Private ruling: Deduction of settlement payment
Date of advice: 23 April 2026
Published: 13 July 2026

Ruling: A2: Yes. This private ruling applies for the following periods: Income year ended 30 June 20XX Income year ended 30 June 20XX Income year ended 30 June 20XX Income year ended 30 June 20XX Income year ended 30 June 20XX Income year ended 30 June 20XX

Relevant facts and circumstances: In 20XX, Company B commenced Federal Court Proceedings against Company A and person A. The Federal Court Proceedings were subsequently amended and person B and person C were joined as respondents to the proceedings. Person A was a former employee of Company B. Their employment contract stipulated that any information acquired by person A in the course of their employment with Company B regarding Company B, Company B's business, Company B's personnel, Company B's suppliers, Company B's clients or Company B's future products was confidential to Company B and not to be disclosed or used otherwise than for the purpose of their employment with Company B. Their employment contract also included a 'Restraint Term' which read: Information supplied Company B's core business is the procurement and supply of specific products. For years, Company B was the exclusive Australian seller and distributor for a particular overseas supplier (the Supplier). Company A was incorporated in 20XX with person A as sole director and a company wholly owned by person A as sole shareholder. Company A operates a business distributing and selling specific products and entered into an arrangement with the Supplier to distribute its products within Australia. In 20XX, the Supplier gave notice to Company B that Company B would no longer be the exclusive seller and distributor of its products in Australia. It was alleged by Company B that during person A's employment period they developed, drafted, prepared and presented to the Supplier a detailed business plan relating to the formation and development by person A of a business to distribute and sell specific products within Australia as a direct competitor to Company B and, in doing so, breached their employment contract. Specifically, this included: • a breach of the contractual duty of confidence, using Company B's confidential information for a purpose other than their employment; and • a breach of the Restraint Term, having made contact with a client of Company B in an attempt to divert the client's business away from Company B within a 2-year period following the cessation of their employment with Company B. Following a mediation, the parties to the Federal Court Proceedings reached agreement on all disputes between them, signed a Binding Heads of Agreement and then entered into the Deed in furtherance of the objects of the Binding Heads of Agreement. Under the terms of the Deed and in consideration of the release and discharge of Company A and each of the other respondents in respect of all claims arising out of or in a connection with any fact, matter and circumstance referred to in the Federal Court Proceedings and the employment of person A and person B with Company B, without admission of liability: • Company A agreed to pay Company B a Settlement Sum of $XX across the following instalments: ­ $XX by X MM 20YY; ­ $XX by X MM 20YY; ­ $XX by X MM 20YY; and ­ $XX by X MM 20YY; • Company A and the other respondents each agreed that all new work from specified entities or in respect of specified projects up until a specified date in 20YY will be referred to Company B and • Company B and person B agree that person B (despite having ceased their employment with Company B at that point in time) will continue to be bound by the terms of their employment agreement with Company B until a specified future date. Following its payment of the Settlement Sum, Company A took the view (based on advice received at the time) that the payment was capital in nature and recognised it as an intangible asset in its Balance Sheet on the basis that the payment resulted in the acquisition of an identifiable non-physical resource, namely: • the extinguishment of litigation risk; • the securing of mutual releases from claims; and • the benefit of temporary restraints and referrals under the Deed. According to Company A, this accounting treatment is in accordance with Accounting Standard AASB XXX Intangible Assets, which permits recognition of an intangible asset where: • the asset is identifiable; • the entity controls the resource as a result of past events; and • future economic benefits are expected to flow to the entity. In the 20YY income year, Company A has reassessed whether the Settlement Sum continued to meet the criteria of an intangible asset under the AASB XXX and formed the view that: • any economic benefits associated with the settlement were fully consumed once the litigation was concluded and the temporary restraints expired in 20YY; and • after that point, no identifiable or controllable intangible asset remained. As a result, Company A took the view that the Settlement Sum no longer satisfied the definition or recognition criteria of an intangible asset and, in accordance with Accounting Standard AASB XXX Impairment of Assets and AASB XXX, should be written off in full in the 20YY income year, being the year in which it was concluded that no future economic benefits remained. According to Company A, this write-off represents: • the derecognition of an intangible asset that no longer exists for accounting purposes; and • a correction of its Balance Sheet to reflect the substance of the arrangement once all contractual benefits had expired.