Private ruling: Employment termination payment
Published: October 2011
Ruling period: 2010-11 income year
Date scheme commenced: 1 July 2010

Ruling: Q1: Is the payment made under the Deed of Settlement an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)? Is the payment made under the Deed of Settlement assessable as ordinary income under section 6-5 ITAA 1997? Are the legal costs incurred in respect of the settlement allowable as a deduction under section 8-1 of the ITAA 1997? | A1: Answer: Yes. Answer: No. Answer: No.

Relevant facts and circumstances: Your client was employed by an employer several years ago. Your client's employment was terminated on a specific date during the 2009-10 income year. Your client commenced legal action on a specific date during the 2009-10 income year. Your client commenced legal proceedings against the employer on a specific date during the 2009-10 income year claiming damages/monies arising out of your client's employment with the employer. On a specific date during 2010-11 income year, your client lodged an Amended Statement of Claim with the Federal Magistrates Court of Australia. It included a claim in relation to the Termination of Employment. The parties settled these proceedings under a Deed of Settlement. Under a Deed of Settlement dated on a specific date during the 2010-11 income year, an amount of was agreed to be paid to your client. An amount was to be paid on a specific date during the 2010-11 income year and an amount was to be paid before a specific date during the 2010-11 income year. No break up of this amount was stipulated in the Deed of Settlement. The PAYG Payment Summary from the employer dated on a specific date during the 2010-11 income year stated that an amount was paid to your client during the 2010-11 income year. Tax was withheld. Your client incurred legal costs of an amount. Your client is over 60 years of age.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1 | 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 Subparagraph 82-130(1)(a)(i) | 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 Paragraph 82-130(4)(a) | Income Tax Assessment Act 1997 Subsection 82-130(7) | Income Tax Assessment Act 1997 Section 82-135 | Income Tax Assessment Act 1997 Section 82-140 | Income Tax Assessment Act 1997 Section 82-150 | Income Tax Assessment Act 1997 Section 82-155 | Income Tax Assessment Act 1997 Subsection 301-20(2) | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Detailed Reasoning - Summary of decision: The payment made under the Deed of Settlement is an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997). The payment made under the Deed of Settlement is not assessable as ordinary income under section 6-5 of the ITAA 1997. The legal costs incurred in respect of the settlement are not allowable as a deduction under section 8-1 of the ITAA 1997. | Detailed Reasoning - Employment termination payment: From 1 July 2007, payments made in consequence of the termination of a taxpayers employment are known as employment termination payments. Prior to 1 July 2007, these payments were known as eligible termination payments. Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states: employment termination payment has the meaning given by section 82-130. 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. Therefore, it can be seen that a number of conditions need to be satisfied in order for the payment to be treated as an employment termination payment. Failure to satisfy any of the conditions will result in the payment not being considered an employment termination payment. | Detailed Reasoning - Payment is made in consequence of the termination of employment: The first condition to be met is that the payment is received by the person in consequence of the termination of their employment. 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. In paragraph 5 of TR 2003/13 the Commissioner states: 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. As further stated by the Commissioner in paragraph 6 of TR 2003/13, there must be: 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 made in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case. Also in paragraph 5 of TR 2003/13 the Commissioner notes that the Courts have considered the meaning of the words in consequence of in several cases. Of note are the decisions made by the Full Bench of the High Court in Reseck v. Federal Commissioner of Taxation (1975) 49 ALJR 370; (1975) 6 ALR 642; (1975) 5 ATR 538; (1975) 75 ATC 4213; (1975) 133 CLR 45 ( Reseck ) and the Full Federal Court in McIntosh v Federal Commissioner of Taxation (1979) 25 ALR 557; (1979) 10 ATR 13; (1979) 45 FLR 279; (1979) 79 ATC 4325 ( McIntosh ). In Reseck , Justice Gibbs stated: 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 my opinion necessary that the termination of the services should be the dominant cause of the payment. While Justice Jacobs, in the same case, 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 considered the decision in Reseck . In doing so the Full Federal Court emphasised that a payment may be in consequence of the termination of employment even though the termination is not the dominant cause of the payment. In particular, Justice Brennan considered the judgments of Justice Gibbs and Justice Jacobs in Reseck and concluded that their Honours were both saying that a causal nexus between the termination and payment was required, though it was not necessary for the termination to be the dominant cause of the payment. Thus, while it is not necessary to show that termination of employment is the sole or dominant cause, a temporal sequence alone would not be sufficient. The phrase in consequence of and the decisions in Reseck and McIntosh were considered more recently by the Federal Court in Le Grand v Federal Commissioner of Taxation [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; (2002) 2002 ATC 4907; (2002) 51 ATR 39 ( Le Grand ). In Le Grand , a settlement payment in relation to legal proceedings involving a wrongful dismissal claim, together with a claim for misleading and deceptive conduct, was held to be an eligible termination payment. Justice Goldberg, the presiding judge, considered