Edited version of private advice

Authorisation Number: 1052219902939

Date of advice: 16 February 2024

Ruling

Subject: Employment termination payment

Question 1

Would the client have received a payment of general and unspecified damages but for the fact that his employment with the former employer was terminated?

Answer

No.

Question 2

Is all or part of the payment able to be considered as capital proceeds from a Capital Gains Tax (CGT) event, based on a right to seek compensation being an intangible CGT asset (acquired at the time of the compensable wrong) and ending when the taxpayer entered into the deed of release?

Answer

No.

This ruling applies for the following period:

Income year ended 30 June 2022

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

1.    The client started working for the Australian subsidiary of a multinational conglomerate in 20XX.

2.    In November 20XX, the client entered into an agreement to work for the overseas subsidiary from early 20XX. This role would have required the client to move overseas. The transfer was delayed due to the COVID-19 pandemic and the client continued working for the Australian subsidiary.

3.    In 20XX, the client was informed that his position with the overseas company had been given to someone else and that his position with the Australian company was being terminated with immediate effect.

4.    The client brought a claim for unfair dismissal against the Australian company seeking compensation for lost salary and entitlements. He also brought a claim against the overseas company for breach of contract.

5      In 20XX, the parties reached an out of court settlement where they agreed to release and discharge each other from their claims unconditionally and irrevocably.

6      The client is asserting that part of the settlement amount should be considered a CGT event pursuant to sections 104-25 and 108-5(1) of the Income Tax Assessment Act (ITAA) 1997 and should therefore not be assessed as an ETP.

7      It is asserted that parts of the settlement amount are not eligible employment termination payments under section 82-130 if the ITAA 1997 because they were not made as a consequence of the termination of the client's employment with the Australian company, but as a consequence of the overseas company's failure to enter into an employment relationship with the client as it was contracted to do.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 82-130(1)

Income Tax Assessment Act 1997 subsection 82-135(i)

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 section 118-37

Reasons for decision

ETP Settlement Payments

1.    A payment is an ETP if it satisfies all the requirements in section 82-130, ITAA 1997 of Division 82 covering ETP's and is not specifically excluded under section 82-135 of the ITAA 1997.

2.    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.

3.    The term 'employment termination payment', as defined in section 82-130 of the ITAA 1997, includes any payment made in respect of a taxpayer 'in consequence of the termination of their employment', other than certain specified payments. Common examples of ETPs include golden handshakes, contractual termination payments and payments for wrongful dismissal.

Paid 'in consequence' of the termination of employment

4.    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'.

5.    Relevant case law deals with provisions that predate Div 82 but, with one caveat, are still relevant to the issue. The caveat is that Div 82, unlike those earlier provisions, requires a payment to be made no later than 12 months after the termination in order to qualify as an employment termination payment. However, in certain circumstances, the Commissioner can make a determination not to apply the 12-month rule.

6.    Paragraphs 5 and 6 of TR 2003/13 state that:

"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.

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."

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

"The Federal Court in Dibb v. FC of T 2004 ATC 4555, 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."

Damages and settlement at law

8.    The decision in Le Grand v FC of T 2002 ATC 4907 mentioned above concerned an amount received by a taxpayer as a result of accepting an offer of compromise in respect of claims brought by him against his former employer.

9.    The claims were for common law damages for breach of an employment agreement and a claim for statutory damages for misleading and deceptive conduct by the employer. The taxpayer argued that the payment was not made in consequence of the termination of employment because the 'occasion' of the payment was not the termination but was, instead in compromise of the taxpayer's claims against the employer. The taxpayer relied on the observation of Brennan J in McIntosh that a termination must be the 'occasion' of a payment before the payment can be held to be an ETP.

10.  The Federal Court rejected the taxpayer's argument, stating that there need only be sufficient connection between the termination and the payment to warrant a finding that the payment is made in consequence of the termination of the employee's employment. The payment was deemed an ETP because there was a sequence of connected events following the termination that ultimately led to the payment.

11.  The reasoning in Le Grand and Dibb was applied in Stark v FC of T 2023 ATC; [2023] FCA 1523. In that case, the Federal Court (Derrington J) upheld the decision of the AAT ( 2021 ATC; [2021] AATA 2583) that a payment received in settlement of a claim for deceptive conduct and wrongful dismissal should be taxed as an ETP after rejecting the taxpayer's claim that the payment was compensation for destruction of earning capacity6 (rather than loss of earnings).

12.  The AAT said that even if the payment was solely compensation for lost earning capacity, the litigation followed as a consequence of the termination of the taxpayer's employment and the payment was directly linked to the discontinuance of the litigation. The payment was thus made in consequence of termination. Derrington J also noted that, as established in Dibb, where a payment was made by way of settlement without any admission of liability or any acknowledgment or finding of injury, there would be no more than an allegation that an injury had been suffered. An allegation was not enough to satisfy s118-37(1)(a)(i), which required gains relating to compensation for personal wrong or injury to be disregarded.

