Private ruling: Employment termination payment - invalidity segment
Published: November 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Is any portion of the payment received by your client in the 2013-14 income year exempt from tax, as an invalidity segment of an employment termination payment, in accordance with section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: Your client was employed in a specific job with an employer (the employer). During the 200XX income year, having suffered a work-related injury, your client consulted a medical practitioner. Your client's worker's compensation claim commenced a short time later. During the relevant income year, your client's employment was terminated due to an illness (the illness). The employer has stated that your client was deemed no longer fit to carry out ordinary duties and therefore your client's employment was terminated on medical grounds. Your client was employed under a specific award (the Award) and made contributions as provided in a clause of the Award. Under another clause of the Award, your client was entitled to either a total and permanent incapacity benefit or a partial and permanent incapacity (PPI) benefit. Your client fulfilled the definitions within the Award for a specific PPI benefit (the PPI benefit). Your client's PPI benefit has been calculated according to a specific clause of the Award which was based on the age and salary of your client. In the subsequent income year, a qualified medical practitioner advised that your client's condition is permanent and advised that the illnesses your client suffered were unlikely to change in the foreseeable future and recommended that your client be medical discharged. Due to these illnesses your client would require continuing medical treatment. Another qualified medical doctor has noted in a report that your client has not worked for a number of years and has advised that with the severity of your client's illnesses and their non-response to treatment, your client may not ever return to the workforce. Two legally qualified medical practitioners have each certified that your client is unfit to work due to their illness and is unlikely to ever be gainfully employed in the capacity for which they are reasonably qualified because of education, experience or training. The PAYG payment summary - employment termination payment made to your client in the subsequent year from the employer shows a taxable component with an amount of tax withheld. Your client is under preservation age.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 27G. | Income Tax Assessment Act 1936 subsection 27A(1). | Income Tax Assessment Act 1997 section 82-130. | Income Tax Assessment Act 1997 subsection 82-10(3). | 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 subsection 82-135(i). | Income Tax Assessment Act 1997 section 82-140. | Income Tax Assessment Act 1997 subsection 82-150(1). | Income Tax Assessment Act 1997 paragraph 82-150(1)(a). | Income Tax Assessment Act 1997 paragraph 82-150(1)(b). | Income Tax Assessment Act 1997 paragraph 82-150(1)(c). | Income Tax Assessment Act 1997 paragraph 82-150(1)(d). | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: The amount calculated under the formula is exempt from tax as an invalidity segment of an employment termination payment. The remaining amount is the taxable component of the employment termination payment and is included in your client's income tax return for the subsequent income year. | Detailed Reasoning - Detailed reasoning: Where a person's employment is terminated because of ill-health and the person receives an employment termination payment (subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)), part of the payment may be tax free. This component is called an invalidity segment (subsection 82-150(1) of the ITAA 1997). In this case the facts show that the lump sum payment (the Payment) your client received upon their termination of employment on medical grounds is an employment termination payment. In relation to whether any part of the Payment includes an invalidity segment it must satisfy subsection 82-150(1) of the ITAA 1997 which states: An employment termination payment includes an invalidity segment if: (a) the payment was made to a person because he or she stops being gainfully employed; and (b) the person stopped being gainfully employed because he or she suffered from ill-health (whether physical or mental); and (c) the gainful employment stopped before the person's last retirement day; and (d) 2 legally qualified medical practitioners have certified that, because of the ill-health, it is unlikely that the person can ever be gainfully employed in capacity for which he or she is reasonably qualified because of education, experience or training. | Detailed Reasoning - Gainful employment: Section 995-1 of the ITAA 1997 defines being gainfully employed as follows: gainfully employed means employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment. Until your client became ill your client was employed on a full-time basis as an employee with the employer. | Detailed Reasoning - Payment for stopping gainful employment: As stated above the payment is considered to be a payment made on the termination of your client's employment as it satisfied the conditions under subparagraph 82-130(1)(a) (i) of the ITAA 1997. | Detailed Reasoning - Employment termination occurred because of ill-health: The requirement under paragraph 82-150(1)(b) of the ITAA 1997 is that the termination of employment resulted from the taxpayer's ill-health, that is, the ill-health was the immediate cause for the termination of the taxpayer's employment. In this case, the facts show the termination of employment during the third quarter of the relevant income year occurred after the employer considered medical reports which indicated your client was unable to resume normal work due to your client's illness and was medically discharged. Therefore, it is considered that this requirement is satisfied. | Detailed Reasoning - Termination of employment occurred before last retirement date: The third condition for a payment to qualify as an invalidity component is that it was made before the taxpayer's last retirement date. The payment was made during the first quarter of the subsequent income year when your client was under