Private ruling: Settlement payment
Date of advice: 6 October 2017
Published: February 2018
Ruling period: Year ending 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Is the settlement sum regarded as ordinary assessable income? | A1: No. | Q2: Is any part of the settlement sum a genuine redundancy payment under section 83-175 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No. | Q3: Is the settlement sum an employment termination payment under section 82-130 of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: You were employed by entity A for many years. The employment was terminated. Without admission, you and your former employer have agreed to settle all matters pertaining to the employment and termination. The Deed of Settlement and Release was entered into. Your former employer paid a settlement sum to you as outlined in the Deed. The Settlement Deed stipulates that your employment was terminated by resignation. The Settlement Deed did not provide a breakdown of the settlement sum and no part was attributed to annual leave or long service leave. Your former employer issued an amended payment summary with the lump sum payment being included in your ordinary earnings. The reason you ceased employment with entity A was that you were offered a position with another entity. The settlement sum was received in the 2015-16 financial year approximately two weeks after the signing of the Settlement Deed.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 83-175 | Income Tax Assessment Act 1997 section 82-130 | Income Tax Assessment Act 1997 section 82-135

Reasons for decision: Summary: Ordinary assessable income Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. 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. For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted ( Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts ( Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433). On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. In Scott v. FC of T (1966) 14 ATD 286, Windeyer J expressed the view that whether or not a particular receipt is income depends upon its quality in the hands of the recipient. The settlement sum received was not earned by you as it does not relate to services performed. Although the settlement sum relates to your previous employment, the payment is not a revenue receipt directly related to your employment duties. The payment is not a payment for lost income. The payment is also a one-off payment and thus does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the circumstances surrounding your termination. Considering the full circumstances, the settlement sum payment is not regarded as ordinary income and is therefore not assessable under subsection 6-5(2) of the ITAA 1997. Statutory income Amounts that are not ordinary income, but are included in your assessable income by another provision are called statutory income (section 6-10 of the ITAA 1997). The provisions dealing with statutory income are listed in section 10-5 of the ITAA 1997. The relevant provisions are discussed below. Genuine redundancy payment. Under subsection 83-175(1) of the ITAA 1997, a genuine redundancy payment is so much of a payment 'received by an employee who is dismissed from employment because the employee's position is genuinely redundant' that exceeds the amount that could reasonably be expected to be received by the employee in consequence of voluntary termination. There are four necessary components within this requirement: 1. The payment being tested must be received in consequence of an employee's termination. 2. That termination must involve the employee being dismissed from employment. 3. That dismissal must be caused by the redundancy of the employee's position. 4. The redundancy payment must be made genuinely because of a redundancy. In addition to the basic requirement for a genuine redundancy payment found in subsection 83-175(1), the further conditions for genuine redundancy payment treatment in subsections 83-175(2) and (3) require that: ● the dismissed employee is not older than specified age limits; ● the termination is not at the end of a fixed period of employment; ● the actual amount paid is not greater than the amount that could reasonably be expected had the parties been dealing at arm's length, in the event that the employer and employee are in fact not dealing at arm's length in relation to the dismissal; ● there is no arrangement entered into between the employer and the employee or the employer and another entity to employ the dismissed employee after the termination; and ● the payment is not in lieu of superannuation benefits. The Commissioner has issued Taxation Ruling TR 2009/2 Income tax: genuine redundancy payments (TR 2009/2), which outlines the requirements to be satisfied before any payment made to a person whose employment is termination qualifies for treatment as a genuine redundancy payment under subsection 83-175(1) of the ITAA 1997. At paragraphs 18 and 25 of TR 2009/2, the Commissioner states: 18. Dismissal is a particular mode of employment termination. It requires a decision to termination the employment at the employer’s initiative without the consent of the employee. This stands in contrast to the employment that is termination at the initiative of the employee… 25. An employee’s position is redundant when an employer determines that it is superfluous to the employer’s needs and the employer does not want the position to be occupied by anyone. Accordingly, it is fundamentally the employer’s decision that a position is redundant… The Settlement Deed stipulates that your employment was terminated by resignation. You confirmed this. The settlement sum was not paid in consequence of you being dismissed from employment and payment was not made as a result of your position being made redundant, and is therefore not a genuine redundancy payment. Employment Termination Payment (ETP) A payment is an 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. 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. Payment ‘in consequence of’ the termination of employment The facts need to show there is a direct causal connection between the payment and a termination of employment. If a termination of employment does not occur, then an employee is not entitled to the payment. In this case, the payment under the Settlement Deed would satisfy the first ETP condition as it is paid in connection with the termination of employment on resignation. Payment received no later than 12 months after termination In addition to meeting the other conditions for a payment to be an ETP, paragraph 82-130(1)(b) of the ITAA 1997 specifies that the payment must be received within 12 months of the employee’s termination of employment, unless they are covered by a determination exempting them from the 12 month rule. In this case, the ETP was paid within 12 months of the date of your termination of work. Not a payment mentioned in section 82-135 of the ITAA 1997 Section 82-135 of the ITAA 1997 lists payments that are not employment termination payments. These include (among others): ● superannuation benefits; ● unused annual leave or long service leave payments; ● foreign termination payments covered under Subdivision 83-D of the ITAA 1997; and ● the part of a genuine redundancy payment or an early retirement scheme payment that is not covered by subsection 83-170(3) of the ITAA 1997. The Settlement Deed refers to a settlement sum and no part of the payment is itemised as being for unused annual leave, long service leave or superannuation. The settlement sum is not considered to be one of the excluded payments referred to in section 82-135 of the ITAA 1997. Conclusion As the payment satisfies all the conditions listed in subsection 82-130(1) of the ITAA 1997 and is not an excluded payment under section 82-135, it is considered to be an ETP. The taxable component of an ETP is included in your assessable income on your tax return and a tax offset applies under section 82-10 of the ITAA 1997 to effectively limit the concessional tax treatment to the applicable cap. Amounts over the cap are taxed at the top marginal rate.