 6-10.

Income Tax Assessment Act 1997 subsection 6-10(1).

Income Tax Assessment Act 1997 subsection 6-10(2).

Income Tax Assessment Act 1997 section 10-5.

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)(a).

Income Tax Assessment Act 1997 section 82-135.

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

Income Tax Assessment Act 1997 paragraph 104-25(1)(b).

Income Tax Assessment Act 1997 paragraph 108-5(1)(b).

Income Tax Assessment Act 1997 paragraph 118-20(1)(b).

Income Tax Assessment Act 1997 section 118-22.

Income Tax Assessment Act 1997 section 118-37.

Income Tax Assessment Act 1997 section 995-1.

Income Tax Assessment Act 1997 subsection 995-1(1).

Return to Work Act 2014 (SA) section 18.

Return to Work Act 2014 (SA) subsection 18(1).

Reasons for decision

Question1

Summary

Amount 1, paid to you for general damages, is not included in your assessable income as ordinary income.

Detailed reasoning

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that an individual's assessable income would include 'income according to ordinary concepts', known as 'ordinary income'. However, this subsection does note that the treatment of ordinary income may be affected by the list of assessable income provisions in section 10-5 of the ITAA 1997.

Subsection 6-10(1) of the ITAA 1997 states that your assessable income may include some amounts that are not ordinary income, and a summary list of these provisions can be found in section 10-5 of the ITAA 1997. Employment termination payments are included in this list.

Subsection 6-10(2) of the ITAA 1997 states that amounts which are not ordinary income, but are included in assessable income by certain provisions determining them as such, are known as statutory income.

Therefore, by virtue of section 6-10 of the ITAA 1997, Amount 1 is not included in your assessable income as ordinary income, because it is statutory income.

Question2

Summary

Amount 1, paid to you for general damages, is included in your assessable income as an employment termination payment (ETP).

Detailed reasoning

Employment termination payments are defined in subsection 82-130(1) of the ITAA 1997 as follows:

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.

Therefore, to be considered an 'employment termination payment', a payment must be received by the taxpayer in consequence of the termination of their employment, be received no later than 12 months after that termination, and not be included under section 82-135 of the ITAA 1997.

Paid 'in consequence of' the termination of employment:

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) states 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.'

Although TR 2003/13 contains references to repealed provisions, it still has effect.

Payments in the settlement of litigation proceedings regarding the termination of a taxpayer's employment was specifically addressed in TR 2003/13:

'32. The Federal Court in Raymond Joseph 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.'

As outlined in the Deed, Amount 1 was paid to you 'in respect to general damages', and you and your solicitor have contended that this relates to the injury you sustained from your employment.

As per the psychiatric assessment, you suffered from a psychiatric injury owing to your employment, and this injury worsened during the last X months of YYYY and culminated the Termination Date in early YYYY. This day was the last physical day that you worked for the Current Employer, after which you took leave.

You then commenced a Workers' Compensation claim in respect of this psychiatric injury. The Current Employer's response to the Workers' Compensation claim resulted in the settlement negotiations, and ultimately, the Deed.

In this case, your termination set in motion the Workers' Compensation claim and the Current Employer's response to such, which resulted in the creation of the Deed and the settlement amounts being paid.

Therefore, although it may not have been the dominant cause for the payment of the settlement amounts, there is a temporal and causal link between the termination of your employment and the receipt of the settlement amounts such that it can be determined that the payment was received in the consequence of the termination of employment.

Received no later than 12 months:

Your termination date was a stated date in early YYYY, and you advised that you received Amount 1 directly in late YYYY.

Therefore, the payment was received no later than 12 months after termination.

Not a payment mentioned in section 82-135:

The final precondition to be met is that a payment not be one of those mentioned in section 82-135 of the ITAA 1997.

