Employment termination payment

1 Is the Injury Payment (the Payment) included in your assessable income as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. Question 2 Is the Payment an employment termination payment (ETP)? Answer Yes. Question 3 Is the Payment excluded from being an ETP pursuant to paragraph 82-135(i) of the ITAA 1997? Answer No. Question 4 If the Payment is an ETP, will any part of the Payment be an invalidity segment of an ETP pursuant to section 82-150 of the ITAA 1997? Answer No Question 5 Is the Payment a capital gain that is disregarded pursuant to section 118-37 of the ITAA 1997? Answer No. This ruling applies for the following period Year ending 30 June 20XX The scheme commences on: 1 July 20XX

You were employed in a professional capacity. Under the agreement (CA) covering your employment a fund (the Fund) was established by a trust deed (the Deed) as a trust. The beneficiaries of the Fund are not specifically identified in a definitional clause of the Deed. The Deed provides the trustee must pay or apply the trust funds for the purpose of assisting employees under various circumstances, including when they can no longer be employed in the profession due to work related injuries. A policy (the Rules) contains the rules, policies, procedures and criteria to be applied by the trustee in connection with benefit payments from the Fund. The Rules outlines the methodology for making a payment based on an employee's age and base salary. Your employment contract was for a set number of years and expired in the year ending 30 June 20XX (the Contract). Your employment ceased when the Contract expired. You retired from the profession due to work related injuries. You made an application to the trustee of the Fund for a payment. The application included relevant medical support. The Payment was approved and made in the year ending 30 June 20XX. You were under your preservation age.

Income Tax Assessment Act 1997 section 1-3 Income Tax Assessment Act 1997 section 6-5 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)I(c) Income Tax Assessment Act 1997 section 82-135 Income Tax Assessment Act 1997 paragraph 82-135(i) Income Tax Assessment Act 1997 subsection 82-150(1) Income Tax Assessment Act 1997 section 118-20 Income Tax Assessment Act 1997 section 118-22 Income Tax Assessment Act 1997 section 118-37 Income Tax Assessment Act 1997 section 995-1 Income Tax Assessment Act 1936 subsection 27A(1)

Summary The Payment is not ordinary income. The Payment is ETP. It is not excluded from being an ETP as a payment for, or in respect of, personal injury. No part of the Payment is an invalidity segment of an ETP. As the Payment is an ETP any capital gain you made is reduced to zero. Question 1 Is the Payment included in your assessable income as ordinary income under section 6-5 of the ITAA 1997? Detailed reasoning Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997). Ordinary income has generally been held to include 3 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.

Compensation receipts which substitute for income have been held by the courts to be ordinary income; whereas, compensation paid for the loss of a capital asset or amount is regarded as a capital receipt and not ordinary income and is potentially taxable as statutory income. In your case, the Payment is not being made to compensate you for the loss of earnings; rather it is a one-off, lump sum amount, being paid to compensate you for the loss of your employment due to injury. The Payment was not earned and does not have any element of periodicity, recurrence or regularity. While it could be argued that the Payment is expected, this expectation comes from your rights under your employment arrangements, rather than from a relationship with any personal services performed. The Payment is considered to be capital in nature and is not assessable as ordinary income under section 6-5 of the ITAA 1997. Question 2 Is the Payment an employment termination payment (ETP)? Detailed reasoning 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. All three conditions need to be satisfied in order for the Payment to be treated as an ETP. Failure to satisfy any of the three conditions will result in the Payment not being considered an ETP. These conditions are considered below. Payment received in consequence of the termination of employment The first condition to be met is that there must be a payment that is made in consequence of the termination of employment of the taxpayer. The Commissioner has issued Taxation Ruling TR 2003/13 which deals with payments in consequence of the termination of any employment and, in particular, the meaning of the phrase ' in consequence of '. In paragraphs 5 and 6 of TR 2003/13, the Commissioner states:

5. The phrase 'in consequence of' is not defined in the ITAA 1936. However, the words have been interpreted by the courts in several cases. Whilst there are divergent views as to the correct interpretation of the phrase, the Commissioner considers that 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. 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 made in consequence of the termination of employment will be determined by the relevant facts and circumstances of each case.

