Private ruling: Employment termination payments
Date of advice: 18 September 2020
Published: November 2020
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: November 20XX

Ruling: Q1: Is any part of the payment assessable as ordinary income under subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Is any part of the payment excluded from Capital Gains tax by section 118-37 of the ITAA 1997? | A2: Yes | Q3: Is any part of the payment considered an employment termination payment as per section 82-130 of the ITAA 1997? | A3: Yes

Relevant facts and circumstances: You commenced your employment with the Employer in mid 20XX. The position you held was in direct sales (Position) You were made redundant from your Position in mid 20XX Your injury commenced in late 20XX. In your application you have detailed what you believe to be difficult circumstances in your work environment including management restructuring and consistent redundancies throughout the department; having to meet exceedingly high expected monetary target KPI's, only to have large sales amounts stripped from your targets and hard work resulting in unfavourable bonuses met and results in overall performance and isolation by your superiors and bullying. You have advised your health deteriorated even further and work became the substantial cause of your suicidal thoughts. Whilst in hospital you got the support you required and took time off work and sought legal advice. You came back to work on a return to work plan in late 20XX and you were made redundant in mid 20XX. You sustained a compensable disability that arose from your employment with the Employer. You were provided with a settlement amount that included a lump sum in the finalisation of your claim by agreement and sealed consent orders filed. On a day in mid 20XX the payroll team provided you with an amount from the payment that was finalised in the orders effectively lodging the amount as part of ordinary income as stipulated in the payment summary for the financial year. Simultaneously you were paid a lump sum redundancy through your regular employment payroll in mid 20XX and reimbursed out of pocket medical expenses. You have advised that consequently having a higher income has attracted higher payments in Medicare, HECS, supplements, a debt with Family Tax, a preclusion period with Centrelink, non-eligibility for a school card and others. You have had to live on your own means in an unemployed state. You confirmed that you received a lump sum amount which has populated as pre-filled information when you lodged your tax for the 20XX-20XX financial year, (the year in which it was paid). The breakdown of the lump sum amount is a portion in lump sum D label, another amount in lump sum A label and an amount for tax withheld. This amount is inclusive of the 20XX-20XX financial year, when this amount was provided, July 20XX, when it was paid into your account.

