It is a fact of life that not all employment arrangements end amicably and sometimes this results in the employer making a payment in settlement against alleged actions of the employer (e.g. wrongful dismissal etc.). Where such a payment is made, a question arises as to the nature of that payment. Is it an Employment Termination Payment (ETP), a Genuine Redundancy Payment or something else? Whilst, this issue may seem to be of concern solely to the employee correctly identifying the nature of the payment will affect the employer’s withholding obligations. A recent Tribunal decision, Stark and FCT  AATA 2583 (Stark’s Case), has shed further light on the issue in relation to on an out of court settlement arising from the dismissal of an employee in settlement of their claims of wrongful dismissal and deceptive conduct
Stark’s Case – OverviewThe Taxpayer, a chartered accountant, commenced a new role with the Employer in late 2000. The experience was ‘not a happy one’, which resulted in the Employer terminating the Taxpayer’s employment in December 2001. The Taxpayer instigated legal proceedings against the Employer for deceptive conduct and wrongful dismissal. The Supreme Court proceedings were part heard when they were settled by the Taxpayer accepting a sum of money. The Taxpayer executed the Settlement Deed in March 2009. The Taxpayer treated the Payment as an ETP in his 2009 income tax return and the Commissioner assessed it on this basis. The Taxpayer subsequently objected to the assessment with the Commissioner disallowing the objection on the basis that the Payment was ordinary income. The Taxpayer then applied to the Tribunal for review of the objection decision asserting that the payment was not an ETP on the basis that it was either a capital payment for personal injury (which would preclude it from being an ETP and would also be exempt from CGT) or a Genuine Redundancy Payment. Relevant clauses of the deed of release include:
- Clause 2.1 provided that in consideration of the payment, the Taxpayer released the Employer from ‘all claims arising out of or in any way connected with the Employment, its Termination, the Complaints and the Proceedings or any one or more of them’
- Clause 2.2 provided that the settlement amount included $505,500 in respect of the claim by the Taxpayer for lost earnings (less any amount required to be withheld by the Employer on account of taxation).
What is an Employee Termination Payment?The key issue in Stark’s Case revolved around what constitutes an ETP. Broadly, a payment will be an ETP if:
- It is received by a taxpayer:
- In consequence of the termination of their employment; or
- After another person’s death, in consequence of the termination of the other person’s employment; and
- It is received no later than 12 months after that termination (subject to certain exceptions); and
- It is not an excluded payment.
- The part of a Genuine Redundancy Payment or Early Retirement Scheme Payment that is non-taxable as calculated in accordance with the statutory provisions; and
- A capital payment for, or in respect of, personal injury to the extent 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.
The Tribunal’s ReasoningIn arriving at its decision the Tribunal was of the opinions outlined below.
Payment was in consequence of the termination of the Taxpayer’s employmentThe authorities establish that it is not necessary for a payment to relate solely to a wrongful dismissal or other termination of employment, or even for that to be the dominant cause, in order for a payment to be characterised as received in consequence of termination of employment. It is sufficient if it follows on from termination of employment. The Supreme Court proceedings followed as a consequence of the termination of the Taxpayer’s employment, and the Payment was directly linked to the discontinuance of that litigation. That was sufficient, based on the authorities, to require the Tribunal to conclude that the Payment was made in consequence of the termination of the Taxpayer’s employment, for the purposes of the definition of an ETP.
Payment was not a Genuine Redundancy PaymentThere was no evidence to suggest that the Taxpayer’s position was actually made redundant, or that the Payment was treated as a redundancy payment by the Employer. Accordingly, the Tribunal rejected the Taxpayer’s submission that the Payment escaped characterisation as an ETP on this basis.
Payment was not in respect of personal injury to the TaxpayerEven if the Taxpayer had been able to establish that the Payment was capital in nature, the Tribunal would not accept that it was for or in respect of personal injury to the Taxpayer. There is nothing in the context in which the term ‘personal injury’ is used in the legislation to suggest it is intended to take other than its normal meaning, which does not extend to mere financial injury. Nor was there any basis for the Tribunal to depart from the terms of the Deed, or to identify any part of the undissected sum as relating to personal injury.
SummaryThe decision in Stark’s Case, reiterates that in most circumstances where a settlement payment has been made due to the termination of an employee’s employment the payment is likely to meet the definition of an ETP and therefore the employer needs to ensure it correctly meets withholding obligations in relation to the ETP. More information on the treatment/withholding obligations of ETP’s can be found here.
This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. It is not intended to be, nor should it be relied upon as, a substitute for professional advice. TaxEd Pty Ltd and any person connected with its production disclaim any liability in connection with any use.