Private ruling: Compensation payment - unfair dismissal
Published: January 2012
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Is a lump sum payment you received in settlement of a legal action against your employer subject to income tax? | A1: Yes

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: · the application for private ruling · a copy of the deed of release · a copy of correspondence from ex employer Your employment was terminated You took legal action through your solicitor for illegal termination, loss of wages, slander and loss of reputation, pain and suffering. You received payment of your entitlements but your employer refused any further liability. You further instructed your solicitor to commence legal action for damages and compensation that included loss of wages plus income differential loss between contract and current employment over the term of the contract. You lodged an application to deal with a general protections dispute relating to your employment and dismissal. You settled out of court under a deed of release which provides for the mutual release of both parties from the circumstances which are defined in the deed without any admission of liability. The payment is in full and final satisfaction and discharge of all claims and entitlements which the employee has or may have had or would have had arising out the employment, dismissal and the matters referred to in the proceedings. You were issued with a PAYG payment summary that included this payment as gross payments and not as a lump sum payment. You understand that some of this amount would be earnings but the amount was only an example of some of your losses.

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 10-5, | Income Tax Assessment Act 1997 Section 82-130 and | Income Tax Assessment Act 1997 Section 82-135.

Reasons for decision: Summary: A lump sum payment received in settlement of a legal action against your employer is assessable as an employment termination payment. | Detailed Reasoning - Detailed reasoning: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that assessable income includes income according to ordinary concepts which is called ordinary income. Section 6-10 of the ITAA 1997 provides that your assessable income includes some amounts that are not ordinary income. This income is described as statutory income. A summary of the various statutory income provisions is found at section 10-5 of the ITAA 1997. A lump sum payment payable by your employer in settlement of a dispute is not ordinary income but consideration must be given as to whether such a payment is statutory income. Section 10-5 of the ITAA 1997 refers to employment termination payments that are assessable under Division 82 of the ITAA 1997. A payment made to an employee on or after 1 July 2007 is an employment termination payment (ETP) if the payment 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. Sub section 82-130(4) of the ITAA 1997 provides two exceptions whereby the Commissioner may determine that: · the payment is a genuine redundancy payment or an early retirement scheme payment; or · by legislative instrument paragraph (1)(b) does not apply . Neither of these exceptions applies in your case. 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. The Full High Court considered the expression 'in consequence of' in Reseck v. FC of T (1975) 133 CLR 45; (1975) 6 ALR 642; (1975) 49 ALJR 370; (1975) 5 ATR 538; (1975) 75 ATC 4213 ( Reseck ). Justice Gibbs stated: Within the ordinary meaning of the words a lump 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 in my opinion necessary that the termination of the services should be the dominant cause of the payment. While Justice Jacobs 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 v. FC of T (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 ( McIntosh ) considered the decision in Reseck . Justice Brennan stated: Though Jacobs J. speaks in different terms, his meaning may not be significantly different from the meaning of Gibbs J... His Honour denies the necessity to show that retirement is the dominant cause, but he does not allow a temporal sequence alone to suffice as the nexus. Though the language of causation often contains the seeds of confusion, I apprehend his Honour to hold the required nexus to be (at least) that the payment would not have been made but for the retirement. The Commissioner in TR 2003/13 considered the phrase 'in consequence of' as interpreted by the Courts. Paragraph 5 of TR 2003/13 states: …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 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. Where, under a deed of release, before any payment is payable the taxpayer is required to resign from employment, it has been held that a payment not paid specifically in relation to that termination is, nevertheless, also an ETP. In your case, there was a dispute between you and your employer relating to your employment. Your employment was terminated by your employer. You made a claim through your solicitor. The employer made an offer to pay you a lump sum and you entered into an agreement under a deed of release. The Courts have held that settlement amounts arising from actions that are in some manner connected with the termination of employment are payments made in relation to the taxpayer in consequence of the termination of their employment. Although the dominant cause of the payment is to settle the claim initiated by you, there is, at least, a causal connection between the termination of employment and the proposed payment. Given the nature of this matter, the dispute, the settlement, the termination of employment and the offer of payment are all intertwined and connected. Based on the principles stated in Reseck and McIntosh and the Commissioner's views expressed in TR 2003/13, the facts presented demonstrate that a clear connection exists between the termination of your employment and the settlement sum. Taxation Ruling IT 2424 deals with compensation payments in respect of unlawful dismissal or wrongful dismissal. Paragraph 24 of the ruling states: A compensation payment received by way of settlement or under a determination of the Commission in respect of an unlawful act of dismissal qualifies as an eligible termination payment. Essentially, the compensation payment for unlawful dismissal, like a payment for wrongful dismissal settled or awarded under a common law action, is considered to be made "inconsequence of the termination of any employment of the taxpayer'. The payment falls within the definition of an eligible termination payment and is liable for income tax in accordance with the special eligible termination payment rules. Accordingly, the settlement sum is considered to be an employment termination payment in accordance with subparagraph 82-130(1)(a)(i) of the ITAA 1997 and is included as assessable income. | Detailed Reasoning - Further information: In respect to the issue of your PAYG payment summary, you will need to seek an amended payment summary from your previous employer to include the amount as a lump sum payment as an ETP. An ETP is reported at item 4 in the 2010-11 income tax return. Further information regrading ETPs is available on the Tax Office website www.ato.gov.au, or by phoning the Superannuation Infoline 131020.

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