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 subsection 8-1(1) | Income Tax Assessment Act 1997 subsection 8-1(2) | Income Tax Assessment Act 1997 subsection 40-25(7) | Income Tax Assessment Act 1997 section 40-880 | Income Tax Assessment Act 1997 subsection 40-880(2) | Income Tax Assessment Act 1997 paragraph 40-880(2)(a) | Income Tax Assessment Act 1997 subsection 40-880(3) | Income Tax Assessment Act 1997 subsection 40-880(4) | Income Tax Assessment Act 1997 subsection 40-880(5) | Income Tax Assessment Act 1997 paragraph 40-880(5)(f) | Income Tax Assessment Act 1997 subsection 40-880(8) | Income Tax Assessment Act 1997 subsection 40-880(9) | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 subsection 104-25(1) | Income Tax Assessment Act 1997 subsection 104-25(3) | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 subsection 995(1)

Reasons for decision: Summary: The payment of the Settlement Sum by Company A under the Deed is not deductible under section 8-1 because it is not necessarily incurred in carrying on a business for the purpose of gaining or producing its assessable income and/or it is an outgoing of capital or of a capital nature. | Detailed Reasoning - Detailed reasoning: Subsection 8-1(1)states that you can deduct a loss or outgoing from your assessable income to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, subsection 8-1(2) states that you cannot deduct a loss or outgoing in accordance with subsection 8-1(1) to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; or (c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or (d) a provision of this Act prevents you from deducting it. To be deductible under section 8-1, the Settlement Sum paid by Company A under the Deed must satisfy one of the positive limbs in subsection 8-1(1) and not be excluded by any of the negative limbs in subsection 8-1(2). To satisfy the relevant positive limb in subsection 8-1(1), the Settlement Sum must have a sufficient connection with the carrying on of Company A's business for the purpose of gaining or producing assessable income. Whether there is the necessary nexus between the Settlement Sum and the carrying on of Company A's business is a question of fact to be determined by reference to all relevant facts and circumstances. An outgoing would take the character from the cause or purpose of incurring the expenditure. In determining whether a deduction for a settlement payment paid to finalise legal proceedings is allowable under section 8-1, the nature of the expenditure must be considered. Broadly, payments which arise from legal settlements are generally deductible if the expenditure: • arose out of, or concerned the day-to-day income producing activities of the taxpayer ( Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169); • is not undertaken to protect the taxpayer's profit yielding structure; and • has more than a peripheral connection to the taxpayer's business ( Magna Alloys and Research Pty Ltd v. Commissioner of Taxation (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542; (1980) 33 ALR 213; Putnin v. Commissioner of Taxation (1991) 27 FCR 508; 91 ATC 4097; (1991) 21 ATR 1245). The Respondents to the Federal Court Proceedings (including Company A) were defending an action taken by Company B (person A's previous employer) in relation to breach of the contractual duty of confidence and breach of the Restraint Term. This is not considered defence of the manner in which Company A conducts its usual day-to-day income producing activities. It follows that the Settlement Sum is not incidental to and does not have a sufficient connection with the carrying on of a business for the purpose of gaining or producing assessable income, as it did not arise as a consequence of the day-to-day activities of the business. Even if this were incorrect, the Settlement Sum is an outgoing of capital or of a capital nature. The High Court decision in Sun Newspapers Ltd. and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 23; (1938) 1 AITR 403 ( Sun Newspapers ) is the leading authority on the distinction between revenue and capital expenditure. In Sun Newspapers , Dixon J