Private ruling: Employment termination payment - invalidity segment
Date of advice: 1 August 2016
Published: September 2016
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20WW

Ruling: Q1: Is any portion of the payment exempt from tax, as an invalidity segment of an employment termination payment (ETP), in accordance with section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: You commenced employment with an employer (the Employer) during the 20UU-VV income year. As part of the Employee's Contract of Employment letter during the 20TT-UU income year, the Employee is eligible for cover under the Employer's, Care and Assurance Plan (the Plan). The Plan incorporates a Serious Illness policy, Income Protection Insurance and Death and Total and Permanent Disablement insurance. The Death and Total and & Permanent Disablement insurance (the Policy) is held by the Employer with an insurance company. You suffer from an illness which has reached the stage where you were unable to return to work. You terminated employment with the Employer during the 20WW-XX income year. A medical certificate from a medical practitioner during the 20WW-XX income year stated that they did not believe you were ever likely to resume work in your own or any other occupation. A medical certificate from another medical practitioner during the 20XX-YY income year advised that you will not be able to retrain in another position with that Employer or work in a similar position with another Employer, or any other role for which you have the experience and training to otherwise be qualified. You do not have the capacity to return to any form of employment for which you are reasonably qualified, due to education, training or experience, as a result of your illness. You made a claim to the insurer for Total and Permanent Disablement (TPD). The TPD claim was subsequently accepted by the insurer during the 20WW-XX income year. Under the Policy the payment is made to the Employer. The Employer is then legally obligated under the terms of the employment contract and the Plan to pay the monies received from that insurance to you. The insurer paid out a lump sum benefit to the Employer. The Employer then paid the lump sum benefit to you during the 20WW-XX income year. The Employer withheld tax from the payment. The payment is an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 . You are under your preservation age.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 82-130(1) | Income Tax Assessment Act 1997 paragraph 82-140 (a) | Income Tax Assessment Act 1997 subsection 82-150(1) | Income Tax Assessment Act 1997 subsection 82-150(2) | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: An amount is exempt from tax as an invalidity segment of an employment termination payment (ETP). The taxable component of the employment termination payment is included in your income tax return for the 20WW-XX income year. | Detailed Reasoning - Detailed reasoning: Under subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997) where a person's employment is terminated because of ill-health and the person receives an employment termination payment (ETP) part of the payment may be tax free. This component is called an invalidity segment (subsection 82-150(1) of the ITAA 1997). In this case, your employment was terminated because of ill-health. From the facts, the lump sum payment (the Payment) you received from the Employer as proceeds from an insurance policy for TPD is an ETP. In relation to whether any part of the Payment includes an invalidity segment it must satisfy subsection 82-150(1) of the ITAA 1997 which states: An employment termination payment includes an invalidity segment if: (a) the payment was made to a person because he or she stops being gainfully employed; and (b) the person stopped being gainfully employed because he or she suffered from ill-health (whether physical or mental); and (c) the gainful employment stopped before the person's last retirement day; and (d) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in capacity for which he or she is reasonably qualified because of education, experience or training. | Detailed Reasoning - Gainful employment: Section 995-1 of the ITAA 1997 defines being gainfully employed as follows: gainfully employed means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment. You were employed on a full-time basis with the Employer until you became ill. | Detailed Reasoning - Payment for stopping gainful employment: The Payment is considered to be a payment made on the termination of your employment. | Detailed Reasoning - Employment termination occurred because of ill-health: The requirement under paragraph 82-150(1) (b) of the ITAA 1997 is that the termination of employment resulted from the taxpayer's ill-health, that is, the ill-health was the immediate cause for the termination of the taxpayer's employment. In this case, the facts show the termination of employment during the 20WW-XX income year occurred after you suffered from an illness and was unable to return to work. You lodged a claim with the insurer for Total and Permanent Disablement (TPD). The claim for TPD was accepted by the insurer during the 20WW-XX income year. Therefore, it is considered that this requirement is satisfied. | Detailed Reasoning - Termination of employment occurred before last retirement date: The third condition for a payment to qualify as an invalidity component is that it was made before the taxpayer's last retirement date. The payment was made during the 20WW-XX income year when you were well under the normal retirement age of 65. Therefore, the condition of paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied. Certification from 2 legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed. In respect of the final requirement, it must be demonstrated that the disability at the time of termination was such that: it is unlikely that the person can ever be gainfully employed in capacity for which he or she is reasonably qualified because of education, experience or training. Therefore, paragraph 82-150(1)(d) of the ITAA 1997 requires that there must be the likelihood that the disability of the taxpayer will preclude the taxpayer from ever being employed in a role, for which the taxpayer is reasonably qualified. A medical certificate from a medical practitioner during the 20WW-XX income year stated that they did not believe you were ever likely to resume work in your own or any other occupation. A medical certificate from another medical practitioner during the 20XX-YY income year stated that you do not have the capacity to return to any form of employment for which you are reasonably qualified, due to your education, training or experience. Therefore, as two medical practitioners have provided certificates that attest to you being unable to ever be employed in a capacity for which you are reasonably qualified because of education, training or experience, it is considered that the final condition of subsection 82-150(1) of the ITAA 1997 has been satisfied. As mentioned above all conditions under section subsection 82-150(1) of the ITAA 1997 must be satisfied before a part of the payment can be treated as an invalidity segment of the ETP. As all of the conditions under subsection 82-150(1) of the ITAA 1997 are satisfied, a part of the ETP payment contains an invalidity segment. | Detailed Reasoning - Components of an employment termination payment: Under section 82-140 of the ITAA 1997 the invalidity segment included in an ETP is tax free. An employment termination payment comprises the following components: _ Tax free component this includes the invalidity segment (if any) or pre-July 83 component (if any); and _ Taxable component the amount remaining after deducting the tax free component from the total payment. As you have satisfied the requirements for the payment of an invalidity payment, an element of the ETP received from the Employer will be tax free. The amount of the invalidity segment is worked out by applying the formula as in subsection 82-150(2) of the ITAA 1997. Work out the amount of the invalidity segment by applying the following formula: Amount of employment termination payment x Days to retirement ÷ Employment days + Days to retirement where: days to retirement is the number of days from the day on which the person's employment was terminated to the last retirement day. employment days is the number of days of employment to which the payment relates. Therefore, an amount of the payment is the invalidity segment included in the ETP which is tax free. The remaining amount is a taxable component to be included in your income tax return for the 20WW-XX income year. The taxable component is taxed at a lower (concessional) rate, in accordance with subsection 82-10(3) of the ITAA 1997, up to a certain cap amount. Subsection 82-10(3) of the ITAA 1997 states: You are entitled to a * tax offset that ensures that the rate of income tax on the amount mentioned in subsection (4) does not exceed: (a) if you are your * preservation age or older on the last day of the income year in which you receive the payment--15%; or (b) otherwise--30%. *To find definitions of asterisked terms, see the Dictionary, starting at section 995-1 In this case, as you are receiving a payment because of a permanent disability, the relevant cap amount is the ETP cap, which is $195,000 for the 20WW-XX income year. Paragraph 82-10(3)(b) of the ITAA 1997 will apply as you were under your preservation age when you received the payment. The rate of tax is at the top marginal rate for amounts above the ETP cap.