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Ruling

Subject: Invalidity segment

Question

Is any part of the partial and permanent disability benefit payment received by your client a tax-free invalidity segment pursuant to section 82-150 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period

2011-12 income year

The scheme commenced on

1 July 2011

Relevant facts

Your client was under preservation age when the payment was made.

Prior to being employed by the employer your client engaged in a trade and then worked in an industry analogous to that of the employer.

Your client commenced working for the employer several years ago.

Your client was a member of a complying superannuation scheme.

In the 2008-09 income year, your client suffered injuries. As a result, your client succumbed to a medical condition.

In a Worker's Compensation report, a legally medical practitioner stated your client has suffered a significant medical condition and is unable to participate in employment and other life roles. Your client has been attending professional treatment since your client's medical condition was diagnosed.

A medical panel, in conjunction with a government medical office's recommendation, has recommended your client be medically discharged from the employer. This was accepted by the employer and your client's last day of service was on a specific date in the 2011-12 income year.

A letter from the employer advised your client that a payment had been approved as a partial and permanent disability benefit.

Further, the letter advised that this payment was calculated in accordance with a Schedule of an award (the Award).

A PAYG payment summary from the employer shows that a payment was made to your client in the 2011-12 income year and comprised only a taxable component. Tax was withheld from the payment.

Your client has not been in any employment since the termination of employment with the employer.

You have provided copies of two medical certificates. In relation to your client's injuries, both certificates state in part that the taxpayer is unable to engage in work consistent with their training, education and experience due to medical condition.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 1-3

Income Tax Assessment Act 1997 Subsection 82-10(1).

Income Tax Assessment Act 1997 Subsection 82-10(2).

Income Tax Assessment Act 1997 Subsection 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 Section 82-135.

Income Tax Assessment Act 1997 Paragraph 82-135(i).

Income Tax Assessment Act 1997 Section 82-140.

Income Tax Assessment Act 1997 Section 82-145.

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 Subsection 82-150(2).

Income Tax Assessment Act 1997 Section 995-1.

Income Tax Assessment Act 1936 Subsection 27A(1).

Income Tax Assessment Act 1997 paragraph 82-10(3)(b)

Reasons for decision

Summary

The employment termination payment received by your client from the employer includes an invalidity segment.

The remaining amount is the taxable component of an employment termination payment and is included in your client's income tax return for the 2011-12 income year.

As your client has not yet reached preservation age, and the taxable component is under the employment termination payment cap, a tax offset will apply to ensure that the taxable component is taxed at no more than 30% plus Medicare levy (if any).

Detailed reasoning

Where a person's employment is terminated because of ill-health and the person receives an employment termination payment, part of the payment may be tax free. This component is called an invalidity segment.

Therefore, prior to determining if the payment includes an invalidity segment, the payment must be an employment termination payment.

Employment termination payment

Employment termination payments are defined in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997). Subsection 82-130(1) declares:

A payment is an employment termination payment if:

Section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments, including:

Therefore, it can be seen that three conditions need to be satisfied in order for the payment to be treated as an employment termination payment.

Failure to satisfy any of the three conditions will result in the payment not being considered an employment termination payment. Any termination payments received more than 12 months after the termination of employment will be taxed as ordinary income at marginal tax rates.

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.

It is considered that the payment received by your client from the employer, was made in consequence of the termination of your client's employment. Your client was unable to continue work due to the medical condition and consequently was medically discharged from the employer.

Retirement on medical grounds was recommended by a medical panel to the employer who approved your client's termination of employment and the payment of a partial and permanent disability benefit under the Award.

The payment received by your client from the employer would not have been approved and paid unless your client's employment was terminated and in this case the termination was based on medical grounds.

Therefore, the 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 second condition for the payment to meet the criteria is that the employment termination payment was paid to the taxpayer no later than 12 months after the taxpayer's employment was terminated.

The facts of this case show that your client's payment was received within 12 months of the termination and therefore satisfies the requirements of paragraph 82-130(1)(b) of the ITAA 1997

Not a payment mentioned in section 82-135 of the ITAA 1997

As noted earlier section 82-135 of the ITAA 1997 provides that certain payments are not employment termination payments. These include:

The payment is the result of a calculation of a partial and permanent disability benefit under the Award. It is not a superannuation benefit, a payment for unused annual leave or unused long service leave, nor is it the tax-free part of a genuine redundancy payment or an early retirement scheme payment.

However, consideration must be given as to whether the payment represents a reasonable capital payment for personal injury. If it does, then the payment will not be an employment termination payment under paragraph 82-135(i) of the ITAA 1997 (payments that are not employment termination payments).

Paragraph 82-135(i) of the ITAA 1997 states that an employment termination payment does not include:

Payments that fall within this exclusion are payments or benefits that compensate or reimburse the person for or in respect of the particular injury.

Prior to 1 July 1997, former paragraph (n) of the definition of an eligible termination payment in former subsection 27A(1) of the Income Tax Assessment Act 1936 (ITAA 1936) (the former paragraph (n) exclusion) applied to exclude similar payments from being eligible termination payments. The former paragraph (n) exclusion stated:

Consideration of a capital nature for, or in respect of, personal injury to the taxpayer, to the extent to which the amount or value of the consideration is, in the opinion of the Commissioner, reasonable having regard to the nature of the personal injury and its likely effect on the capacity of the taxpayer to derive income from personal exertion.

From 1 July 2007, the former paragraph (n) exclusion has been replaced by paragraph 82-135(i) of the ITAA 1997. However, the Explanatory Memorandum (EM) to the Tax Laws Amendment (Simplified Superannuation) Bill 2006 which, as enacted, inserted section 82-135 of the ITAA 1997, states that:

consistent with current legislation, certain payments are prevented from qualifying as employment termination payments.