stated: There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. The primary considerations in determining whether a settlement payment to resolve or finalise a legal dispute is on revenue or capital account are: • whether the settlement payment relates to the profit-yielding structure and the process (which is indicative of a capital nature) or profit-yielding subject (which is indicative of an income nature); • whether the nature of the asset or advantage sought to be gained is of an enduring benefit, which is indicative of a capital nature; and • whether the settlement payment was incurred in establishing, preserving, perfecting or defending title to property or a right over an asset, which is indicative of a capital nature. The payment of the Settlement Sum by Company A to Company B finalised the dispute and the Federal Court Proceedings and allowed Company A (and person A) to continue to carry on its business without the uncertainties and risk of a protracted legal dispute. The business is the 'profit yielding structure' and payments to protect that structure or enable the business to be undertaken uninhibited provide an enduring advantage. The advantages sought by making the payment of the Settlement Sum were to finalise the legal proceedings over the breach of contract, prevent future litigation, avoid business disruptions and avoid or minimise damages payable in the event of an unfavourable legal outcome. These advantages have provided a lasting or enduring benefit, as the settlement gives Company A ongoing freedom from further action related to this dispute. This is not an incidental outcome but a core advantage of the settlement. | Summary: The write-off of the Settlement Sum paid by Company A under the Deed and treated as an intangible asset in its Balance Sheet does not give rise to a capital loss under Part 3-1. However, the payment of the Settlement Sum by Company A under the Deed is deductible under section 40-880. | Detailed Reasoning - Capital gains, Part 3-1: CGT event C2 happens if your intangible asset ends in a way listed in subsection 104-25(1). Pursuant to subsection 104-25(3), a capital loss is made if the capital proceeds from the ending are less than the CGT asset's reduced cost base. Section 108-5 defines a CGT asset to mean: (a) any kind of property, or a (b) legal or equitable right that is not property. The reference to a legal or equitable right requires that, to be a CGT asset, a right which is not property must be recognised by the law or equity and presumably be enforceable by legal or equitable proceedings. Mere personal rights and freedoms would not be included. Pursuant to the Deed, the Settlement Sum provided for the release and discharge of all claims against Company A, dismissal of proceedings, the requirement to refer new work from specified entities or in respect of specified projects to Company B (for a temporary period), and a reduction in the time during which an employment restraint on person B would apply. The Settlement Sum did not create any legal or equitable rights in Company A or any other entity that would be enforceable. Company A did not acquire a CGT asset for the purposes of section 108-5 as a consequence of having paid the Settlement Sum. As such, it is not possible that any capital loss under section 104-25 may be claimed in connection with the writing off of the Settlement Sum recognised as an intangible asset in Company A's Balance Sheet. | Detailed Reasoning - Deductibility of business related costs under section 40-880: The object of section40-880 is to make certain business capital expenditure deductible if: • the expenditure is not otherwise taken into account; • a deduction is not denied by some other provision; and • the business is, was or is proposed to be carried on for a taxable purpose. Taxation Ruling TR 2011/6 Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues sets out the Commissioner's views on the interpretation of the operation and scope of section 40-880. Pursuant to paragraph 40-880(2)(a), y ou can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur in relation to your business. As established in response to question 1 of this ruling, the Settlement Sum constitutes capital expenditure incurred by Company A. Paragraph 79 of TR 2011/6 states: Whether the capital expenditure is truly business expenditure is determined by the facts. Determining whether the expenditure has the character of a business expense can be approached by asking what the expenditure is for, in the sense of identifying the need or object that the expenditure serves. If the facts show that the expenditure satisfies the ends of the relevant business, it will have the character of a business expense. Further, paragraph 98 of TR 2011/6 states: Paragraph 40-880(2)(a) of the ITAA 1997gives an entitlement to a deduction for capital expenditure the taxpayer incurs in