that the settlement of the misleading and deceptive conduct component of the claim did not break the casual relationship that existed between the settlement payment and the termination of the taxpayer's employment. In making his decision, Justice Goldberg stated: I am satisfied that there is a sufficient connection between the termination of the applicants employment and the payment to warrant the finding that the payment was made in consequence of the termination of the applicants employment. I am satisfied that the payment was an effect or result of that termination in the sense that there was a sequence of events following the termination of the employment which had a relationship and connection which ultimately led to the payment. Justice Goldberg concluded that the test for determining when a payment is made in consequence of the termination of employment is that which was articulated by Justice Gibbs in Reseck . The approach taken in Le Grand was also adopted in Dibb v Commissioner of Taxation (2004) 207 ALR 151; (2004) 2004 ATC 4555; (2004) 55 ATR 786; (2004) 136 FCR 388; [2004] ALMD 5780; [2004] FCAFC 126, where the Full Federal Court held that a payment received under a deed of release following the settlement of legal proceedings against the taxpayer's former employer was an eligible termination payment. The Court considered that there was a clear chain of causation between the payment and the termination. That is, the subject matter of the litigation was clearly interwoven and intertwined with the termination. Thus, for the payment to have been made in consequence of the termination of employment, the payment must follow as an effect or result of the termination of employment. As noted in both paragraphs 6 and 28 of TR 2003/13, there must be 'a causal connection between the termination and the payment even though the termination need not be the [sole or] dominant cause of the payment'. Therefore if the payment follows as an effect or a result from the termination of employment, the payment will be made in consequence of the termination of employment for the purposes of subparagraph 82-130(1)(a)(i) of the ITAA 1997. Hence the payment will be an employment termination payment unless the payment is specifically excluded under section 82-135. From the facts provided your client's employment with the employer was terminated on a specific date during the 2009-10 income year. As a result of the termination of employment, your client commenced legal action against the employer on a specific date during the 2009-10 income year. Your client lodged an Amended Statement of Claim with the Federal Magistrates Court of Australia on a specific date during the 2010-11 income year. The Amended Statement of Claim included a claim in relation to the termination of employment. A settlement was reached between your client and the employer on a specific date during the 2010-11 income year. Under the Deed of Settlement, an amount was paid to your client. The payment was made on a specific date during the 2010-11 income year. No break up of this amount was stipulated in the Deed of Settlement, however the payment under the Deed of Settlement was to satisfy the Amended Statement of Claim which included a claim in relation to the termination of employment. The payment would be considered to be made in consequence of the your client's termination of employment. The payment would not have been made had there been no termination of employment. The termination of employment and the payment are all intertwined and connected. If not for the termination of employment, the issue of paying a lump sum would not have arisen. The lump sum payment is considered to be received by your client in consequence of the termination of employment. Therefore the requirement of subparagraph 82-130(1)(a) of the ITAA 1997 will be met. | Detailed Reasoning - Payment received more than 12 months after termination: In addition to meeting the other conditions for a payment to be an employment termination payment, paragraph 82-130(1)(b) of the ITAA 1997 specifies that the settlement sum must be received within 12 months of the employees termination of employment, unless they are covered by a determination exempting them from the 12 month rule. As already noted in the facts, your client's employment was terminated on a specific date during the 2009-10 income year and the payment was made on a specific date during the 2010-11 income year which is more than 12 months after your client's termination of employment. Notwithstanding your client received the payment more than 12 months after your client's termination of employment, it is considered that the payment in this instance is exempted from the 12 month rule by the operation of paragraph 82-130(4)(a) and subsection 82-130(7) of the ITAA 1997. Paragraph 82-130(4)(a) of the ITAA 1997 states: Paragraph (1)(b) does not apply to you if: You are covered by a determination under subsection (5) or (7); Subsection 82-130(7) of the ITAA 1997 states: The Commissioner may, by legislative instrument, determine that paragraph (1)(b) does not apply to either or both of the following, as specified in the determination: (a) a class of payments; (b) a class of recipients of payments. The Employment Termination Payments (12 month rule) Legislative Instrument 2007 is a determination made under subsection 82-130(7) of the ITAA 1997, which has been registered by the Commissioner on the Federal Register of Legislative Instruments. In accordance with paragraph 3 of the determination entitled Application , it will apply to a payment received by a person after 30 June 2007 if the payment is received: (a) either (i) in consequence of the termination of that persons employment, or (ii) after another persons death, in consequence of the termination of that other persons employment; and (b) more than 12 months after that termination; and (c) is not a payment under section 82-135 of the Income Tax Assessment Act 1997. Where these conditions are satisfied, the payment is referred to in the determination as a late termination payment . In accordance with paragraph 4 of the instrument entitled Determination , paragraph 82-130(1)(b) of the ITAA 1997 will