Private ruling: Employment termination payment- Deed of Released
Published: May 2012
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Is the settlement payment made to your client pursuant to a Deed of Release (the Deed) an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)? Is the payment received from a private company assessable under section 15-2 of the ITAA 1997? Was the taxpayer's right to be issued shares in the private company a capital gains tax (CGT) asset as that term is defined in subsection 108-5(1)(b) of the ITAA 1997? Did the execution of the Deed give rise to the disposal of a CGT asset under CGT event C2? | A1: 1. No. 2. Yes 3. Yes 4. No


Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5. | Income Tax Assessment Act 1997 section 6-10. | Income Tax Assessment Act 1997 section 15-2. | Income Tax Assessment Act 1997 Section 82-130. | Income Tax Assessment Act 1997 Subsection 82-130(1). | Income Tax Assessment Act 1997 Paragraph 82-130(1)(a). | Income Tax Assessment Act 1997 Subsection 82-130(2). | Income Tax Assessment Act 1997 Section 82-135. | Income Tax Assessment Act 1997 subsection 108-5(1)(b). | Income Tax Assessment Act 1997 section 115-5. | Income Tax Assessment Act 1997 section 118-20. | Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision: Detailed Reasoning - Summary of decision: The settlement payment in respect of Company A's unissued shares is not an employment termination payment as the payment has not been made in consequence of the termination of your client's employment. The compensation payment your client received is assessable income and is not assessable as a capital gain. | 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 Income Tax Assessment Act 1997 (ITAA 1997)). Section 995-1 of the ITAA 1997 states: employment termination payment has the meaning given by section 82-130. 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. Therefore, it can be seen that a number of conditions need to be satisfied in order for the payment to be treated as an employment termination payment. To determine if the settlement payment is 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. Payment is made in consequence of the termination of employment The first condition to be met is that the payment is received by the person in consequence of the termination of their employment. The phrase 'in consequence of' is not defined in the ITAA 1997. However, the words have been interpreted by the courts in several cases. The Commissioner has also issued Taxation Ruling TR 2003/13 which discusses the meaning of the phrase. 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. Also in paragraph 5 of TR 2003/13 the Commissioner notes that the Courts have considered the meaning of the words in consequence of in several cases. Of note are the decisions made by the Full Bench of 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 Reseck , Justice 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 my opinion necessary that the termination of the services should be the dominant cause of the payment. While Justice Jacobs, in the same case, 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 . In doing so the Full Federal Court emphasised that a payment may be in consequence of the termination of employment even though the termination is not the dominant cause of the payment. In particular, 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. Thus, 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. The phrase in consequence of and the decisions in Reseck and McIntosh were considered more recently by the Federal Court 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 ). In 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 eligible termination payment (ETP). It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an ETP. In making his decision, Justice Goldberg stated: · I am satisfied that there is a sufficient connection between the termination of the applicants employment and the payment to warrant the finding that the payment was made in consequence of the termination of the applicants 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 . The approach taken in Le Grand was also adopted in Dibb v Commissioner of Taxation (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126, where the Full Federal Court held that a payment received under a Deed of Release following the settlement of legal proceedings against the taxpayer's former employer was an ETP. The Court considered that there was a clear chain of causation between the payment and the termination. That is, the subject matter of the litigation was clearly interwoven and intertwined with the termination. 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 noted in both paragraphs 6 and 28 of TR 2003/13, there must be 'a causal connection between the termination and the payment even though the termination need not be the [sole or] dominant cause of the payment'. Therefore if the payment follows as an effect 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. