Edited version of private advice

Authorisation Number: 1052137053100

Date of advice: 8 August 2023

Ruling

Subject: Eligible termination payment - personal injury

Question

Is the payment made to you in respect of a claim as part of a Deed of Release assessable as an employment termination payment (ETP) as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period

Income year ended 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You commenced employment with your former employer in 2015.

In late 2021, following a number of incidents at work, you commenced attending treatment sessions with a psychologist.

In early 2022, you subsequently sent a Letter of Demand to your employer, advising you would escalate your concerns via legal avenues, if your concerns were not addressed.

The letter set out your issues of concern, the factual background to these issues, and the causes of action that were available to you.

The letter stated that you were entitled to seek significant compensation and civil penalties and requested contact from your employer's legal representatives to discuss further.

You subsequently resigned from your employment, providing 4 weeks' notice. You also advised that it was not possible for you to return to your role, or the physical premises of your workplace, without further impact to your mental health.

Upon the end of the 4 weeks' notice period, your employment was terminated.

Documentation provided by your former employer confirmed the period of your employment, and noted their understanding that you had ceased work voluntarily.

You subsequently undertook a Fair Work mediation with your former employer, but no outcome was reached.

In late 2022, you filed an application and statement of claim with the Federal Court of Australia.

In early 2023, both you and your former employer reached agreement via a mediator's bid, for an amount of $X to be paid to you as an 'additional termination payment' and an equivalent amount to be paid to your solicitors for legal expenses.

In May 2023, you were paid the above amount, less tax, which was documented by the employer as a 'life benefit ETP'.

Detailed reasoning

Summary

The payment made to you in respect of a claim as part of a Deed of Release is assessable as an employment termination payment.

Employment termination payment

An employment termination payment, where the payment is made during the life of a taxpayer, is known as a life benefit termination payment (subsection 82-130(2) of the Income Tax Assessment Act 1997 (ITAA 1997)).

Section 995-1 of ITAA 1997 states:

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

Subsection 82-130(1) of 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.

In order for the payment made to you under the Deed to constitute an employment termination payment, all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied.

Failure to satisfy any of the above 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.

Payment is made in consequence of the termination of employment

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

In light of these decisions, the Commissioner discusses the meaning of the 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).

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.

The phrase 'in consequence of the termination of employment' has been interpreted by the Courts in several cases.

Of note are the decisions made by the High Court in Reseck v. Federal Commissioner of Taxation (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 (Reseck) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325(McIntosh).

In ReseckJustice Gibbs stated:

Within the ordinary meaning of the words a sum is paid in consequence of the termination of employment when the payment follows as an effect or result of the termination. It is not in my opinion necessary that the termination of the services should be the dominant cause of the payment.

While Justice Jacobs stated:

It was submitted that the words in consequence of import a concept that the termination of the employment was the dominant cause of the payment. This cannot be so. A consequence in this context is not the same as a result. It does not import causation but rather a following on.

In looking at the phrase 'in consequence of' the Full Federal Court in McIntosh considered the decision in Reseck. Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment.

Suffice it to say that both Courts' views were that for a payment to be made in consequence of the termination of employment it had to follow on as a result or effect of the termination of employment. Additionally, while it is not necessary to show that termination of employment is the sole or dominant cause, a temporal sequence alone would not be sufficient.

Furthermore, in Le Grand v Federal Commissioner of Taxation [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39 (Le Grand), the issue before the court was whether an amount received by the applicant as a result of accepting an offer of compromise in respect of claims brought by him against his former employer, in relation to the termination of his employment was in whole, or in part, an ETP. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an ETP.

Justice Goldberg stated:

I am satisfied that there is a sufficient connection between the termination of the applicant's employment and the payment to warrant the finding that the payment was made in consequence of the termination of the applicant's employment. I am satisfied that the payment was an effect or result of that termination in the sense that there was a sequence of events following the termination of the employment which had a relationship and connection which ultimately led to the payment.

Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was articulated by Justice Gibbs in Reseck. Thus, for the payment to have been made in consequence of the termination of employment, the payment must follow as an effect or result of the termination of employment. As earlier stated 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 Full Federal Court in Dibb v Federal Commissioner of Taxation [2004] FCAFC 126; (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786, has applied the above decisions in finding that the payment received by the taxpayer under a Deed of release to settle various causes of action against the employer, following the termination of employment, was an ETP.

In paragraph 31 of TR 2003/13, the Commissioner states:

It is clear from the decision in Le Grand, that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of the taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

The essence of this analysis is that, if the payment follows as an effect of, or a result from, the termination of employment, the payment will be made in consequence of the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. The termination of the payment need not be the sole or dominant cause of the payment.

Whether a payment is made in consequence of the termination of employment is determined by the relevant facts and circumstances of each case.

1.             From the facts provided, your employment with your former employer was terminated on DD MM 2022. Following the termination of employment, you filed a Statement of Claim with the Federal Court of Australia against your former employer on DD MM 2022.

