Edited version of private advice

Authorisation Number: 1052164957797

Date of advice: 28 September 2023

Ruling

Subject: Assessable income

Question

Is the payment made to you under the Settlement Agreement (the Agreement) assessable income?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You were employed by Company A (the Employer).

You made complaints or inquiries regarding your employment, thereby exercising a workplace right pursuant to the Fair Work Act 2009 (Commonwealth).

The Employer was issued with a Compliance Notice, with one of the matters listed on the notice relating to underpayment of wages.

You were dismissed from your employment.

Following your dismissal, you engaged a lawyer.

You reached a settlement with the Employer a short time after this.

As part of this settlement, you agreed to withdraw your actions and investigation with the Fair Work Ombudsman. This meant that all matters regarding underpayment of wages were removed from the Compliance Notice.

The Employer agreed to pay you an amount.. The relevant paragraphs from the Settlement Deed are extracted below:

1. Within a few weeks of the parties signing the terms of this Agreement, the Employer will pay into the relevant lawyer's trust account representing payment to you a sum of money (calculated as general damages to take account of your alleged hurt and humiliation) (Settlement Payment)

2. Superannuation based on an underpayment of wages to you to be paid within a few weeks of signing the settlement agreement to the relevant lawyer's trust account

The Employer also agreed to pay you superannuation based on an underpayment amount of income.

You received the amount shortly after signing the Settlement Agreement..

Relevant legislative provisions

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 82-135

Reasons for decision

Summary

The payment made to you under the Agreement is assessable income as it is an employment termination payment.

Detailed reasoning

A payment is an employment termination payment (ETP) if it satisfies all the requirements in section 82-130 of the ITAA 1997 and is not specifically excluded under section 82-135 of the ITAA 1997.

Subsection 82-130(1) of the 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.

Received 'in consequence' of the termination of 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. Taking into account the courts' decisions on the meaning of the phrase, the Commissioner's view on the meaning and application of the 'in consequence of' test are 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' .

Paragraphs 5 and 6 of TR 2003/13 state 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.

At paragraph 32 of TR 2003/13, the Commissioner considers payments from a former employer to settle litigation:

32. The Federal Court in Dibb v. FC of T[1] 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. Heery J found at 296 that:

'The various causes of action whether breach of contract, conspiracy, breach of fiduciary duty or contravention of the Trade Practices Act were, as Goldberg J would say (Le Grand at [36]), 'interwoven and intertwined' with the termination. The payment was a consequence of the settlement, which was a consequence of the Federal Court proceeding, which in turn was a consequence of the termination.'

The payments in these cases were ETPs because there was a sequence of connected events following the termination, which ultimately led to the payment. The payments would not have been made but for the termination.

In this case, after your employment was terminated, you lodged matters with the relevant courts and ombudsman.

You subsequently entered into the Agreement with your former employer, whereby you would receive a lump sum, conditional upon releasing and discharging your former employer from any claim or liability in relation to those matters.

The payment would not have been made but for the termination of your employment.

While the settlement of the legal proceedings is the direct cause of the payment, the proceedings were commenced by you as a result of the termination of your employment. That is, there was a sequence of events following the termination which ultimately led to the settlement payment being made - the termination, the legal proceedings and the payment were all intertwined.

Therefore, it is considered that the settlement payment was received by you in consequence of the termination of your employment.

As such, the requirement of subparagraph 82-130(1)(a)(i) of ITAA 1997 has been satisfied.

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.

Your employment was terminated on Date one.

The Agreement states that you will receive a payment within a number of weeks of the Parties signing.

You signed the Agreement on Date two .

You stated that you received the payment on Date 3.

Therefore, the requirement of subparagraph 82-130(1)(b) has been satisfied.

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

Section 82-135 of the ITAA 1997 provides that certain payments are not ETPs, including:

•         unused annual leave and unused long service leave payments

•         genuine redundancy and early retirement scheme payments, up to the tax-free limit

•         capital payments for personal injury as compensation for your inability to be employed

In Re Luke and Federal Commissioner of Taxation [2011] AATA 801; (2011) 2011 ATC 10-216; the Administrative Appeals Tribunal (AAT) accepted that the taxpayer had been adversely affected by what they perceived to be unreasonable harassment and discrimination in their employment but said that 'personal injury' does not extend 'beyond physical injury and mental illness to include emotional hurt'. The AAT added that:

Evidence is required that the payment had 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.

In view of the above, a physical and/or mental injury would require diagnosis by a qualified medical practitioner, in order to fall within the meaning of 'personal injury'.

The payment must also be calculated by reference to the nature of the injury and the extent to which the injury will affect the individual's capacity to derive income from employment.

Although the settlement payment relates to a claim for psychiatric injury (as well as economic loss), your former employer has denied any liability.

The Agreement states that the payment was calculated as general damages to take account of your 'alleged hurt and humiliation'.

Further, you have released your former employer from all claims relating to the matter, as a condition of receiving the settlement payment.

The Agreement provides no medical qualification that the payment was calculated with regard to your likely loss of income-producing capacity.

Therefore, in accordance with paragraph 82-130(1)(c) of the ITAA 1997, the payment is not for, or in respect of, a personal injury.

As such, the payment is not 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 was received by you in consequence of the termination of your employment, was received no later than 12 months after termination, and was not a payment under section 82-135 of the ITAA 1997, the full amount of the payment is assessable as 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);

•         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 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 after June 1983. 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 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 is to be included in your income tax return for the 20XX-XX 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.

[1] (2003) 53 ATR 290.