relation to their business. The expenditure must relate to an existing business that the taxpayer is carrying on at the time they incur the expenditure. Capital expenditure incurred on the structure by which an entity carries on (or used to or proposes to carry on) their business, on the profit yielding structure of the business, or relating to the business's trading operations, are capable of being described as capital expenditure incurred 'in relation to' that business for the purposes of subsection 40-880(2). Whether such capital expenditure is incurred 'in relation to' the particular business will depend on whether there is a sufficient and relevant connection between the incurring of the expenditure and that business. Company A carries on business of distributing and selling specific products. The payment of the Settlement Sum by Company A to Company B under the Deed was made to finalise the dispute between the relevant parties and allowed Company A (and person A) to continue to carry on its business without the disruption and risk of an ongoing legal dispute. The Settlement Payment is related to Company A's current business. It is therefore considered that the Settlement Sum was a business expense of Company A and incurred 'in relation to' its business for the purpose of paragraph 40-880(2)(a). Subsection 40-880(3) may apply to limit the deductibility of capital expenditure under subsection 40-880(2) to the extent that the business it relates to is being carried on for a taxable purpose. Taxable purpose is defined in subsection 40-25(7) to include 'the purpose of producing assessable income'. The 'purpose of producing assessable income' is defined in subsection 995(1) as being something done for the purposes of gaining or producing assessable income, or in carrying on a business for the purpose of gaining or producing assessable income. Since its establishment, Company A has carried on a business in Australia, derived assessable income and therefore carried on that business for a taxable purpose, as required by subsection 40-880(3). Once entitlement is initially established under section 40-880(2) and the limitations in subsections 40-880(3) or 40-880(4) [1] are considered, further restrictions may be placed on the amount of expenditure which is deductible under section 40-880(2). The further restrictions are contained in subsections 40-880(5), 40-880(8) and 40-880(9). Of those restrictions, the one in subsection 40-880(5)(f) is the most relevant to the Settlement Sum. Paragraph 40-880(5)(f) provides that the taxpayer cannot deduct anything under section 40-880 for an amount of expenditure they incur to the extent that it could be taken into account in working out the amount of a capital gain or capital loss from a CGT event. In most cases, capital proceeds and cost base (or reduced cost base) are taken into account in working out the amount of a capital gain or capital loss from a CGT event. Therefore, capital expenditure which reduces capital proceeds from a CGT event or forms part of the cost base (or reduced cost base) of a CGT asset could be taken into account in working out the amount of a capital gain or capital loss from a CGT event for the purposes of paragraph 40-880(5)(f). The fact that the Settlement Sum was paid by Company A to end the dispute which was the subject of the Federal Court Proceedings, was not made in consideration for any CGT assets owned by Company A, and was not incurred in respect of any kind of property owned by Company A, means that the Settlement Sum could not be taken into account in working out the amount of capital gain or capital loss from a CGT event. Accordingly, paragraph 40-880(5)(f) does not exclude the Settlement Sum from deductibility and the Settlement Sum is deductible over a period of 5 income years in equal proportions (i.e. across the 20XX to 20XX income years) pursuant to section 40-880. [1] The application of subsection 40-880(4) is not relevant to the Settlement Sum.

Is the payment of the Settlement Sum by Company A under the Deed of Settlement and Release (the Deed) deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Question 2: If the payment of the Settlement Sum by Company A under the Deed is deductible under section 8-1 of the ITAA 1997 and expensed from its Income Statement for the year ended 30 June 20XX, is the deduction allowed in that year? | Answer 2: Not relevant as the Settlement Sum is not deductible under section 8-1 of the ITAA 1997. | Question 3: Does the write-off of the Settlement Sum paid by Company A under the Deed (and treated as an intangible asset in its Balance Sheet) give rise to a capital loss under Part 3-1 of the ITAA 1997? | Question 4: Is the payment of the Settlement Sum by Company A under the Deed deductible under section 40-880 of the ITAA 1997? | Reasons for decision: All subsequent legislative references are to the ITAA 1997.