not apply to a late termination payment if the payment is received more than 12 months after the termination of a persons employment because: (a) legal action was commenced within 12 months of the termination of employment, of which the subject is either or both: (i) the persons entitlement to the payment; (ii) the amount of the persons entitlement; or (b) the payment was made by a liquidator, receiver or trustee in bankruptcy of an entity that is otherwise liable to make the payment, where that liquidator, receiver or trustee is appointed no later than 12 months after the termination of employment. In this case legal action was commenced within 12 months of the termination of employment concerning your client's entitlement to the payment. Accordingly, it is considered that the conditions for the payment to be viewed as a late termination payment are satisfied. The payment is exempt from the 12 month rule found in paragraph 82-130(1)(b) of the ITAA 1997. Therefore the requirement of subparagraph 82-130(1)(b) of the ITAA 1997 is met. | Detailed Reasoning - 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 tax free part of a genuine redundancy payment or an early retirement scheme payment. In your case, the facts provided show that the payment did not include any of the payments mentioned in section 82-135 of the ITAA 1997 which would preclude any part of the payment from being an employment termination payment. Consequently, it is considered that the payment is not of a type mentioned in section 82-135 of the ITAA 1997. As the payment is not it is not a payment mentioned in section 82-135, the requirement of subparagraph 82-130(1)(c) of the ITAA 1997 is met. As all the conditions under subsection 82-130(1) of the ITAA 1997 have been satisfied, the amount paid on a specific date during the 2010-11 income year under a Deed of Settlement is an employment termination payment. | Detailed Reasoning - Tax Treatment of the employment termination payment: An employment termination payment made after 1 July 2007 will be comprised of the following components: · Tax free component this includes the pre-July 83 segment (if any) and/or the invalidity segment (if any); and · Taxable component the amount remaining after deducting the tax free component from the total payment. The tax free component is not assessable income and is not exempt income. The taxable component is included, in full, as assessable income. Your client commenced employment with the employer on 16 August 2004. Therefore, there will not be any pre-July 83 segment within the meaning of section 82-155 of the ITAA 1997. As the payment is not made because your client ceased being gainfully employed as a result of suffering from ill-health, there is no invalidity segment for the purposes of section 82-150 of the ITAA 1997. As the employment termination payment contains neither a pre-July 83 segment nor an invalidity segment, there is no tax free component as defined in section 82-140 of the ITAA 1997. Rather the entire employment termination payment is a taxable component as defined in section 82-145 of the ITAA 1997. The taxable component is subject to tax, depending on the person's age when the payment is received. For recipients below preservation age, the taxable component of an employment termination payment is taxed at 30% for amounts below the employment termination payments cap of $160,000 for the 2010-11 income year, and at the top marginal rate for amounts above the cap. For recipients above preservation age, the taxable component of an employment termination payment is taxed at 15% for amounts below the employment termination payments cap of $160,000 for the 2010-11 income year, and at the top marginal rate for amounts above the cap. Preservation age is the age at which retirees can access their superannuation benefits. This will be 55 for persons born before 1 July 1960 and between 55 and 60 for persons born after 30 June 1960. In your case, your client was over preservation age on the last day of the income year in which the payment was made. As your client was over preservation age, the whole payment is taxed at a maximum rate of 15%. A tax offset will apply to ensure the amount of tax is not greater than 15% plus Medicare levy in accordance of subsection 301-20(2) of the ITAA 1997. | Detailed Reasoning - Ordinary income: Section 6-5 of the Income Tax Assessment Act 1997 (TAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). 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 includes receipts that: · are earned; · are expected; · are relied upon; and · have an element of periodicity, recurrence or regularity. The compensation payment received under the Deed of Settlement by your client was not income from rendering personal services, income from property or income from carrying on a business. The payment is also a one-off payment and thus it does not have an element of recurrence or regularity. Therefore the payment received under the Deed of Settlement is not assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Deduction for legal expenses: Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent that they are incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income, ( Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431). Also, in determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business. and the legal action has more than a peripheral connection to the taxpayer's income producing activities. If the advantage to be gained is of a capital nature then the expenses incurred in gaining the advantage will also be of a capital nature. The fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer The employment termination payment (ETP) lump sum, being a payment for the loss of your client's earning capacity, is a capital receipt. Your client incurred the legal expenses in order to obtain the ETP. Although the ETP will be included in your client's assessable income, the ETP retains it's character as a capital receipt. As the legal expenses were incurred in gaining a capital sum they will also be of a capital nature and are therefore not deductible under section 8-1 of the ITAA 1997.

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