Private ruling: Employer payment - Release Agreement
Published: August 2013
Ruling period: For the year ending 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Is any part of the payment made under an agreement (the Agreement) as a result of your employment dismissal considered to be an employment termination payment in accordance with subsection 82-130(1) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: Over 30 years ago, you commenced employment with an employer (the Employer). You were absent from work on sick leave, which subsequently became worker's compensation leave. At or about the time you were absent from work, you received a letter regarding certain allegations made against you. In a letter to your Employer you refuted these allegations. This occurred in late 20XX. No further action was taken regarding the allegations until you attended a disciplinary hearing with the Employer. As a result of the hearing, the Employer terminated your employment in a date specified in early 20YY. You subsequently received a notice ceasing your worker's compensation based on your employment dismissal. You disputed the allegations against you and the cessation of your worker's compensation. You lodged a claim which is currently before a Worker's Compensation Tribunal awaiting a date for hearing. In mid 20YY, an application for unfair dismissal was lodged with Fair Work Australia to commence proceedings against the Employer. You denied the validity of the termination and further denied that you were engaged in conduct that would justify your dismissal. Furthermore, you were to bring proceedings against the Employer and its officers for defamation. The Employer denied the allegations. During the conciliation conference neither party would deter from their beliefs however both parties agreed to resolve the matter under the terms of the agreement (the Agreement). At a specific clause of the Agreement, the Employer denied liability and maintained the termination and the reason for the termination however agreed to pay you a settlement sum less tax. In another specified clause of the Agreement, without accepting the reason for the termination, you agreed to accept the settlement sum in full and final satisfaction. You agreed to the discharge of all claims, actions and demands which you may have had against the Employer, including their directors and associated entities relating to the employment including the termination, the proceedings and defamation claim with the exception of any such claims pursuant to a state Worker's Rehabilitation and Compensation Act. You have advised that the payment was made to you with an amount of tax deducted in late 20YY. You are over the age of 55 years.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 82-10(3). | 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 Subsection 82-130(4). | Income Tax Assessment Act 1997 Section 82-135. | Income Tax Assessment Act 1997 Section 995-1. Summary | The settlement sum is an employment termination payment (ETP) as it was made in consequence of your termination of employment. Part of the payment is a tax free component and therefore not assessable. The remaining amount is assessable as a taxable component of the ETP and is to be included in your income tax return for the relevant income year. | Detailed reasoning | Employment termination payment | Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) states that: | employment termination payment has the meaning given by section 82-130 of the ITAA 1997. | 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. | A life benefit termination payment is an ETP to which subparagraph (1)(a)(i) of the ITAA 1997 applies. | A death benefit termination payment is an ETP to which subparagraph (1)(a)(ii) of the ITAA 1997 applies. | Section 82-135 of the ITAA 1997 provides that certain payments are not ETPs, including: | § payment for unused annual leave or unused long service leave; | § the tax-free part of a genuine redundancy payment or an early retirement scheme payment. | § reasonable capital payments for personal injury. | To determine if a settlement sum constitutes an ETP, all the conditions in section 82-130 of the ITAA 1997 will need to be satisfied. | Failure to satisfy any of the three conditions will result in the payment not being considered an ETP. Furthermore, any termination payments received outside of the 12 months will be taxed as ordinary income at marginal tax rates, unless the taxpayer is covered by a determination exempting them from the 12 month rule. | Paid as a consequence of the termination of your employment | It should be noted that the phrase 'in consequence of the termination of your employment' is not defined in the legislation. However, both the Courts and the Commissioner have considered the meaning of this phrase. | In Taxation Ruling TR 2003/13 the Commissioner has considered the meaning of the phrase 'in consequence of'. | 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. | The phrase 'in consequence of termination of employment' has been interpreted by the courts in several cases. | Of note are the decisions made by 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 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 . | 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. | Suffice it to say that both Courts' views were that for a payment to be made in consequence of the termination of employment it had to follow on as a result or effect of the termination of employment. Additionally, 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. | Furthermore, in Le Grand v Federal Commissioner of Taxation [2002] FCA 1258; (2002) 124 FCR 53; (2002) 195 ALR 194; 2002 ATC 4907; (2002) 51 ATR 39 ( Le Grand ), the issue before the court was whether an amount received by the applicant as a result of accepting an offer of compromise in respect of claims brought by him against his former employer, in relation to the termination of his employment was in whole, or in part, an ETP. It was held that a settlement payment for litigation in relation to a taxpayer's dismissal was an ETP. | Justice Goldberg stated: | I am satisfied that there is a sufficient connection between the termination of the applicant's employment and the payment to warrant the finding that the payment was made "in consequence of the termination" of the applicant's 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 . 