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135. From the facts provided, your client's employment with the employer was terminated in the last quarter of the 2009-10 income year. The termination of your client's employment from Company A gave rise to a legal dispute regarding your client termination payment entitlements and the failure to issue Company A's shares to which your client believed they were entitled. An examination of the Deed of Release (the Deed) dated in the 2010-11 income year shows the following made at a particular recital: Before 30 June 2010, [your client] gave notice in writing to [Company A] asserting an entitlement to be issued shares of the company and that certain actions purportedly taken by [Company D] as its sole shareholder were invalid. This entitlement allegedly arises from a "shareholder Table" and other agreements, correspondence and conduct between [your client] and [Person B]. [Your client] also disputed the validity of the resolution terminating your client's directorship and employment based on your client assertion that your client should have been given notice of the first Resolution as though your client was recorded as a member on [Company A] shareholder's register. Furthermore, in another recital of the Deed, it states: · The parties have an agreement which settles the disputes between [your client] on one hand and [Company A], [Company C], [Company D], [Person B] and any entity that is related to [Company A], [Company C], [Company D], [Person B] ("Group") on the other hand on the terms and conditions of this Deed. It can be seen in the recital, the word 'dispute' is used in the plural and not in the singular. This would imply that there is more than one matter in dispute; that is, the entitlement to the issued shares and the validity of the resolution terminating the directorship and employment. Other than this, there appears to be nothing else that could be construed as linking the payments under the Deed of Release to the termination of your client's employment as CEO and director of Company A. A letter in the 2009-10 income year, your client demanded payment of their termination payment entitlement to be paid by the last quarter of the 2009-10 income year. You advised that the legal dispute regarding your client's termination payment entitlements was resolved in the 2009-10 income year. Your client received their termination payment entitlements for unused annual leave, long service leave and in lieu of notice in the 2009-10 income year. In a letter from your client's representative to Company A in the 2010-11 income year provided an offer of settlement in respect of unissued shares. In the letter it stipulated your client's entitlement for the unissued shares was a specific percentage. Your client worked out the present value of their shares as a specific amount (the settlement amount). The present value of your client's shares was based on the formula used to settle a former employee's dispute with Company A regarding their purported shareholding. In a reply letter in the 2010-11 income year from Company A's representative to your client's representative stated that they received instructions regarding the assertions and the proposal contained in your client's letter in the previous month. The letter states: Notwithstanding, and in a spirit of compromise, Company A is willing to resolve these issues upon the following basis: 1. The proposal is submitted on a without prejudice basis; 2. There is no admission by Company A that your client has any entitlement to the issue or shares out to the payment of any sum in lieu of such issue; 3. The Company will pay your client the settlement amount in the following instalments: (a)… 4.… 5. If this proposed is accepted, I will send you a deed of settlement and release incorporating these terms for immediate execution by the parties… A settlement was reached between your client and the employer in the second quarter of the 2010-11 income year. Under the Deed, a settlement amount was paid to your client. It can be seen from the above, the settlement payment was made to satisfy of the claim for unissued share. The settlement payment was exactly the value of the shares your client contested had not been issued and was calculated on the same basis as was applied in settling the earlier dispute on the same issue with the other former employee. The Commissioner considers that the termination of your client's employment by Company A did not have any substantive effect on the existence of the right to be issued shares (which apparently arose several years before the termination date). Nor did the termination of employment affect the nature or value of that right in any way. There is no evidence to indicate that your client would not have received the shares had your client's employment continued. The dispute of the unissued shares would still have occurred at a later stage. In other words, the settlement payment was not conditional on the termination of your client's employment. The connection between the settlement payment and the termination of employment was merely temporal. Based on the above finding, it is concluded that the settlement payment was not made in consequence of the termination of your client's employment. Accordingly, the requirement under subparagraph 82-130(1)(a) of the ITAA 1997 has not been met and the payment is not an employment termination payment. It is not necessary to examine the remaining conditions under section 82-130(1). | Detailed Reasoning - Capital gains tax: How a lump sum or other compensation amount is assessable in the hands of the recipient depends on whether it is a receipt of capital or income. A payment is on the revenue account if it is received as a replacement for an item that would have been on the revenue account if it was received. Similarly, the payment is on the capital account if the item it replaces would have been on the capital account if it