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 118-37 | 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 Paragraph 82-130(1)(b) | Income Tax Assessment Act 1997 Paragraph 82-130(1)(c) | Income Tax Assessment Act 1997 Section 82-135 | Income Tax Assessment Act 1997 Paragraph 82-135(i) Summary | Part of the payment is not assessable as ordinary income and is excluded from Capital Gains tax by Section 118-37 of the ITAA 1997. | The lump sum payment paid to you on the termination of your employment is considered an employment termination payment ('ETP') and is not otherwise excluded from being considered an ETP. | The lump sum payment has been reported as paid in the 20XX-20XX income year and is therefore assessable in that year. | Detailed reasoning | Question 1 - Assessable income | Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes income according to ordinary concepts (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. | Payments of salary and wages are examples of ordinary income. | Receipts that are not salary or wages but are paid as a substitute for salary or wages that would normally have been earned, expected and relied upon by a taxpayer are also assessable as ordinary income. | The general principle is that such payments take on the character of the salary or wages they replace. That is, if the substituted amount was an amount of ordinary income, the amount paid to compensate for the loss of that amount will also be ordinary income. | In your case, the payment was paid to you settle a claim relating to an injury you had allegedly suffered in your work, it was not paid to replace ordinary income. | As the payment is not compensating you for loss of income that would have been assessable, the payment is not assessable as income. | Question 2 - Statutory income and capital gains tax (CGT) | Section 6-10 of the ITAA 1997 looks at amounts that are not ordinary income but are included in assessable income by another provision. These amounts are called statutory income and are also included in assessable income. | The general CGT provisions are set out in Part 3-1 of the ITAA 1997. Under the CGT provisions a taxpayer will make a capital gain or loss only if a CGT event happens to a CGT asset. | To determine if a CGT event happens in respect of a compensation payment it is necessary to consider the nature of the asset to which the compensation payment relates. | The Commissioner's policy on the treatment of compensation payments is set out in Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts. | Taxation Ruling TR 95/35 states that the particular asset for which compensation has been received by the taxpayer may be: | · an underlying asset, or | · a right to seek compensation. | In determining which is the most relevant asset, it is often appropriate to adopt a 'look through' approach to the transaction or arrangement which generates the compensation receipt. | In TR 95/35 the term 'underlying asset' is used. The underlying asset is defined in TR 95/35 as: | '...the asset that, using the 'look-through' approach, is disposed of or has suffered permanent damage or has been permanently reduced in value because of some act, happening, transaction, occurrence or event which has resulted in a right to seek compensation from the person or entity causing that damage or loss in value or against any other person or entity.' | If there is more than one underlying asset, the relevant underlying asset is the asset which leads directly to the payment of the amount of compensation. For example, if a taxpayer receives an amount of compensation for the destruction of his or her truck, the truck is the underlying asset. | The right to seek compensation is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract, personal injury or other compensable damage or injury. A right to seek compensation is an asset for the purposes of Part 3-1. The right to seek compensation is acquired at the time of the compensable wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged. This disposal triggers a CGT C2. | In your situation, the payment clearly relates to the injury you incurred, although the payer does not admit liability, there is no other reason given in the agreement for the payment. | Paragraph 118-37(1)(a) of the ITAA 1997 states that: | (1) A capital gain or loss you make from a CGT event relatedly directly to any of these is disregarded: | (a) compensation or damages you receive for: | (i) any wrong or injury you suffer in your occupation; or | (ii) any wrong, injury or illness you or your relative suffers personally; | Therefore, the payment is not assessable as normal income or as a Capital Gain. | Question 3 | Employment termination payment | A payment made to an employee is an ETP if the payment satisfies all the requirements of 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 persons 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. | The Commissioner considers the meaning of the phrase 'in consequence of' in Taxation Ruling TR 2003/13 Income tax: employment termination payments (ETP): payments made in consequence of the termination of any employment: meaning of the phrase 'in consequence of' ('TR 2003/13'). | Paragraph 5 of TR 2003/13 states the following: | ... the Commissioner considers that a payment is received by a taxpayer in consequence of the termination of the taxpayer's employment 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 received by the taxpayer. | Paragraph 6 of TR 2003/13 further states: | 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 question of whether a payment is received in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case. | The phrase 'in consequence of' is not defined in the ITAA 1997. However, those words appeared in the former provisions of the Income Tax Assessment Act 1936 ('ITAA 1936') and have been judicially considered in that context. The Full High Court of Australia considered the expression 'in consequence of the termination of any employment' in Reseck v Federal Commissioner of Taxation 75 ATC 4213 (Reseck). In that case, Gibbs J stated at 4216-17 that: | 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 in my opinion necessary that the termination of the services should be the dominant cause of the payment... | In Reseck, Jacobs J also stated the following at 4219: | 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 McIntosh v Federal Commissioner of Taxation 79 ATC 4325 (McIntosh), the Full Federal Court considered the judgments of Jacobs J and Gibbs J in Reseck. With respect to differing interpretations of the phrase 'in consequence of', Brennan J stated at 4328: | 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. | In Le Grand v Commissioner of Taxation (2002) FCA 1258 (Le Grand) the Federal Court considered whether an amount received in settlement of litigation proceedings, arising from the termination of employment, was in whole (or in part) an ETP. As per paragraph 31 of TR 2003/13, a payment will be taken to be have been made in consequence of the termination of employment if it would not have been made but for the termination. | In Dibb v Federal Commissioner of Taxation (2003) 53 ATR 290 (Dibb), the Federal Court adopted the approach of Goldberg J in Le Grand . Heery J stated, at 296: | The various causes of action, whether breach of contract, conspiracy, breach of fiduciary duty or contravention of the Trade Practices Act were, as Goldberg J would say ( Le Grand at [36]), interwoven and intertwined with the termination. The payment was a consequence of the settlement, which was a consequence of the Federal Court proceeding, which in turn was a consequence of the termination. This reasoning was accepted by the Full Federal Court in Dibb v Federal Commissioner of Taxation (2004) 207 ALR 151 . | Based on the information provided, there was a dispute between you and the Employer regarding your claim for workers' compensation arising out of your period of employment with the Employer. Your employment with the Employer has been terminated. | You and the Employer have agreed to resolve the dispute pursuant to the terms of the Agreement. As per paragraph D in the Recital of the Agreement, the Employer informed you that upon the termination of your employment they will make a lump sum payment including your accrued entitlements to annual and /or long service leave less tax deducted at the appropriate rate which payment will be made as at the date the payment becomes effective which is mid 20XX. | Clause 2.4 of the Release of claim acknowledges that the Employer is not bound to find you employment in accordance with the Return to Work Act 2014 . As per paragraphs 5 and 6 of TR 2003/13, it is clear that but for the termination of employment by termination on the specified date, the Payment would not be paid to you. | Based on the information provided, the Payment paid in consideration for the undertakings and releases in the Agreement is considered to be an ETP in accordance with subparagraph 82-130(1)(a)(i) of the ITAA 1997. | The payment is assessable as an ETP to the extent that it is not specifically excluded under section 82-135 of the ITAA 1997. | Exclusions under section 82-135 of the ITAA 1997 | Paragraph 82-130(1)(c) of the ITAA 1997 specifies that an ETP does not include a payment mentioned in section 82-135 of the ITAA 1997. | Based on the information provided, consideration has been given to whether the payment is covered by the specific exemption at paragraph 82-135(i) of the ITAA 1997, which states that the following is not an ETP: | (i) a capital payment for, or in respect of, personal injury to you so far as the payment is reasonable having regard to the nature of the personal injury and its likely effect on your capacity to *derive income from personal exertion (within the meaning of the definition of income derived from personal exertion in subsection 6(1) of the Income Tax Assessment Act 1936 ); The exclusion under paragraph 82-135(i) of the ITAA 1997 is for a payment or benefit that compensates or reimburses the taxpayer for or in respect of a particular injury. | Based on the information provided, the lump sum payment component of the settlement sum is not referrable to a personal injury, or the likely effect of a personal injury on your capacity to derive income from personal exertion. | Accordingly, the exclusion under paragraph 82 135(i) of the ITAA 1997 does not apply in these circumstances. | The 12 month rule set out in paragraph 82-130(1)(b) of the ITAA 1997 | Paragraph 82-130(1)(b) of the ITAA 1997 specifies that a payment must be received within 12 months of the termination of employment, unless employee is covered by a determination exempting them from the '12 month rule'. | Based on the information provided, you were terminated on XX/month/20XX and received the payment on that date. | As they payment was made within 12 months of the date that termination is effective, the requirement in paragraph 82-130(1)(b) of the ITAA 1997 will be satisfied. | Relevant year of income | The documentation provided and reporting of the payment by the Employer to the ATO supports the conclusion that the Payment for tax purposes is considered to have been made in the 20XX- 20XX income year.