Private ruling: Lump sum payment
Date of advice: 26 February 2016
Published: April 2016
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Questions and answers | 1. Are you entitled to the tax offset in section 159ZRA of the Income Tax Assessment Act 1936 in relation to the lump sum payment you received? | No. | 2. Is the lump sum amount you received assessable under the capital gains tax provisions? | Yes. | 3. Can you include the legal costs you incurred in pursuing your claim as part of the cost base when calculating your capital gain? | Yes. | 4. Can you apply the 50% discount in Division 115 of the Income Tax Assessment Act 1997 to your capital gain? | Yes.

Relevant facts and circumstances: You worked with an organisation (the other party) for some years and the other party classified you as a contractor. You ceased working with the other party and commenced legal action against the other party several months later. You commenced legal action on the basis that your employment status for the relevant years was that of an employee and you were entitled to receive annual leave, sick leave and superannuation guarantee payments. As part of your legal action, you calculated an amount to cover the annual leave, sick leave and superannuation guarantee payments you believed you were entitled to. The court proceedings became protracted and offers and counter offers were made in relation to the amount you were seeking. Your legal fees were mounting and you decided to settle your claim against the other party for a lesser amount than you originally claimed. You and the other party signed a settlement agreement (the Agreement) over 12 months after you commenced the legal proceedings. The Agreement included a clause which stated that in consideration of the settlement figure to be paid with a denial of liability to you by the other party, the parties agreed to finalise all actions, proceedings, claims, demands and damages which the parties had or may hereafter have against each other in respect of or arising out of the described incidents. The Agreement made mention that your claim related to a contract for services and/or of service between you and the other party. Under the Agreement, you agreed to: • complete an invoice for payment of the settlement figure and provide it to the other party following execution of the Agreement, and • meet any taxation liability arising out of the payment of the settlement figure by the other party. Under the Agreement, you and the other party acknowledged that: • the payment of the settlement figure was not an admission of liability by the other party, and • the settlement figure was inclusive of all your legal costs. The Agreement does not make any reference to salary, wages, annual leave, sick leave or superannuation guarantee payments in any of its clauses or Schedules. You incurred legal costs in pursing your claim against the other party.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 159ZRA | Income Tax Assessment Act 1997 section 102-20 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 section 110-25 | Income Tax Assessment Act 1997 Division 115

Reasons for decision: Summary: Income from employment, such as salary, wages or other payments to employees for services rendered, is generally derived only when received. Accordingly, back payments of employment related income that relate to an earlier income year or years will be assessable only in the year of receipt. Section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936) provides for an income tax offset in relation to certain lump sum payments that accrued in a prior year or years. Lump sum payments that may be eligible for the tax offset include those relating to back payments of salary or wages that accrued in a period more than 12 months before the date of payment In your case, you engaged in legal action against the other party in order to obtain payment for annual leave, sick leave and superannuation guarantee payments you believed you would have been entitled to if you had been correctly treated as an employee instead of a contractor. You commenced the legal action seeking a certain amount and eventually agreed to accept a lesser amount in settlement of your claim. You believe that you are entitled to a tax offset in regard to the lump sum you received as it relates to the amounts you would have received progressively over the period you worked with the other party. In this regard, you have provided calculations of how the amount you received should be apportioned to each of the years you worked with the other party. However, examination of the Agreement shows that the settlement amount was payable in relation to you and the other party agreeing to finalise all actions, proceedings, claims, demands and damages which you and the other party had or may have against each other in respect of or arising out of your claim. Further, the other party settled your claim without admitting any liability. Although the Agreement states that your claim related to the contract for services and/or of service between you and the other party, the Agreement does not make any reference to salary, wages, annual leave, sick leave or superannuation guarantee payments in any of its clauses or Schedules. We also note that the settlement figure is not apportioned or split up in any way. Accordingly, we consider that the amount you received constituted a lump sum compensation or settlement payment and cannot be considered as being a back payment of 'salary or wages' that the tax offset can be applied against. Consequently, you are not entitled to a tax offset under section 159ZRA of the ITAA 1936. Receipt of a lump sum compensation or settlement amount will be considered to be a capital payment unless it can be identified as compensation for loss of income. Taxation Determination TD 93/58 provides that a lump sum compensation or settlement payment will only be assessable as income: to the extent that a portion of the lump sum payment is identifiable and quantifiable as income. This will be possible where the parties either expressly or impliedly agree that a certain portion of the payment relates to a loss of an income nature [cf. Mc Laurin v. FC of T (1961) 104 CLR 381; (1961) 8 AITR 180 and Allsop v. FC of T (1965) 113 CLR 341; (1965) 9 AITR 724]. In your case, you received a lump sum payment that was not apportioned in any way and there was no mention in the Agreement of any part of the payment being of an income nature. Consequently, the payment you received is of a capital nature and will be assessable under the capital gains tax (CGT) provisions. You pay tax on your capital gains. It forms part of your income tax and is not considered a separate tax, although it is generally referred to as capital gains tax (CGT). Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a capital gain is made only if a CGT event happens. A CGT event is generally something that happens in relation to a CGT asset, for example, disposing of the asset. For most CGT events, your capital gain is the difference between your capital proceeds and the 'cost base' of the CGT asset. Section 108-5 of the ITAA 1997 states that a CGT asset is any kind of property or a legal or equitable right that is not property. The right to seek compensation is a legal or equitable right and therefore an intangible asset. CGT event C2 happens if your ownership interest in an intangible CGT asset ends when the asset is released, discharged or satisfied (section 104-25 of the ITAA 1997). Taxation Ruling TR 95/35 discusses the CGT implications of compensation receipts and explains that the right to seek compensation is an asset for the purposes of the capital gains tax legislation. The right to seek compensation is the right of action that arises on the occurrence of any breach of contract, personal injury or other compensable damage or injury. The right is acquired at the time of the compensable wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged. In your case, you acquired the right to seek compensation at the time you commenced legal action against the other party and you disposed of the right when you settled your claim. Therefore, CGT event C2 happened when you disposed of the right and the capital gain you made will be included in your assessable income. The capital gain arising from the disposal of your right to seek compensation is calculated using the cost base of that right (section 110-25 of the ITAA 1997). The cost base of a CGT asset consists of five elements: • The first element is the total of the money paid, or required to be paid, in respect of acquiring the asset. • The second element is the incidental costs incurred in acquiring the asset. • The third element is the costs of owning the asset. • The fourth element is the capital costs associated with increasing or preserving the value of the asset, or installing or moving the asset. • The fifth element is the capital expenditure incurred in establishing, preserving or defending title to the asset, or right over the asset. In your case, the first element of the cost base will be nil as you did not pay anything for acquiring the right to seek compensation. However, any legal expenses you incurred in preparing, contesting or finalising your claim against the other party can be included in the cost base when calculating your capital gain. We also note that any other costs you incurred in relation to your claim that fall into any of the above categories can also be included in your cost base. Under Division 115 of the ITAA 1997, a discount of 50% can be applied to a capital gain if a CGT event happens after 11:45am on 21 September 1999 and the CGT asset was acquired at least 12 months before the CGT event. In your case, you acquired the CGT asset (the right to seek compensation) when you commenced legal action and disposed of the right when you received the settlement amount over 12 months later. Consequently, you acquired the CGT asset at least 12 months prior to its disposal and are entitled to apply the 50% CGT discount to your capital gain.