Payment of a lump sum redemption is in effect the 'bringing forward' of the payment of weekly compensation as income replacement. The advice from the Australian Taxation Office (ATO) regarding Sections 30 and 137 (please see the exceptions 21 below) is that, 'a capital sum received in substitution of weekly payments does not alter the character of the compensation for 'income replacement' and that such payments are subject to taxation in accordance with Subsection 25(1) of the Income Tax Assessment Act 1936.
More recent advice from the ATO (following a decision in an AAT case (Coward and Commissioner of Taxation No ST97/87)) is that a redemption made under Section 137 in respect of the portion of incapacity beyond [glossary::469] will be characterised as a 'capital receipt' and will therefore not be subject to either income or capital gains tax. In other words, that part of a lump sum redemption which relates to incapacity for work after the injured employee turns [glossary::469] cannot be considered to be 'income replacement' and is not therefore considered to be taxable.
In cases where a 'former employee' is under [glossary::469] at the time a Section 137 lump sum redemption is to be paid, it will be necessary to identify that part of the redemption which is taxable (for incapacity before the employee is to turn [glossary::469]) and the portion which will not be taxable (after the employee is to turn [glossary::469]).
The amount of the redemption which is to be taxed and the amount which is not to be taxed can be established by running a second Defcare redemption calculation setting the date of determination (fact p209) as the day after the client turns [glossary::469]. This calculation should not be saved within the Defcare record as it would otherwise give the appearance of two redemptions being paid. The extra calculation will identify only the amount to be redeemed after the employee turns [glossary::469], which is the non taxable amount. The difference between the total lump sum redemption amount and the amount determined to be for 'incapacity' after the employee is to turn [glossary::469] will establish the part of the redemption that is to be taxed. Section 134 is to be used in working out the weekly amount for redemption's beyond [glossary::469]. (Please note that the Defcare Incapacity Calculator automatically calculates the reduced Section 134 amount for periods beyond [glossary::469]). Section 134 has the effect of reducing the weekly entitlement of any 'Former' employee born prior to 1 December 1943 to $zero. Consequently, for these clients no portion of the redemption will be in respect to time after they turn [glossary::469].
The appropriate rate of tax to be deducted is determined by using the MYSTIC calculator. The calculation should include other income known to be earnt by the person during the financial year including:
- Incapacity payments paid prior to the redemption;
- Superannuation pension payments; and
- Earnings from paid employment.
Delegates should note that for section 137 redemptions only the taxable component should be entered into MYSTIC.
Delegates should refer to the MYSTIC User Guide available on the SRCA and MRCA tools site for more detailed information on how MYSTIC calculates the amount of taxation to be withheld. The amount of taxation withheld is based on an estimate of the individual's full year earnings, in order to minimise the prospect of a significant under or overpayment of taxation. Ultimately individuals should be advised that it is their responsibility to obtain appropriate taxation advice.
The MYSTIC calculation sheet should be forwarded to the client to enable them to approach their Taxation agent for advice on the affect of the taxation calculated. For SRCA transitional (section 137) cases, this will allow them to consider whether to accept the redemption and for SRCA (section 30) cases to ensure they are aware of any taxation implications.
As the redemption payment should (normally) appear on the individual's 'Payment Summary' (Group Certificate), payments must not be made through DEFCARE/DOLARS but should be processed through PMKeyS using Earnings Codes M11 for Section 30 and M20 for Section 137 redemptions. The non-taxable component of a Section 137 redemption, for that component of a redemption for post [glossary::469], should be entered in PMKeyS using the Code M70.
Taxation on those payments should be calculated as per the previous section and entered on PMKeyS ensuring that the relevant code overriding automatic taxation code is selected.