13.  Under Case 7/2010, 2010 ATC 1-026, the taxpayer was the finance director of a wholly owned Australian subsidiary of an overseas company until he 'retired' in 2005. He subsequently put in a claim against the overseas company alleging unlawful discrimination and breach of contract. The parties settled the matter in 2008, with the company agreeing to make a settlement payment of $395,000 less applicable tax in release of all claims the taxpayer may have had against the company.

14.  The taxpayer sought a private ruling of the taxation treatment of the payment. The Commissioner ruled that the payment was an ETP within s82-130(1), having been received by the taxpayer in consequence of the termination of his employment. The taxpayer objected to the ruling and sought review of the Commissioner's disallowance of his objection.

15.  The taxpayer's argument against the payment being treated as an ETP was that;

(i)    he did not receive the payment in consequence of the termination of his employment,

(ii)   even if the payment answered that description, then either the whole payment or a significant part of it was covered by s82-135(i) as a "capital payment for, or in respect of, 'personal injury' to him, and

(iii)  the payment was "compensation or damages" covered by s118-37(1), having been received either for a wrong or injury he suffered in his employment, or for a wrong, injury or illness he suffered personally.

16.  The AAT upheld the Commissioner's decision and affirmed;

'the payment was received by the taxpayer 'in consequence of the termination' of his employment. Even accepting that the termination of the employment need not be the dominant cause of the payment, it was clear that the payment was in consequence of the settlement, which was a consequence of the Federal Court proceeding, which in turn was a consequence of the termination. The payment would not have been made but for the termination. It was therefore an ETP unless it was a payment under s82-135'.

17.  The settlement amount was a single, undissected lump sum with no attribution of any portion of it to any of the various heads of relief claimed by the taxpayer. There was no admission of liability by the former employer. It followed that, even if the "pain, suffering, anxiety, hurt, stress, and humiliation" claimed by the taxpayer amounted to "personal injury", no part of the payment could represent a payment 'for, or in respect of, personal injury'. Section 82-135(i) did not apply.

18.  The Commissioner ' s general views are set out in TR 2003/13 is that:

•         The payment must follow as an effect or result of the termination. In other words, but for the termination, the payment would not have been made. It is not sufficient that the payment is simply made subsequently to the termination.

•         Although it is necessary that there be a causal connection, it is not necessary that the termination be the dominant cause.

•         The termination must be a necessary condition of the payment.

•         The greater the length of time between the termination and the payment, the more likely it is that the causal connection between the termination and the payment may be too remote.

19.  However, length of time is not determinative where there is a presently existing right to the payment at the time of termination. For example, if at the time of termination the taxpayer has a right to commute a pension (as in Seabright v FC of T 99 ATC 2011), a payment resulting from the subsequent exercise of that right would be considered to be in consequence of termination. If, on the other hand, that right only arose after termination, a payment resulting from its exercise would not be made in consequence of termination

20.  On this basis, for example, the Commissioner considers that the following payments would satisfy the test:

•         A severance payment made to the taxpayer by a former employer after the termination of employment

•         A payment made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature

•         A payment in lieu of notice on termination of employment (through payments for work performed while working out a period of a period of notice are assessable as ordinary income: Taxation Determination TD 94/62).

21.  The Commissioner also takes the view that compensation for unlawful dismissal under discrimination legislation is paid in consequence of a termination of employment (Taxation Ruling IT 2424).

22.  Example 1, under TR 2003/13 below reinforces the legal view;

Fred Brown was dismissed from his employment. He believed that he had been treated unjustly and took legal action against his former employer for unfair dismissal. Approximately 18 months later, Fred and his former employer agreed to an out of court settlement and a lump sum was paid to Fred soon after.

The payment was made in consequence of the termination of employment. Although the dominant cause of the payment was the claim brought by Fred against his former employer, there is still a causal connection between the termination and the payment of the settlement. But for the termination of employment, Fred would not have brought legal action against his former employer. The legal action, the termination and the payment are intertwined.

Conclusion

23.  The client and his Employer agreed to settle their claims and differences under the terms of a Deed of Release. The settlement amount was not apportioned between the two Australian and overseas employment agreements.

24.  While the settlement of the legal proceedings is a direct cause of the payment, the proceedings in respect of the claim were commenced by the client as a result of the termination of his employment. That is, there was a sequence of events following the termination which had a relationship and connection which ultimately led to the total settlement payment - the termination, claim for an ETP, legal proceedings and payments were all intertwined.

25.  Although s82-130(1)(b) requires a payment to be made no later than 12 months after the termination to qualify as an ETP, the Commissioner will consider the timeframe under certain circumstances.

26.  Legal decisions have held that the length of time between the termination of employment, the commencement of court proceedings and payment following settlement does not sever the causal connection between the termination and the payment. It was sufficient that the subject matter of the litigation was the termination (Dibb v. FC of T 2004 ATC 4555).

27.  Therefore, it is considered that the total settlement payment was received by the client in consequence of the termination of his employment with the employer as per paragraph 82-130(1)(a) of the ITAA 1997.