Amount 1 could potentially be exempt under paragraph 82-135(i) of the ITAA 1997, if it was determined to be:

'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)'

The case law has defined 'personal injury' to include both physical injuries and mental illnesses, but not to extend to emotional hurt or tarnished reputations. You have suffered from a recognised psychiatric illness as a consequence of your employment.

To satisfy that the personal injury has affected a taxpayer's capacity to derive income from personal exertion, there must have been a personal injury which has had 'an assessable and identifiable impact on the capacity of the taxpayer to earn income', as per Senior Member Block at 1096 in McMahon v Commissioner of Taxation 99 ATC 2025.

The psychiatric assessment detailed that you had wanted to work and had even attended an employment agency sometime in early YYYY, but were informed there that you were not ready to get another job. The psychiatric assessment also detailed that, as of the date of the assessment, you would be able to begin working again, although not for the Director in any capacity.

Therefore, there has been an identifiable impact on the taxpayer's capacity to earn income, in that you were not able to undertake new employment from the date of termination to early YYYY, due to the psychiatric illness you had suffered.

However, it is not clear that this impact upon your capacity to earn income would be assessable or calculable in reference to your injury.

The settlement amount must also have 'some form of identifiable and unambiguous connection with a personal injury, for which compensation was necessary as a reflection of the fact that the applicant's capacity to derive income from personal exertion had been impaired', as per Member Hughes at 50 in Luke v Federal Commissioner of Taxation [2011] AATA 801.

Additionally, as per Commissioner of Taxation v Scully (2000) 201 CLR 148, the payment must be calculated with reference to the nature and the extent of the injury.

In this case, your solicitor stated that the payment could be seen in relation to the Workers Compensation Claim and your section 18 release of your employer ("the section 18 release").

Subsection 18(1) of the Return to Work 2014 Act 2014 (SA) states that:

If a worker who has been incapacitated for work in consequence of a work injury is able to return to work (whether on a full-time or part-time basis and whether or not to his or her previous employment), the employer from whose employment the injury arose (the "pre-injury employer") must provide suitable employment for the worker (the employment being employment for which the worker is fit and, subject to that qualification and this section, so far as reasonably practicable the same as, or equivalent to, the employment in which the worker was working immediately before the incapacity).

Amount 1 was calculated both in reference to the Workers' Compensation claim, which you claimed and was accepted in relation to the psychiatric illness you sustained at your employment, and in reference to the section 18 release, which relates to a work injury. Therefore, the payment has an 'identifiable and unambiguous connection with a personal injury'.

It now needs to be determined whether this compensation was necessary to reflect your impaired ability to derive income and whether this payment was calculated with reference to the nature and extent of your injury.

By definition, the Workers' Compensation claim was to provide financial support while you were unfit to work due to the psychiatric injury you sustained at your employment. The section 18 release also refers to the incapacitation of a worker due to a work-related injury.

However, no reference is made in the Deed as to how Amount 1 was calculated and determined, and as stated above, it is not clear that any impact upon your ability to derive income has been assessed or referenced in deciding upon the payment for general damages.

Additionally, the settlement amounts are paid 'in consideration of the releases provided in this document', and the Release Clause makes clear that this refers to all claims, including those made for underpayment of wages and leave entitlements, which have no relation to your injury.

Therefore, Amount 1 is not a payment under section 82-135 of the ITAA 1997.

Conclusion

As Amount 1 was paid in consequence of the termination, received no later than 12 months after termination and was not a payment under section 82-135 of the ITAA 1997, Amount 1 is an ETP.

Question3

Summary

Amount 1, paid to you for general damages, is not included in your assessable income as a capital gain.

Detailed reasoning

A CGT asset is defined in paragraph 108-5(1)(b) of the ITAA 1997 as including a 'legal or equitable right that is not property'. In this case, that CGT asset would be your right to seek compensation.

Paragraph 104-25(1)(b) of the ITAA 1997 states that CGT event C2 occurs when a taxpayer's ownership of an intangible CGT asset ends by the asset being 'released, discharged or satisfied'. In this case, this occurred when you accepted the payment of Amount 1. Therefore, a CGT event has occurred and you have incurred a capital gain.