In your case it is considered that the Payment will be made in consequence of the termination of your employment. This is because you were unable to continue your profession due to your injury and you received the Payment in accordance with the Rules of the Fund. The Rules of the Fund provide that in order for an employee to receive a payment the injury must prevent or be likely to prevent an employee from ever working in the profession. When your contract expired you retired from the profession due to ongoing concerns about your injury. You subsequently applied to the trustee of the Fund for the Payment. There was a causal connection between the termination of your employment and the Payment. Therefore, the first condition under subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied. Payment is received no later than 12 months after termination of employment The Payment was made within 12 months after the termination of your employment. Therefore, the second condition in paragraph 82-130(1)(b) of the ITAA 1997 has been satisfied. Not a payment mentioned in section 82-135 of the ITAA 1997

Certain payments made on termination of employment are excluded from being an ETP under section 82-135 of the ITAA 1997. These payments, among others, include: •         accrued annual leave and long service leave payments which are covered by Subdivision 83-A and Subdivision 83-B respectively •         superannuation benefits which are covered by Divisions 301 to 307 •         the tax-free parts of a genuine redundancy payment or an early retirement scheme payment worked out under section 83-170; and •         certain capital payments for personal injury. None of the exclusions in section 82-135 of the ITAA 1997 apply to the Payment. Therefore, the third condition in paragraph 82-130(1)(c) of the ITAA 1997 has been satisfied. Accordingly, the Payment is assessable as an ETP. Question 3 Is the Payment excluded from being an ETP pursuant to paragraph 82-135(i) of the ITAA 1997? Detailed reasoning Paragraph 82 135(i) of the ITAA 1997 specifically excludes from being an ETP:

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 ). This exclusion is for a payment that compensates or reimburses you for, or in respect of, the particular injury. In relation to the Payment, the Commissioner accepts: •         it is a capital payment •         you did sustain a 'personal injury', and •         the payment was made due to the injury and its likely effect that you would no longer be able to derive income in the profession. The principal question for determination therefore is whether the Payment can be characterised as 'a capital payment for, or in respect of, the personal injury'. The words require a relationship between the injury and the Payment. From 1 July 2007, paragraph 82-135(i) of the ITAA 1997 has replaced former paragraph (n) of the definition of ' eligible termination payment ' in former subsection 27A(1) of the Income Tax Assessment Act 1936

(ITAA 1936) (former paragraph (n)). However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 stated, in relation to section 82-135, that: consistent with current legislation, certain payments are prevented from qualifying as employment termination payments. In accordance with section 1-3 of the ITAA 1997, provisions in the ITAA 1936 which have been rewritten in the ITAA 1997 will have the same meaning where they express the same idea, even if the words used are different. It is therefore appropriate to consider cases that refer to the previous legislation. In Commissioner of Taxation v. Scully (2000) 201 CLR 148; [2000] HCA 6; 2000 ATC 4111; (2000) 169 ALR 459; (2000) 74 ALJR 504; (2000) 43 ATR 718 ( Scully ) the High Court, in considering former paragraph (n), held that compensation must be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer. The payment in Scully was held not to be in respect of personal injury. Acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stated in their joint decision:

30. However, the payment in this case cannot be said to be compensation for or in respect of the personal injury. Clauses 2.4.1 and 3.5.1, pursuant to which the respondent's payment was calculated, make no attempt to place a monetary value on a member's injury. They do not even provide a formula, roughly comparable to the manner in which a court or tribunal might assess damages in a claim for personal injury, to quantify the amount of the payment. Indeed, the very similarity of benefits for death, retirement, resignation, retrenchment and dismissal to those for total and permanent disablement deny that the purpose of a payment pursuant to cll 2.4.1 and 3.5.1 is concerned with the value of any injury sustained by an employee. ...

41. In our opinion, the payment in this case cannot be characterised as "consideration... in respect of, personal injury". The fact that the payment is not calculated by reference to the nature and extent of the injury or likely loss to the respondent and the fact that the other benefits are similar to that for total and permanent disablement point inevitably to the conclusion that the payment was "consideration... for, or in respect of" the respondent's termination of employment and her rights under the Trust Deed and was not "consideration... for, or in respect of" her injury. Using the principles in Scully, for an amount to meet the requirements of paragraph 82-135(i) of the ITAA 1997, the payment must be for, or in respect of, personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer. The Federal Court in Bond v FC of T (2015) 2015 ATC 20-499; [2015] FCA 245 ( Bond ) considered the decision in Scully and the change of terminology used in the ITAA 1997. Justice Mansfield stating:

95. Section 27A(1)(n) of the ITAA 1936 exempted from an ETP a payment in terms which, in my view, are relevantly not materially different from s 82-135(1). One difference is that it exempted "consideration of a capital nature" rather than "a capital payment". Another is that it applied "to the extent to which the amount or value of the consideration" is reasonable, rather than "so far as the payment" is reasonable. A third difference is that it made the judgment to be the opinion of the Commissioner, whereas s 82-135(1)(i) does not do so. Fourthly, ... 96. In my view, the textual differences are not of apparent significance. ... ... 100. Having regard to the Schedule of Benefits, Schedule A under the Scottish Re Policy, and the varied range for the LOL Capital Benefit set out depending upon age and seniority, I do not think it can be said that the amount of the Capital Benefit is "for or in respect of" Mr Bond's condition or can be assessed to be reasonable having regard to the nature of the injury and its likely effect on the capacity to derive income from personal exertion, in the way that "reasonable" is explained in Scully