2.             A settlement was reached between you and your former employer. Under the Deed of release, a payment of $X, being an additional termination payment, was made to you.

3.             The additional termination payment of $X would not have been made had there been no termination of employment. The termination of employment and the payment are intertwined and connected. The payment is considered to be received by you in consequence of the termination of your employment. Therefore, the requirement of subparagraph 82-130(1)(a)(i) of ITAA 1997 has been met.

Payment received more than 12 months after termination

Paragraph 82-130(1)(b) of the ITAA 1997 requires that the payment must be received no later than 12 months after the termination of employment.

However, paragraph 82-130(4)(a) of the ITAA 1997 states that the 12-month rule prescribed in paragraph 82-130(1)(b) of the ITAA 1997 will not apply if a person is covered by a determination made by the Commissioner under subsection 82-130(7) of the ITAA 1997.

The Employment Termination Payments (12-month rule) Legislative Instrument 2007 is a legislative instrument made by the Commissioner of Taxation pursuant to subsection 82-130(7) of the ITAA 1997. This instrument applies to employment termination payments received after 30 June 2007.

This instrument states that a payment received more than 12 months after the termination of a person's employment will be an employment termination payment if the delay in the payment was due to the commencement of legal action concerning either or both:

•                     the person's entitlement to the payment;

•                     the amount of the person's entitlement;

•                     and the legal action was commenced within 12 months of the termination of employment.

In this case, your employment with your former employer terminated on DD MM 2022 and the payment of $X was made to you on DD MM 2022, more than 12 months after the termination of your employment. However, you commenced legal action within 12 months of the termination of your employment as you filed a Statement of Claim with the Federal Court of Australia on DD MM 2022. Therefore, the payment is exempt from the 12-month rule found in paragraph 82-130(1)(b) of the ITAA 1997.

Not a payment mentioned in section 82-135 of the ITAA 1997

Certain payments made on termination of employment are excluded from being an employment termination payment under section 82-135 of the ITAA 1997. These payments include any accrued annual and long service leave, the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments which do not apply to your settlement payment.

Under section 82-130(1) of the ITAA 1997, consideration must be given to whether the specific exemption for personal injury in paragraph 82-135(i) of the ITAA 1997 (payments that are not employment termination payments) applies. 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 a person for, or in respect of, the particular injury.

In Commissioner of Taxation (Cth) v. Scully (2000) 201 CLR 148; [2000] HCA 6; (2000) 2000 ATC 4111; (2000) 43 ATR 718 the High Court held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer. The payment in this case was not in respect of personal injury, acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stating in their joint decision:

In our opinion, the payment in this case cannot be characterised as consideration... in respect of, personal injury. The fact that the payment is not calculated by reference to the nature and extent of the injury or likely loss to the respondent and the fact that the other benefits are similar to that for total and permanent disablement point inevitably to the conclusion that the payment was consideration... for, or in respect of the respondent's termination of employment and her rights under the Trust Deed and was not consideration... for, or in respect of her injury.

In the Administrative Appeals Tribunal (AAT) decision AAT Case 11,722 (1997) 35 ATR 1114; (1997) 97 ATC 258, a taxpayer negotiated a settlement with their past employer by agreeing to be paid a certain amount, also to forgo all past, present and future claims against the employer, except for personal injury. Senior Member Dwyer ruled that, given the 'exception' in the settlement clause, no amount of the settlement could be for personal injury. Therefore, the ETP exclusion provisions could not apply to the amount.

There are three types of injury that a person can receive:

(a)          behavioural injury - one that involves physical injury (internal and/or external) and/or mental illness that is clearly discernible to a qualified medical practitioner;

(b)          non-behavioural injury - hurt, distress, anxiety, etc., that flows from the death of, or serious injury to, a relative or close friend; wrongful dismissal; defamation; etc. This type of injury may have legal remedies under the law of torts (e.g., defamation, slander), statute (e.g., sexual harassment, discrimination), or contract (e.g., employment, professional negligence); and

(c)           property injury - damage to a person's property.

Notwithstanding it may be said that all three types of injury may be personal, it is considered that only the first type (i.e. behavioural injury) falls within the meaning of the term personal injury.

The reasoning above is based on the decision by the Victorian Supreme Court in Graham v. Robinson [1992] 1 VR 279 (Graham v. Robinson), where the Court had to decide if emotional hurt (i.e. hurt, distress, public scandal, hatred, odium, ridicule and contempt) was a personal injury. At 281, Justice Smith stated:

In the absence of express authority, I have come to the conclusion that the expression personal injury does not extend beyond physical injury and mental illness to include emotional hurt. I am encouraged to this view by the fact that the law has rejected grief or sorrow as a form of injury which can be relied on to mount a claim in negligence: Mount Isa Mines Ltd. v. Pusey (1970) 125 CLR 383, at p. 394 and Jaensch v. Coffey (1984) 155 CLR 549, at p. 587. It is true that damages are awarded for pain and suffering in the typical personal injury case. They are awarded, however, where pain and suffering flow from and are connected with physical or mental injury and may therefore be said to be damages in respect of personal injury.