However, paragraph 118-20(1)(b) of the ITAA 1997 states that any capital gain incurred from a CGT event is reduced if that amount is included in an individual's assessable income. As per section 118-22 of the ITAA 1997, an employment termination payment, by definition, is included in an individual's assessable income.

Therefore, any capital gain made on Amount 1 is reduced to zero.

As it has been determined that you have made no capital gain, the exemption under section 118-37 of the ITAA 1997 regarding compensation payments for wrongs or injuries suffered in an individual's occupation need not be considered as per the anti-overlap provisions.

Question4

Summary

Amount 2, paid to your solicitor for legal costs, is included in your assessable income as ordinary income.

Detailed reasoning

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

The characteristics of income taken from significant case law, includes receipts that are earned, expected, relied upon and have an element of periodicity, recurrence or regularity.

The legal costs payment made to your solicitor on your behalf does not have the characteristics of ordinary income.

Section 6-10 of the ITAA 1997 provides that some amounts are included in your assessable income, that are not ordinary income. These amounts are referred to as statutory income.

Subsection 20-20(2) of the ITAA 1997 explains that an amount you received as a recoupment of a loss or outgoing is an assessable recoupment if:

a.            You received the amount by way or insurance or indemnity; and

b.            You can deduct an amount for the loss or outgoing for the current year or an earlier income year.

The legal costs payment paid directly to your solicitor for costs incurred by you in defending against the action from your employer in respect of the workers compensation claim, and bringing the action against your employer in respect of unpaid monies, is an amount received (applied on your behalf) by way of an indemnity.

To determine whether the legal costs are deductible requires the character of the costs to be established; that is, whether they are considered to be on revenue account, capital account or are private in nature.

Establishing the character of the expenses is achieved, not with reference to the outcome of the legal action taken, but consideration of the advantage sought.

In your case, you incurred the legal expenses bringing an action against your employer in respect of unpaid monies and leave entitlements and defending a successful workers compensation claim in respect health issues you suffered from bullying and harassment.

To the extent that your legal expenses were incurred in relation to lost wages and leave entitlements, the expense has sufficient nexus to seeking compensation that would be assessable, regardless of the fact that the actual payment received at the conclusion of the dispute was for general damages.

Given this, to the extent that your legal expenses related to your action against your employer for lost wages and leave entitlements, they are deductible under section 8-1 of the ITAA 1997.

It follows that, to the extent that your legal expenses are deductible, the amount paid to your solicitor on your behalf meets the criteria provided in subsection 20-20(2) of the ITAA 1997 and is included in assessable income. You can also claim a deduction for the same amount.

To the extent that your legal expenses related to your claim regarding health issues you experienced from bullying and harassment, they cannot be deducted and are not included in your assessable income.

Question5

Summary

Amount 2, paid to your solicitor for legal costs, is not included in your assessable income as an employment termination payment.

Detailed reasoning

Paragraph 82-130(1)(a) of the ITAA 1997 refers to an 'employment termination payment' as one which is 'received by you'.

As mentioned above, Amount 2 was not received by you, but directly by your solicitor, and so therefore cannot be included in your assessable income by definition.

Additionally, amounts received regarding a termination of employment dispute will not be considered an employment termination payment, nor form part of one, if said amounts are 'capable of being identified as relating specifically to the reimbursement of legal costs', as per Taxation Ruling TR 2012/8 Income tax and fringe benefits tax: assessability of amounts received to reimburse legal costs incurred in disputes concerning termination of payment (TR 2012/8).

Clause 4(b) of the Deed states that Amount 2 is 'payment in respect to the Employee's legal costs'.

Therefore, as per TR 2012/8, since Amount 2 has been specifically identified as relating to the reimbursement of legal costs, it is not an employment termination payment, nor does it form part of one.