Private ruling: Employment termination payment
Published: August 2014
Ruling period: Year ending 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Is any part of the payment received by your client in settlement of legal proceedings brought against the employer, considered to be a genuine redundancy payment in accordance with section 83-175 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: Your client is less than 65 years old. Your client commenced employment with the Employer in the 2010 income year in two senior managerial roles under a contract of employment. In the 2011 income year, your client and the Employer agreed to a variation of the terms of the employment contract which also confirmed your client's role in several senior managerial positions. In the 2012 income year, your client and the Employer entered into a varied contract of employment which amended the relevant provision in relation to 'Notice of Termination'. In the 2012 income year, the Employer issued to your client the contract of employment formally recording the terms on which they were employed, including confirmation of their role in several senior managerial positions. You advised in your ruling application that in the 2013 income year, the taxpayer did not believe that it was tenable to continue their employment. In the 2013 income year, your client gave their Employer written notice of constructive redundancy of their employment contract. In the 2014 income year, your client instigated legal proceedings against the Employer, seeking payment of their employee entitlements. In the 2014 income year, your client and their previous Employer reached a settlement whereby the Employer would pay the taxpayer a lump sum. In the 2014 income year, your client and their previous Employer executed a Deed of Settlement and Release (the Deed) which noted the following: • your client was employed by the Employer under a contract of employment from the 2010 to the 2012 income years in two senior managerial positions. • your client's employment ended in the 2012 income year; • your client commenced Action against the Employer seeking damages arising from, and consequent upon, the Loss Event; • the parties have reached a settlement on all the issues in the Action and the Claims on the terms of the Deed; • a settlement sum inclusive of legal costs and disbursements payable to your client within 14 days from the date of execution of the Deed by the Parties; • the Deed contains the entire agreement and understanding between the Parties on everything connected with the subject matter of that document and supersedes any prior agreement or understanding on anything connected with that subject matter. Your client has not recommenced work with the Employer.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 82-130. | Income Tax Assessment Act 1997 section 82-135. | Income Tax Assessment Act 1997 section 83-170. | Income Tax Assessment Act 1997 section 83-175.

Reasons for decision: Summary: The payment (excluding the amount for legal costs) received by your client is a genuine redundancy payment. The total tax-free part of the genuine redundancy payment is calculated in accordance with subsection 83-170(2) of the ITAA 1997. The remaining amount of the payment is an employment termination payment and treated as assessable income. | Detailed Reasoning - Detailed reasoning: To determine if any part of the payment made to your client is a genuine redundancy payment, it must first be determined whether any part of the payment is an employment termination payment. | Detailed Reasoning - Employment termination payment: A payment is an employment termination payment if it 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) 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. Section 82-135 of the ITAA 1997 provides that certain payments are not employer 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 tax-free part of a genuine redundancy payment or an early retirement scheme payment. Based on the information provided, your client's employment terminated on 11 October 2012. Taxation Ruling TR 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' (TR 2003/13) states that: 5. ...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. 6. 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 payment received by your client was in settlement of legal proceedings brought against your client's former Employer. Whilst your client terminated their employment with their former Employer without an express 'dismissal' by the Employer, your client successfully instigated court proceedings against their former Employer, seeking payment of their employment entitlements, on the basis that they had been constructively dismissed. Paragraph 31 of TR 2003/13 states: 31. It is clear from the decision in Le Grand , that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of the taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination. The payment received by your client was made in consequence of the termination of their employment with their former Employer. There is a clear causal connection between the termination of their employment and the payment made under the Deed. The lump sum was paid 'in consequence' of the termination of employment as defined in subparagraph 82-130(1)(a)(i) of the ITAA 1997. Paragraph 82-130(1)(b) of the ITAA 1997 also requires the payment to be received within 12 months of the termination. Your client's employment ended in the 2012 income year and payment was made to your client in the 2014 income year. However, as per paragraph 82-130(4) of the ITAA 1997, the '12 month rule' under paragraph 82-130(1)(b) will not apply if: • you are covered by a determination under subsection (5) or (7); or • the payment is a genuine redundancy payment or an early retirement scheme payment. The Commissioner has determined in Employment Termination Payments (12 month rule) Determination 2007, that paragraph 82-130(1)(b) of the ITAA 1997 does not apply to a late termination payment if the payment is received more than 12 months after the termination of a person's employment because of legal action commenced within 12 months of the termination of employment, of which the subject is either or both, the person's entitlement to the payment, or