was received. Under section 6-5 of the ITAA 1997, income according to ordinary concepts (ordinary income) is assessable to a resident taxpayer in the year it is derived. Ordinary income is defined under common law based on a number of factors that indicate whether an amount has the character of income according to ordinary concepts. However, section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income and are also included in assessable income. Section 15-2 of the ITAA 1997, provides that the value of all allowances, gratuities, compensations, benefits, bonuses and premiums allowed, given or granted in respect of, or for or in relation directly or indirectly to, any employment of a taxpayer or services rendered by them is included in assessable income. In your case, the compensation payment is a capital payment that directly relates to your client's employment. It is therefore assessable under section 15-2 of the ITAA 1997. Section 108-5 of the ITAA 1997 provides that a CGT asset includes a legal or equitable right. Section 104-25 provides that CGT event C2 happens when your ownership interest of a CGT asset ends when it is released discharged or satisfied. In your client situation your client's right to be issued shares in Company A is a CGT asset and CGT event C2 happened when your client entered into the Deed. However, where the disposal of an asset gives rise to assessable income and a capital gain, the amount of the income is included in assessable income and the capital gain is reduced by that amount, or to zero, in accordance with section 118-20 of the ITAA 1997. Therefore the compensation payment your client received is assessable under section 15-2 of the ITAA 1997 and not under the capital gains provisions.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Your client commenced employment with Company A several years ago. | Company A provides services to private enterprise corporations in Australia and other overseas countries. | Person B was appointed as a director of Company A several years ago. | Your client was appointed as a director of Company A in the 2003-04 income year. Your client also acted as the Chief Executive Officer (CEO) from after 1 January 2006 until your client's departure from Company A in the 2009-10 income year. | No formal employment agreement was entered into between your client and Company A; however your client was paid a salary. | In the 2005-06 income year Company C was incorporated in an overseas country and Person B was the sole shareholder. | Your client and Person B were appointed as directors of Company C. | Company D is the owner of a number shares in Company A including number of fully paid shares that were redeemed and reissued to Company D, pursuant to the First Resolution in the 2009-10 income year. As a result, Company D asserts it is the sole shareholder of Company A and Person B is Company's sole director and shareholder. | In the last quarter of the 2009-10 income year, a few issues were determined pursuant to a resolution of members (First Resolution). These issues were: | · that a number of fully paid shares currently issued to Company A be redeemed and reissued to Company D; | · removal of your client as a director of Company A; and | · termination of your client's employment with Company A as CEO, effective immediately. | Later in the 2009-10 income year, pursuant to a Second Resolution of the sole shareholder (Person B) of Company C, your client was removed as a director of Company C. | Your client's termination from Company A gave rise to a legal dispute regarding your client's termination payment entitlements and the failure to issue Company A's shares to which your client believed they were entitled. | The legal dispute regarding your client's termination entitlements was resolved towards the end of the 2009-10 income year. At that time your client received their termination entitlements from Company A which included unused long service leave, unused annual leave and in lieu of notice. | Several weeks later, your client gave notice in writing to Company A asserting an entitlement to be issued equalling a certain percentage of the share capital of Company A and that certain actions purportedly taken by Company D as its sole shareholder were invalid. This entitlement allegedly arises from a 'Shareholder Table' and other agreements, correspondence and conducts between your client and Person B. | Your client also disputed the validity of the resolution terminating their directorship and employment based on the assertion that your client should have been given notice of the First Resolution as though your client was recorded as a member on Company A shareholder's register. | The parties (your client, Company A, Company C, Company D and Person B) have reached an agreement to settle the disputes. A Deed of Release (the Deed) was executed in the 2010-11 income year by the parties. | The Company will pay your client a settlement amount by instalments to be made on the dates set out in a schedule to the Deed, or accelerated under a specific clause of the terms and conditions of the Deed. | You state that the Deed did not preclude your client from taking further action with respect to the purported resolutions terminating their employment as CEO and their directorship. However, you further state that it was completely silent on those issues because, so far as your client was concerned, they became academic once your client's claim for employment entitlements was resolved.