Paragraph 82-135(i) of the ITAA 1997 represents a rewrite of the former paragraph (n) exclusion. Despite the fact that the wording of the legislation has changed from 'consideration of a capital nature' to 'capital payment', the meaning of the legislation has not changed.

In accordance with section 1-3 of the ITAA 1997,section in the ITAA 1936 which have been rewritten in the ITAA 1997 will have the same meaning where it is expressing the same idea, even when if the words used are different. It is therefore appropriate to cite cases that refer to the previous legislation.

In Commissioner of Taxation v. Scully [2000] HCA 6; (2000) 2000 ATC 4111; (2000) 169 ALR 459; (2000) 43 ATR 718; (2000) 74 ALJR 504; (2000) 201 CLR 148 (Scully) the Full Bench of the High Court considered whether a payment made by a superannuation fund as a result of the taxpayer's termination of employment because of invalidity was:

It was held that the payment was 'consideration' within the broad sense of that term. However, the payment was not 'consideration for or in respect of personal injury to the taxpayer' which would fall within the paragraph (n) exclusion. The clauses of the trust deed which calculated the payment made no attempt to place a monetary value on the taxpayer's injury, nor was it the purpose of superannuation schemes to compensate for personal injury.

Acting Chief Justice Gaudron and Justices McHugh, Gummow and Callinan stated in their joint decision:

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.

From the foregoing it is apparent that for an amount to be a capital payment for, or in respect of, personal injury, the payment must actually be for personal injury and be calculated by reference to the nature and extent of the injury or likely loss to the taxpayer.

As advised in a letter from the employer the payment was calculated in accordance with the Award. Payments under the Award are made where an employee has suffered a partial and permanent disability (PPD) as a result of an on-duty injury and their employment is subsequently terminated.

A Schedule of the Award determines the amount to be paid as a lump sum under the Award. The amount is calculated by reference to the age and salary of the employee at the time of the injury.

Consequently, the level of incapacity is irrelevant as to the amount received under the Award. For example, an employee who is 20% incapacitated will receive the same amount as an employee who is 80% incapacitated provided they are at the same salary level and age at the date of injury.

The only criterion is that the employee has suffered a PPD and cannot be redeployed elsewhere within the employer.

The lump sum payments are consideration for, or in respect of the employee's termination of employment and the employee's rights under the Award and not consideration for, or in respect of the employee's injury. The lump sum payment is not calculated by reference to the nature and extent of the injury or likely loss to the employer. In other words, the payment is to compensate the employer for the loss of their employment as a result of the injury sustained rather than to compensate for the injury itself and any subsequent loss of earning capacity.

Accordingly, it is considered that paragraph 82-135(i) of the ITAA 1997 does not apply to the lump sum payment being made under the Award.

Therefore your client's payment is not of a type paragraph 82-130(1)(c) of the ITAA 1997 would exclude.

As all the conditions under subsection 82-130(1) of the ITAA 1997 have been met, the payment will be an employment termination payment.

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 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 becoming ill, your client was employed on a full-time basis as an employee with the employer. In the 2011-12 income year your client's employment with the employer was terminated after a medical panel considered your client was unfit for the substantive requirements of their position due to your client's disabilities and recommended his medical discharge.

Under normal conditions of employment your client would have retired at age 65. Your client was under preservation age at the time of the termination of his employment. Therefore the conditions in paragraphs 82-150(1)(a), (b) and (c) of the ITAA 1997 have 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 this requirement, it must be demonstrated that the disability was such that it is unlikely that the person can ever be gainfully employed in a 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.

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 your client's case, two legally qualified medical practitioners have certified that as a result of the injury your client will never be able to be gainfully employed in any capacity for which your client is reasonably qualified because of education, training or experience.

It is also noted that prior to being employed by the employer your client engaged in a trade and then worked in an industry analogous to that of the employer. You advised that your client has not been in any employment since the termination of your client's employment with the employer.

Therefore, as two medical practitioners have provided certificates that attest to your client being unable to ever be employed in a capacity for which he 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.

Components of an employment termination payment

An employment termination payment comprises the following components:

The tax-free component of an employment termination payment is not assessable income and is not exempt income (subsection 82-10(1) of the ITAA 1997). However, the taxable component is assessable income (subsection 82-10(2)) and subject to tax, depending on the person's age when the payment is received.

Calculation of invalidity segment

As noted above, the invalidity segment of an employment termination payment is included in the tax-free component (section 82-140 of the ITAA 1997). As a consequence, the invalidity segment is not assessable income and is not exempt income.

The amount of the invalidity segment is worked out by applying the formula in subsection 82-150(2) of the ITAA 1997:

Work out the amount of the invalidity segment by applying the following formula:

The amount calculated as per the formula above is the invalidity segment which, as noted earlier, forms part of the tax-free component of the employment termination payment.

As your client's employment commenced after 30 June 1983 there will not be any pre-July 83 segment.

Tax treatment of taxable component

The remaining is a taxable component of the employment termination payment as defined in section 82-145 of the ITAA 1997. This component is to be included in your client's tax return for the 2011-12 income year. As this amount is under the employment termination payment cap ($165,000 for the 2011-12 income year), and your client has not yet reached preservation age, it will be taxed at 30% plus Medicare levy.

Your client will be eligible to a tax offset under paragraph 82-10(3)(b) of the ITAA 1997. The tax offset will ensure that the rate of tax on the taxable component will be no more than 30% plus Medicare.

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