at [30]. For a pilot, the Capital Benefit is the same for any illness or injury causing loss of licence for any age up to age 54, although it then drops significantly for each year after that age. It is the same for all senior officers, whether Captains, First or Second Officers, or Flight Engineer Officers. It is the same irrespective of the nature of the injury, although the nature of the injury and consequential disability must be relevant to the ongoing capacity to derive income. It is the same whether the relevant employee is or is nor re-employed, and irrespective of the actual earnings in any new position. 101. I do not consider, therefore, that the LOL payment can be said to be a capital payment "for or in respect of" Mr Bond's condition. ...

102. It is, of course, clear that reference to "a capital payment" in s 82-135(i) is a different expression from the introductory words of s 27A(1)(n). However, as there said, as a matter of construction the focus is on the character and purpose of the payment rather than its cause. There is no doubt that the cause of the LOL payment is the condition of (injury to) Mr Bond. But the limiting words following focus on the character of the payment, and in my view the approach of the majority at [30] of its reasons in Scully applies to the task of identifying that character. In your case the Payment was made from the Fund in accordance with the Rules. The amount of the Payment was determined by reference to your base salary in the final year of your contract and your age. Your injury was a criterion in being eligible to receive the Payment. However, the nature and extent of your injury and your likely loss are not factors in determining the amount of the Payment. The Payment was made to compensate you for the loss of your employment as a result of the injury rather than to compensate for the injury itself and any subsequent loss of earning capacity.

It should be noted that not only should regard be had to the nature of the injury but also its likely effect on your capacity to derive income from personal exertion. This is broader in scope than the injury's effect on your ability to earn income from personal exertion in the profession. The making of the Payment does not take into account your ability to earn income from other personal exertion activities. Based on the facts in your case, paragraph 82-135(i) of the ITAA 1997 does not exclude the Payment from being an ETP. Question 4 If the Payment is an ETP, will any part of the Payment be an invalidity segment of an ETP pursuant to section 82-150 of the ITAA 1997? Detailed reasoning Where a person's employment is terminated because of ill-health and the person receives an ETP, part of the payment may be tax-free. This component is called an invalidity segment. Subsection 82-150(1) of the ITAA 1997 states that: 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. Section 995-1 of the ITAA 1997 defines the term '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. You were gainfully employed as a professional until you retired from the profession because of your injuries.

As stated above, the Payment is considered to be made in consequence of the termination of your employment. However, the Payment was not made because you ceased to be gainfully employed. When the requirements are taken together it is clear that 'stops being gainfully employed' should be taken to mean that gainful employment has ceased altogether. There is nothing in the Rules of the Fund that requires you to have ceased gainful employment. You could still be gainfully employed in another capacity and be eligible to receive the Payment. Furthermore, your employment did not cease before your last retirement day. The term ' last retirement day ' is defined in section 995-1 of the ITAA 1997 as follows: last retirement day means: (a) if an individual's employment or office would have terminated when he or she reached a particular age or completed a particular period of service - the day he or she would reach the age or complete the period of service (as the case may be); or. (b) in any other case - the day on which he or she would turn 65.

Your employment contract was for a set period. Your employment ended at the end of the set period. Therefore, your employment had not stopped before your last retirement day. The medical reports provided in support of your claim for the Payment do not satisfy the requirements of paragraph 82-150(1)(d). Those medical reports only consider your capacity to be employed in the profession. The reports do not consider your capacity to be employed in any other capacity for which you are reasonably qualified. As the requirements of subsection 82-150(1) of the ITAA 1997 are not satisfied no part of the Payment is an invalidity segment of an ETP. Question 5 Is the Payment a capital gain that is disregarded pursuant to section 118-37 of the ITAA 1997? Detailed reasoning CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied (paragraph 104-25(1)(b) of the ITAA 1997). A CGT asset is a legal or equitable right that is not property (paragraph 108-5(1)(b)).

You acquired a right to receive a payment under the terms of your employment. When the Payment was made this right was released, discharged or satisfied; and CGT event C2 happened. Section 118-20 of the ITAA 1997 recognises that a capital gain you make from a CGT event is reduced if, because of the event, a provision of the ITAA 1997 includes an amount in your assessable income for any income year. Section 118-22 of the ITAA 1997 treats an ETP that you receive as being included in your assessable income. As such, any capital gain you made will be reduced to zero. As any capital gain you made will be reduced to zero, under the anti-overlap provisions, it is not necessary to consider the exemption in section 118-37 of the ITAA 1997 for compensation or damages you receive for any wrong or injury you suffer in your occupation.