Edited version of private advice

Authorisation Number: 1052041235816

Date of advice: 10 October 2022

Ruling

Subject:Employment termination payment and invalidity segment

Question 1

Is the lump sum payment 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 payment represent an invalidity segment under section 82-150 of the ITAA 1997?

Answer

Yes

Relevant facts and circumstances

You commenced employment with the Employer.

Due to deterioration of a chronic medical condition you could no longer continue to work

You made an application for Voluntary Medical Retirement with the Employer.

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

Four 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 82-145

Income Tax Assessment Act 1997 Section 82-150

Income Tax Assessment Act 1997 Section 995-1

ATO View documents

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'

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

All three conditions need to be satisfied in order for the Payment to be treated as an ETP. Failure to satisfy any of the three conditions will result in the Payment not being considered an ETP.

Paid as a consequence of the termination of employment

The first condition to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer.

The Commissioner has issued 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), which deals with payments in consequence of the termination of any employment and in particular, the meaning of the phrase 'in consequence of'.

In paragraphs 5 and 6 of TR 2003/13 the Commissioner states:

5. The phrase 'in consequence of' is not defined in the ITAA 1936. However, the words have been interpreted by the courts in several cases. Whilst there are divergent views as to the correct interpretation of the phrase, 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.

In your case, you were medically diagnosed with PTSD and could no longer continue in your 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 payment was made to you in consequence of termination of your 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 employment termination payments 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

Where a person's employment is terminated because of ill-health and the person receives an ETP, part of the payment may be tax-free. This component is called an 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.

Payment for stopping gainful employment

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.

The payment was made to you because your employment was terminated on medical grounds and therefore is a payment that was made to you because you stopped being gainfully employed.

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 was based on medical grounds. 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.

The payment was made before you reached 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, four qualified medical practitioners have certified that you are suffering from a medical condition, which in their opinion states that you are unlikely to have the capacity to return to work for which you are qualified.

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.

Based on the information provided your ETP satisfies all requirements prescribed under subsection 82-150(1) of ITAA 1997.

Tax exemption for an invalidity payment

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

Section 82-145 of the ITAA 1997 states that the taxable component of an ETP is the ETP less the tax-free component.

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.