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 earlier stated in paragraph 6 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'. | The Full Federal Court in Dibb v Federal Commissioner of Taxation [2004] FCAFC 126; (2004) 207 ALR 151; 2004 ATC 4555; (2004) 55 ATR 786, has applied the above decisions in finding that the payment received by the taxpayer under a Deed of Release to settle various causes of action against the employer following the termination of employment was an ETP. | Paragraph 31 of TR 2003/13 the Commissioner states: | 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 essence of this analysis is that 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 ETP unless the payment is specifically excluded under section 82-135. | 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. | In the present case, you commenced employment with an employer (the employer) over 30 years ago. | You were dismissed from employment with effect in early 20YY. | A short time later, an application for unfair dismissal was lodged with Fair Work Australia which commenced proceedings against the employer. | You alleged that your employment was terminated unfairly and you were to bring proceedings against the employer and its officers for defamation. | The employer denied the allegations. | During the unfair dismissal conciliation neither party would deter from their beliefs however both parties agreed to resolve the matter under the terms of an agreement (the Agreement). | At a specific clause of the Agreement, the Employer denied liability and maintained the termination and the reason for the termination however agreed to pay you a settlement sum less tax. | In another specified clause of the Agreement, without accepting the reason for the termination, you agreed to accept the settlement sum in full and final satisfaction. You agreed to the discharge of all claims, actions and demands which you may have had against the Employer, including their directors and associated entities relating to the employment including the termination, the proceedings and defamation claim with the exception of any such claims pursuant to a state Worker's Rehabilitation and Compensation Act. Therefore, it was agreed that the employer would make the payment to you in full and final settlement of all and any claims arising from your employment and the termination of your employment at a date specified in early 20YY. The employer made the payment with an amount of tax deducted which was made to you in late 20YY. | It is clear from the facts provided that the settlement sum made to you is made as 'in consequence of the termination of employment'. Although the dominant cause of the payment was the claims brought by you against the employer, there is still a causal connection between the termination and the payment of the settlement. The legal action, the termination and the payment are all intertwined and connected. Therefore the first requirement under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied. | The payment is received no later than 12 months after termination | The second condition for the payment to meet the criteria, as an ETP is stated under paragraph 82-130(1)(b) of the ITAA 1997. The settlement sum must be received within 12 months of the taxpayer's termination of employment, unless the taxpayer is covered by a determination exempting him from the 12 month rule. | The facts of this case show that your employment was terminated in early 20YY and the payment was made to you in late 20YY. As the payment was made within 12 months of the termination of employment the requirement under paragraph 82-130(1)(b) of the ITAA 1997 has been met. | The final requirement under paragraph 82-130(1)(c) of the ITAA 1997 is that the payment is not a payment mentioned in section 82-135. | Exclusions from being an employment termination payment | Certain payments made on termination of employment are excluded from being an ETP under section 82-135 of the ITAA 1997. These payments include any accrued annual and long service leave and the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments which do not apply to an ETP. | As stated above, the payment is considered to be a payment received in consequence of the termination of employment and is not a payment mentioned in section 82-135 of the ITAA 1997. Thus, the requirement in paragraph 82-130(1)(c) is satisfied in this instance. | Consequently, the payment made to you in late 20YY is considered to be an ETP as it satisfies all the requirements in section 82-130 of the ITAA 1997, and are not specifically excluded under section 82-135. | Tax Treatment of the employment termination payment | An ETP made on or 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. | Pre-July 1983 segment | Subsection 82-155(1) ITAA 1997 states: | An employment termination payment includes a pre-July 83 segment if any of the employment to which the payment relates occurred before 1 July 1983. | Calculating the pre-July 83 segment | Subsection 82-155(2) ITAA 1997 provides the following formula to calculate the pre-July 83 segment : | ; | where: | pre-July 83 days are the number of days of employment to which the payment relates that occurred before 1 July 83; and | employment days are the total number of days of employment to which the payment relates. | Tax treatment of an ETP made in the 2013-14 income year | In your case, the ETP included a tax-free component comprised entirely of a pre-July 83 segment. There is no invalidity component. | The amount calculated as the pre-July 83 segment under the formula in subsection 82-155(2) of the ITAA 1997 is tax free and not included in your assessable income. | The remaining amount is the taxable component of the ETP and is to be included in your assessable income for the relevant income year (subsection 82-10(2) of the ITAA 1997). | In this case, the payment was made to you for unfair dismissal therefore the employment termination payments cap (ETP cap) will apply. The ETP cap for the relevant income year is $180,000. | The ETP cap is reduced by the amount of any earlier ETP you may have received in the same income year or, in relation to the same employment termination, in previous income years. Any tax-free amounts are not counted towards the cap. | As you have reached preservation age and the payment is under the ETP cap, you are entitled to a tax offset that ensures that the rate of income tax on the taxable component does not exceed 15% in accordance with subsection 82-10(3) of the ITAA 1997. In addition, the Medicare levy may apply.