preservation age well before the normal retirement age. Therefore, the condition of paragraph 82-150(1)(c) of the ITAA 1997 has been satisfied. Certification from 2 legally qualified medical practitioners that the disability is likely to result in the taxpayer being unable ever to be employed. In respect of the final requirement, it must be demonstrated that the disability at the time of termination was such that: it is unlikely that the person can ever be gainfully employed in capacity for which he or she is reasonably qualified because of education, experience or training. Therefore, paragraph 82-150(1)(d) of the ITAA 1997 requires that there must be the likelihood that the disability of the taxpayer will preclude the taxpayer from ever being employed in a role, for which the taxpayer is reasonably qualified. Prior to 1 July 1994, it had only been necessary for the termination of employment to occur because the taxpayer was physically or mentally incapacitated and therefore unable to engage in that employment. It did not require there be incapacity to engage in any employment. However, amendments made to the section that applied prior to 1 July 2007, section 27G of the ITAA 1936, by the Taxation Laws Amendment (Superannuation) Act 1992 require the incapacity to prevent the taxpayer ever being able to undertake any employment for which the taxpayer is reasonably qualified. The EM to the Taxation Laws Amendment (Superannuation) Bill 1992 confirms this. In explaining the test for invalidity, the EM stated the following: To clarify the test for incapacity and to place the onus of determining invalidity on legally qualified medical practitioners, from 1 July 1994 the incapacity of the person will have to be certified by two medical practitioners. The invalidity payment concession is extended only to people who are unable to undertake any form of employment for which they are reasonably qualified. A person who is unable to continue his or her current employment, but is able to undertake other appropriate employment, will not have access to the concession. Therefore, a person, who is unable to continue to perform the duties of his or her current employment, but is able to undertake other appropriate employment for which they are reasonably qualified, would not now satisfy the condition in paragraph 82-150(1)(d) of the ITAA 1997, which is the rewritten provision for section 27G of the ITAA 1936. However, the use of the term 'appropriate employment' in the EM suggested the intention that the term 'reasonably qualified' be interpreted as meaning neither over nor under qualified to any significant extent. Even if a taxpayer's employment is terminated by reason of disability, this does not mean that the second part of test for invalidity is satisfied. The two parts are independent. The fact that the medical practitioners have to determine invalidity does not mean that the medical practitioners have to determine the reason for termination. A person's employment can be terminated because of disability, irrespective of whether two medical practitioners form an opinion as to whether the disability will prevent the taxpayer from ever being able to be employed in a capacity for which the taxpayer is reasonably qualified because of education, training or experience. Further, the requirement that the disability is likely to result in the taxpayer being unable ever to be employed in a capacity for which he or she is reasonably qualified extends to full-time employment, part-time or casual employment. A person who is not able to work full-time but can work part-time or casual in any employment for which the taxpayer is reasonably qualified will not receive the concessional component. In this case, after examining the contents of the medical reports provided it is considered that there are two reports that satisfy the requirement prescribed in paragraph 82-150(1)(d) of the ITAA 1997. Two legally qualified medical practitioners have certified, in two medical certificates, that your client is suffering from a medical condition the result of which, in their opinion, it is unlikely that your client can ever be gainfully employed in any capacity for which your client is reasonably qualified because of education, experience and training. Furthermore, in making the statement, they have both considered not only your client's role with the employer, but any other education, training or experience. Therefore, as two medical practitioners have provided certificates that attest to your client being unable to ever be employed in a capacity for which your client is reasonably qualified because of education, training or experience, it is considered that the final condition of subsection 82-150(1) of the ITAA 1997 has been satisfied. | Detailed Reasoning - Components of an employment termination payment: Under section 82-140 of the ITAA 1997 the invalidity segment included in an employment termination payment is tax free. An employment termination payment comprises the following components: _ Tax free component this includes the invalidity segment (if any) or pre-July 83 component (if any); and _ Taxable component the amount remaining after deducting the tax free component from the total payment. | Detailed Reasoning - Conclusion: As your client has satisfied the requirements for the payment of an invalidity payment, an element of the employment termination payment received from the employer will be tax free. The amount of the invalidity segment is worked out by applying the formula as in subsection 82-150(2) of the ITAA 1997: Work out the amount of the invalidity segment by applying the following formula: Amount of employment termination payment X Days to retirement ÷ Employment days + Days to retirement where: days to retirement is the number of days from the day on which the person's employment was terminated to the last retirement day. employment days is the number of days of employment to which the payment relates. The calculation of the invalidity payment would be using the payment made to your client and the employment figures relevant to your client's employment. Therefore, the amount calculated under the formula in subsection 82-150(2) of the ITAA 1997 as the invalidity segment is tax free. The remaining is a taxable component to be included in your client's income tax return for the subsequent income year.