the amount of the person's entitlement. In this case, as your client's court proceedings commenced within 12 months of their termination, your client has satisfied the '12 month rule' under paragraph 82-130(1)(b). Further, apart from the possible exception of the tax free part of a genuine redundancy payment, which is discussed below, it is not a payment excluded from being an employment termination payment under section 82-135. It is important to note that your client received a lump sum on execution of the Deed. A portion of that lump sum was received 'in consequence' of termination of employment, in satisfaction of the '12 month rule' and is not covered by the payments mentioned in section 82-135 (with the possible exception of the tax free part of a genuine redundancy payment). That portion of the payment is therefore an employment termination payment. The amount paid in relation to legal action concerning the termination of your client's employment is paid to indemnify them for the cost of pursuing litigation. It is not received in consequence of termination of employment and is therefore not an employment termination payment. That amount is not an assessable recoupment or assessable as ordinary income. Furthermore, the legal costs incurred by your client are not deductible, as the advantage sought by the legal action is of a capital nature. | Detailed Reasoning - Genuine redundancy payment: Under subsection 83-175(1) of the ITAA 1997 a genuine redundancy payment is one 'received by an employee who is dismissed from employment because the employee's position is genuinely redundant'. In Taxation Ruling 2009/2 Income tax: genuine redundancy payments , the Commissioner has outlined the requirements to be satisfied before any payment made to a person whose employment is terminated qualifies for treatment as a genuine redundancy payment under section 83-175 of the ITAA 1997. There are four necessary components within this termination 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. | Detailed Reasoning - Component 1: Payment being tested must be received in consequence of an employee's termination: It has been established previously that the payment (excluding the amount for legal costs) received by your client, has been received in consequence of the termination of their employment. Therefore the requirement of the first component of subsection 83-175(1) of the ITAA 1997 has been satisfied. | Detailed Reasoning - Component 2: That termination must involve the employee being dismissed from employment: On the basis of the facts as presented in this case, it is evident that the actions of your client's former Employer were the principal contributing factor leading to your client's resignation. Whilst your client was not dismissed from their employment at the initiative of their former Employer, it is accepted that your client was constructively dismissed due to the nature of the employment relationship between your client and their former Employer during the relevant period. Therefore, this second component of subsection 83-175(1) of the ITAA 1997 has been satisfied. | Detailed Reasoning - Component 3: That dismissal must be caused by the redundancy of the employee's position: Based on information available it is evident that one of the senior managerial positions no longer exists within the organisational structure of your client's former Employer. The third requirement of a genuine redundancy has therefore been satisfied. | Detailed Reasoning - Component 4: The redundancy payment must be made genuinely because of a redundancy: The need for an employee's position to be genuinely redundant establishes that contrived cases of redundancy will not meet the conditions in section 83-175 of the ITAA 1997. In this case, there is nothing to indicate that the redundancy is not genuine. Therefore, the fourth component of a genuine redundancy has been satisfied. | Detailed Reasoning - Further conditions for a genuine redundancy payment: Before a payment that meets the basic redundancy requirement in subsection 83-175(1) of the ITAA 1997 qualifies as a genuine redundancy payment, all other conditions in subsections 83-175(2) and (3) must be met. These conditions include: • the payment must be made before a person turns 65 or an earlier mandatory age; • the termination was not at the end of a fixed period of employment; • the actual amount that was paid is not greater than the amount that could reasonably be expected to be paid had the parties been dealing at arm's length; • the amount that was paid was in excess of what a person would have been entitled to receive if they had voluntarily resigned; • there was no arrangement for re-employment with the employer or a related party after the termination date; and • the payment was not in lieu of superannuation benefits. On the basis of the information provided, it is considered that all the conditions of subsections 83-175(2) and 83-175(3) of the ITAA 1997 are also satisfied. Section 83-170 then applies to treat so much of the relevant payment (that does not exceed the amount worked out under a specified formula) as tax-free. That is, the tax-free part is not assessable income and is not exempt income. Any amount in excess of the tax-free amount is taxed as an employment termination payment. | Detailed Reasoning - Taxation of a genuine redundancy payment: Subsection 83-170(2) of the ITAA 1997 provides that so much of the genuine redundancy payment that does not exceed the amount worked out using the formula prescribed in subsection 83-170(3) is not assessable income and is not exempt income. The formula for working out the tax-free amount is: Base amount + ( Service amount × Years of service ) Years of service means the number of whole years in the period, or sum of periods, of employment to which the payment relates. For the 2013-14 income year: Base amount means $9,246; and Service amount means $4,624. Therefore, the tax-free part of a genuine redundancy payment your client can receive in the 2013-14 year is calculated in accordance with subsection 83-170(3) of the ITAA 1997. This tax-free amount is not assessable income and is not exempt income in accordance with subsection 83-170(2) of the ITAA 1997. The remainder is taxed as an employment termination payment.