Edited version of private advice

Authorisation Number: 1052168328007

Date of advice: 28 September 2023

Ruling

Subject: Eligible termination payment - settlement agreement

Question 1

Is the payment made to you under a settlement agreement assessable as an employment termination payment (ETP), as defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the lump sum settlement payment excluded from the assessable income under section 6-5 of the ITAA 1997?

Answer

Yes.

Question 3

Is the lump sum settlement payment a capital receipt and assessable under the capital gains tax (CGT) provisions?

Answer

Yes. However, section 118-20 of the ITAA 1997 recognises that a capital gain you make from a CGT event is reduced if, because of the event, a provision of the ITAA 1997 includes an amount in your assessable income for any income year. Section 118-22 treats an ETP that you receive as being included in your assessable income. As such, any capital gain you made will be reduced to zero.

This ruling applies for the following period

Income year ended 30 June 2023

Relevant facts and circumstances

You were employed by a government body.

You have stated that you were subjected to bullying and discrimination from a work colleague and that this, combined with inaction from your employer's management, resulted in you developing a psychiatric condition.

You lodged a Workcover claim.

You were deemed partially incapacitated. You advised that you wished to return to work, but your employer did not provide you with suitable duties.

You were advised that your then-current fixed term contract, which was due to expire, would not be renewed.

You filed an application with the XXX (XXX).

You lodged an application for unfair dismissal and a provision for suitable employment where you sought the remedies of re-employment and/or monetary compensation.

In 2022, you and your former employer entered into a settlement agreement (the Agreement).

You confirmed that you disposed of your right to seek compensation when you agreed to the payment of the settlement amount, as your acceptance released your former employer from all present and future claims.

You have stated that this payment arose out of a claim for damages for wrongful dismissal, and that, as it cannot be itemised, it represents a single undissected amount which is not a substitution or claim for any loss of income.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 82-130

Income Tax Assessment Act 1997 section 82-135

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 section 118-22

Income Tax Assessment Act 1997 section 118-37

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

The payment made to you under a settlement agreement is assessable as an employment termination payment.

Detailed reasoning

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 ITAA 1997).

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.

In order for the payment made to you under the Agreement 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 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

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 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).

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 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.

From the facts provided in this case, your employment with your former employer was terminated when your fixed-term contract expired.

Both prior to and following the expiry of your contract, you lodged a number of applications with the XXX.

Subsequently, you signed an Agreement with your former employer confirming that a lump sum payment would be made to you.

By signing the Agreement, you both agreed to withdraw your applications with the XXX and confirmed that the employer was relieved of any obligation to provide you with suitable employment.

The payment 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, as it resulted from applications that you lodged in relation to your employment being terminated. 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.

In this case, your employment with your former employer terminated and the payment was made to you within 12 months. Therefore, the requirement under paragraph 82-130(1)(b) of the ITAA 1997 is 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 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 your capacity to derive income from employment.

Although the settlement payment, received for the execution of the Agreement and for not pursuing your employer with XXX, relates to your unfair dismissal and medical claims, the employer has denied any liability to the allegations and you have released them from all claims relating to the matter. The Agreement does not provide any medical qualification or clarification that the payment was calculated with regard to your likely loss of income producing capacity.

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 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, this payment is an ETP.

Question 2

Assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997).

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, and

•                     have an element of periodicity, recurrence, or regularity.

Compensation receipts which substitute for income have been held by the courts to be ordinary income; whereas compensation paid for the loss of a capital asset or amount is regarded as a capital receipt and not ordinary income and is potentially taxable as statutory income.

In your case, the gross lump sum payment arose out of a claim for damages for wrongful dismissal, and it is a single undissected amount which is not a substitution or claim for any loss of income.

The payment was not earned and does not have any element of periodicity, recurrence, or regularity.

While it could be argued that the payment is expected, this expectation comes from your rights under your employment arrangements, rather than from a relationship with any personal services performed.

The payment is capital in nature and is not assessable as ordinary income under section 6-5 of the ITAA 1997.

However, this will not alter the fact that the lump sum settlement payment is assessable as an ETP pursuant to subsection 82-130(1) of the ITAA 1997.

Question 3

CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged, or satisfied (paragraph 104-25(1)(b) of the ITAA 1997). A CGT asset is a legal or equitable right that is not property (paragraph 108-5(1)(b)).

In your case, the gross lump sum payment arose out of a claim for damages for wrongful dismissal. As such, you acquired a right to receive a payment under the terms of your employment.

When the payment was made this right was released, discharged, or satisfied; and CGT event C2 happened. As such the lump sum received is a capital payment.

Section 118-20 of the ITAA 1997 recognises that a capital gain you make from a CGT event is reduced if, because of the event, a provision of the ITAA 1997 includes an amount in your assessable income for any income year. Section 118-22 treats an ETP that you receive as being included in your assessable income. As such, any capital gain you made will be reduced to zero.

However, as any capital gain you made in your case will be reduced to zero, under the anti-overlap provisions, it is not necessary to consider the exemption in section 118-37 of the ITAA 1997 for compensation or damages you receive for any wrong or injury you suffer in your occupation.