The decision in Graham v. Robinson was applied in the AAT decision McMahon v. Commissioner of Taxation Case [1999] AATA 5; (1999) 41 ATR 1056; (1999) 99 ATC 2025 (McMahon) in relation to a payment for alleged damage to a taxpayer's reputation. In McMahon, a critical performance appraisal of the taxpayer and other comments were published in the media. Subsequent to this, the taxpayer's employment was terminated and it was agreed to pay him certain amounts including an amount for the alleged damage to his reputation. Senior Member Block stated:

The Tribunal also notes the stipulation in the concluding portion of s. 27A(1)(n) of the Act that the amount of consideration for personal injury is to be regarded as an ETP only to the extent that it is reasonable having regard to the nature of the injury and the taxpayer's capacity to derive income from personal exertion. The Tribunal considers that the inclusion by the legislature of the words "from personal exertion" tends to confirm that the section is intended to exclude from the definition of ETP payments in respect of injuries to the person, where such injuries being physical injuries or mental illnesses which have an assessable and identifiable impact on the capacity of the taxpayer to earn income. The Tribunal considers in summary that an injury to person is distinguishable from an injury to a person's reputation.

For the Reasons set out previously, (and bearing in mind that the decision in Graham v. Robinson is binding on the Tribunal), the reputation payment was not made in respect of personal injury within s. 27A(1)(n) of the Act which does not operate to exclude it from the provisions of s. 27A of the Act; accordingly the reputation payment was correctly assessable as an ETP.

To reiterate, there must be a 'behavioural'-type personal injury. From the above case, the term 'personal injury' is limited to physical and/or mental injury.

In the statements you have made along with your application, and in documents presented to the Court, you have made the case that your mental health suffered as a result of actions taken by your former employer, and the pressure placed upon you by such actions.

You have provided a copy of a Psychological Report dated DD MM 2023, in which your psychologist confirms the symptoms experienced by you

However, it is not clear that, under the Deed of release, the payment of $X made to you was assessable or calculable with reference to the nature and extent of any personal injury suffered by you.

Therefore, in accordance with paragraph 82-130(1)(c) of the ITAA 1997, the $X payment is not for, or in respect of, a personal injury, which would be excluded from being an ETP under section 82-135.

As the payment is not of a type mentioned in section 82-135 of the ITAA 1997, all of the conditions under subsection 82-130(1) of the ITAA 1997 have been satisfied.

Conclusion

As the payment made to you 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, this payment is an ETP.

Other Relevant Comments

Tax Treatment of the payment as a Life Benefit Termination Payment (LBTP):

An ETP will be comprised of the following components:

•         Tax free component - as provided in section 82-140 of the ITAA 1997, this includes an invalidity segment within the meaning of section 82-150 (if any) and/or a pre-July 83 segment within the meaning of section 82-155 (if any); and

•         Taxable component - the amount remaining after deducting the tax-free component from the total payment, as prescribed in section 82-145 of the ITAA 1997.

The tax-free component is not assessable income and is not exempt income.

As the payment of $xxx,xxx made to you was not made because you ceased being gainfully employed as a result of suffering from ill-health, there is no invalidity segment for the purposes of section 82-150 of the ITAA 1997.

Further, you commenced employment with the employer on DD MM 2015. Therefore, there will not be any pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997.

As the employment termination payment of $X contains neither a pre-July 83 segment nor an invalidity segment, there is no tax-free component as defined in section 82-140 of the ITAA 1997. The whole LBTP was comprised of a taxable component.

Subsection 82-10(2) of the ITAA 1997 provides that the taxable component of a life benefit termination payment is assessable income. Accordingly, the payment of $X is to be included in your income tax return for the 2022-23 income year.

In relation to the rate of tax that applies, subsection 82-10(3) of the ITAA 1997 specifies that a taxable component is subject to tax and the rate applied depends on the recipient's age.

As you are under your preservation age, the taxable component of the LBTP is taxed at 30% plus Medicare levy for amounts below the employment termination payment cap (which is $230,000 for the 2022-23 income year), and at the top marginal rate for the amount above this cap.

Payment for legal expenses

The $X settlement amount paid to your solicitor for legal costs is not included in your assessable income as an employment termination payment.

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

The legal costs payment was not received by you, but directly by your solicitor, and so therefore cannot be included in your assessable income, by definition.

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 employment states at paragraph 4:

An amount received in relation to a dispute concerning termination of employment is not an ETP, nor forms part of an ETP, where the amount is capable of being identified as relating specifically to the reimbursement of legal costs.

Therefore, the $X payment made to your solicitors is not an employment termination payment, nor does it form part of one.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 82-10

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 82-155

Income Tax Assessment Act 1997 section 995-1