Edited version of private advice

Authorisation Number: 1052090186924

Date of advice: 10 March 2023

Ruling

Subject: Taxation of a foreign termination payment and personal injury payments

Question 1

Are the ex-gratia payment and the termination award received by you in the 20XX-XX income year from your ex-employer (the Employer) as part of a settlement agreement (the Agreement) exempt from taxation under section 83-235 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes.

Question 2

Is the component of the lump sum payments, related to 'injury to feelings' and 'aggravated damages', assessable as ordinary income?

Answer 2

No.

Question 3

Is the component of the lump sum payments, related to 'injury to feelings' and 'aggravated damages', subject to the capital gains tax provisions?

Answer 3

Yes.

Question 4

If the answer to question 3 is yes, will any capital gain on the components of the lump sum payments, related to 'injury to feelings' and 'aggravated damages' be disregarded under section 118-37 of the ITAA1997?

Answer 4

Yes.

This ruling applies for the following period:

Year ending on 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

•           You commenced your employment with the Employer in a foreign country in 20XX.

•           In 20XX you emailed a fellow employee to raise your concerns about the discriminatory nature of a comment made in a presentation provided by the Employer.

•           In the same period, you made an oral disclosure to two of your fellow employees on the same matter.

•           Later that year, the Employer terminated your employment and paid your salary and other benefits up to the date of termination.

•           In 20XX you commenced legal proceedings for an unfair dismissal, contending the reason for your dismissal was either that you made a protected disclosure or were discriminated against.

•           Proceedings were held in the Employment Tribunal in the foreign country in 20XX.

•           The Judgment confirmed that the termination of your employment by the Employer represented an unfair dismissal.

•           As a result of this finding, you and the Employer entered into a settlement agreement in the 20XX-XX income year.

•           As part of this Agreement, you received the following payments:

−     ex-gratia

−     termination award

−     injury to feelings

−     aggravated damages

•         You became an Australian tax resident during the 20XX-XX income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 10-5

Income Tax Assessment Act 1997 section 83-235

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 118-37

Reasons for decision

Question 1

Are the ex-gratia payment and the termination award, received by you in the 20XX-XX income year from your ex-employer (the Employer) as part of a settlement agreement (the Agreement) exempt from taxation under section 83-235 of the ITAA 1997?

Summary

The ex-gratia payment and the termination award, made to you by the Employer under the Agreement are termination payments that meet the requirements of section 83-235 of the ITAA 1997. These were paid to you in consequence of the termination of your employment in a foreign country and are not superannuation benefits, or a pension or an annuity. Accordingly, they are tax-free payments.

Detailed reasoning

Termination payments tax free - foreign resident period

Section 83-235 of the ITAA 1997 states that a payment received by you is not assessable income and is not exempt income if:

(a) it was received in consequence of the termination of your employment in a foreign country; and

(b) it is not a superannuation benefit; and

(c) it is not a payment of a pension or an annuity (whether or not the payment is a superannuation benefit); and

(d) it relates only to a period of employment when you were not an Australian resident.

In order for a payment to be a tax-free termination payment for a foreign resident period, all of the above conditions must be satisfied.

Payment is made 'in consequence of the termination of' your 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 is 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. ... the Commissioner considers that 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 this case, your employment was terminated in 20XX after you raised your concerns, via email and orally, about the discriminatory nature of a comment made in a presentation provided by the Employer in the same year.

As you felt the termination of your employment was unfair and discriminatory, you commenced legal proceedings in 20XX, contending the reason for your dismissal was that you made a protected disclosure or were discriminated against.

The Judgment confirmed that the termination of your employment by the Employer represented an unfair dismissal.

As a result of this finding, you and the Employer entered into the Agreement in the 20XX-XX income year.

Therefore, both the ex-gratia payment and the termination award, received as part of the Agreement, are termination payments that meet the requirements of section 83-235 of the ITAA 1997.

It follows that as these were paid to you in consequence of the termination of your employment in a foreign country, in relation to a period of employment in which you were not an Australian resident, and are neither superannuation benefits, nor pensions or annuities, they are exempt from taxation.

Question 2

Is the component of the lump sum payments, related to 'injury to feelings' and 'aggravated damages', assessable as ordinary income?

Summary

No, the component of the lump sum payments, related to 'injury to feelings' and 'aggravated damages, is not assessable as ordinary income under section 6-5 of the ITAA 1997.

Reasoning

Section 6-5 of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

−     are earned

−     are expected

−     are relied upon

−     have an element of periodicity, recurrence or regularity.

This compensation amount you have accepted is not income from rendering personal services, income from property or income from carrying on a business. The payment is also a one-off payment and therefore does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from pain and suffering, rather than from a relationship to personal services performed.

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. However, no part of these lump sums you have received is to compensate for loss of income.

Accordingly, no part of the lump sum that relates 'injury to feelings' and 'aggravated damages' will be assessable under section 6-5 of the ITAA 1997.

Question 3

Is the component of the lump sum payments, related to 'injury to feelings' and 'aggravated damages', subject to the capital gains tax provisions?

Summary

Yes, the disposal of your right to seek compensation triggers the capital gains tax provisions and the settlement amount is treated as capital proceeds, to which the capital gains tax provisions apply.

Detailed Reasoning

Section 6-10 of the ITAA 1997 provides that a taxpayer's assessable income includes statutory income amounts that are not ordinary income but are included in assessable income by another provision.

Section 10-5 of the ITAA 1997 lists those provisions. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains.

Amounts received in respect of personal injuries which are not for reimbursement of medical expenses, or direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax provisions of the ITAA 1997.

Taxation Ruling TR 95/35: Income tax: capital gains: treatment of compensation receipts (TR 95/35) deals with the capital gains treatment of compensation receipts. The ruling advocates a look-through approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

The disposal of a taxpayer's right to seek compensation triggers the capital gains tax provisions and the settlement amount is treated as capital proceeds and consequently subject to the capital gains tax provisions.

Question 4

If the answer to question 3 is yes, will any capital gain on the components of the lump sum payments, related to 'injury to feelings' and 'aggravated damages' be disregarded under section 118-37 of the ITAA 1997?

Summary

Yes, any capital gain or loss related the component of the lump sum payment for 'injury to feelings' and 'aggravated damages' will be disregarded under paragraph 118-37(1)(a) of ITAA 1997.

Detailed Reasoning

Paragraph 118-37(1)(a) of the ITAA 1997 disregards a capital gain where the amount relates to compensation or damages you receive for any 'wrong, injury or illness you... suffer personally'.

In your case, it is considered that the lump sum payments you received for 'injury to feelings' and aggravated damages' falls within the scope of paragraph 118-37(1)(a) of the ITAA 1997 and therefore any capital gain or loss is disregarded.