Private ruling: Lump sum payments in settlement of litigation proceedings
Date of advice: 29 January 2019
Published: May 2019
Ruling period: Year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: A3: No.

Relevant facts and circumstances: More than seven years ago an individual (the employee) commenced working as an employee of your client. In the 2016-17 income year, the employee was offered and accepted a different role, still within your client’s structure. After the employee informed management in their current role, of their new position, the employee’s employment was terminated due to serious concerns about their performance and conduct at the time. The employee was stood down in any capacity with your client, until the allegations were investigated. After several months, the allegations against the employee could not be upheld and the employee commenced in the new role previously accepted. At the same time, further allegations were made against the employee by an associated entity, including the threat of legal proceedings. For several months later, the employee was the subject of alleged defamation by your client. Your client was aware of the mental strain the preceding events had taken on the employee and suggested to the employee some time away to seek support and assistance. The employee consequently sought legal advice, alleging a number of issues and employment related breaches that arose during the course of their employment. The parties very soon later commenced discussions in an effort to resolve the issues. A short period later, the employee’s employment was terminated (prior to reaching agreement on any of the issues). Several months later, the parties agreed to resolve all issues in dispute and executed separate deeds (the Deeds) (in relation to employment and defamation) of settlement and release. The Deeds made provision for: (a) an amount for reimbursement of the employee’s legal costs incurred in relation to the dispute; (b) an amount as compensation for mental injury alleged by the employee to have been suffered by them in connection with the dispute (as defined); and (c) an amount as compensation for defamation. The payments under the Deeds were made within the 2017-18 income year. The defamation claims and employment claims are unrelated. The claim for alleged mental injury arose from a series of events prior to the termination of the employee’s employment.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 82-130 | Income Tax Assessment Act 1997 Subsection 82-130(1) | Income Tax Assessment Act 1997 Subparagraph 82-130(1)(a)(i) | Income Tax Assessment Act 1997 Section 82-135 | Income Tax Assessment Act 1997 Section 995-1 All references are to the ITAA 1997 unless otherwise indicated.

Reasons for decision: Summary: The settlement sum amount representing the reimbursement of legal costs is not an employment termination payment (ETP). The settlement sum amount paid as compensation for mental injury is not an ETP. The settlement sum amount paid as compensation for defamation is not an ETP. | 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. 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. A payment is an ETP if it satisfies all the requirements in section 82-130 and is not specifically excluded under section 82-135. | Detailed Reasoning - Paid ‘in consequence of’ the termination of employment: 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, at paragraphs 5 and 6 that: 5. 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. 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 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. While TR 2003/13 contains references to repealed provisions, some of which may have been rewritten, the ruling still has effect. Whether payments made in respect of a taxpayer as a result of settlement of litigation arising out of the termination of the taxpayer’s employment, is made ‘in consequence of’ the termination of employment is specifically addressed in TR 2003/13. According to paragraph 31 of TR 2003/13: 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. Whether a payment is ‘in consequence of’ the termination of employment will depend on the facts of the case. | Detailed Reasoning - Question.1: The Commissioner’s view of the application of section 82-130 to amounts received for legal costs and disbursements is set out in Taxation Ruling TR 2012/8 Income tax and fringe benefits tax: assessability of amounts received to reimburse legal costs incurred in disputes concerning termination of employment (TR 2012/8). Paragraph 4 of TR 2012/8 states that: An amount received in relation to a dispute concerning termination of employment is not an ETP, nor forms part of an ETP, where the amount is capable of being identified as relating specifically to the reimbursement of legal costs. The settlement amount paid to the employee, has been clearly identified under the Deeds as relating specifically to the reimbursement of legal costs incurred in relation to the dispute. The amount received by the employee as a reimbursement of the legal costs, incurred in relation to the litigation, is not in consequence of the termination of the employee’s employment, but in consequence of the legal action. As the settlement amount for legal costs is not in consequence of the termination of employment, that amount is therefore not an ETP, having failed to satisfy subparagraph 82-130(1)(a)(i). | Detailed Reasoning - Question.2: As outlined in the Deeds, a settlement amount was paid to the employee to compensate them for mental injury alleged to have been suffered by them. As per the facts of this case, the alleged mental injury arose from a series of events which occurred over a period of time, well before the commencement of any legal proceedings and well before the termination of the employee’s employment. Whilst settlement of the dispute and the payment for serious mental injury, happens to be after the termination of the employee’s employment, the connection to the termination of the employee’s employment is temporal. The employee’s cause of action (when they commenced legal proceedings), was not the termination of their employment and the settlement amount paid did not follow on as a result of their termination. Therefore, it cannot be argued that ‘but for the termination’ of the employee’s termination of employment, the payment for mental injury would not have been made to the employee. The settlement amount for mental injury was compensation for a personal injury suffered during the course of the employee’s employment, in consequence of the legal action. As the settlement amount for mental injury is not in consequence of the termination of employment, that amount is therefore not an ETP, having failed to satisfy subparagraph 82-130(1)(a)(i). | Detailed Reasoning - Question.3: As per the facts of this case, the defamation claims pre-dated the employee’s dismissal and were unrelated to the termination of their employment. The settlement amount received by the employee in satisfaction of their claim for defamation is not in consequence of the termination of their employment, but in consequence of the settlement claims that arose during the period of the employee’s employment with your client. Consequently the requisite causal connection between the employee’s termination of employment and the defamation settlement amount paid is absent. Therefore, the settlement amount in settlement of the employee’s claim for defamation is not an ETP, having failed to satisfy subparagraph 82-130(1)(a)(i).

Does the reimbursement of legal expenses that relate to the termination of employment dispute form part of an employment termination payment under section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Is the settlement amount paid by your client in satisfaction of an employee’s claim for mental injury that arose during the period of their employment an employment termination payment under section 82-130 of the ITAA 1997? | Is the settlement amount paid by your client in satisfaction of an employee’s claim of defamation that arose during the period of their employment an employment termination payment under section 82-130 of the ITAA 1997?