Private ruling: Subject
Published: May 2012
Ruling period: For the year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Is the payment made under a Deed of Release (the Deed) in relation to the termination of employment in an earlier year of income considered to be a transitional termination payment as defined in section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (IT(TP)A)? Are the legal fees allowable as a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? Advice/Answers No. No.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 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 Subsection 82-130(2). | Income Tax Assessment Act 1997 Paragraph 82-130(4)(a). | Income Tax Assessment Act 1997 Subsection 82-130(5). | Income Tax Assessment Act 1997 Subsection 82-130(7). | Income Tax Assessment Act 1997 Section 82-135. | Income Tax Assessment Act 1997 Section 83-295. | Income tax (Transitional Provisions) Act 1997 Section 82-10. | Income tax (Transitional Provisions) Act 1997 Subsection 82-10(1). | Income tax (Transitional Provisions) Act 1997 Subsection 82-10(2). | Income tax (Transitional Provisions) Act 1997 Subsection 82-10(3). | Income tax (Transitional Provisions) Act 1997 Subsection 82-10(4). | Income tax (Transitional Provisions) Act 1997 Subsection 82-10(5). | Income tax (Transitional Provisions) Act 1997 Subsection 82-10(6).

Reasons for decision: Summary: The payment made to your client during the 2010-11 income year is an employment termination payment (ETP). The payment does not meet the requirements to be a transitional termination payment. The ETP was not a payment received by your client because your client was entitled to it under a written contract, a law, an instrument under a law, a collective agreement or an Australian workplace agreement (AWA) as in force just before 10 May 2006, it is made under a Deed of Release. The legal fees which were incurred by your client are an outgoing of a capital nature and therefore not allowable as a deduction. | Detailed Reasoning - Employment termination payment: A payment made to an employee on or after 1 July 2007 is an ETP if the payment satisfies all the requirements in section 82-130 of the Income Tax Assessment Act 1997 (ITAA 1997) and is not specifically excluded under section 82-135. Subsection 82-130(1) of the ITAA 1997 states: A payment is an employment termination payment if: (a) it is received by you: (i) in consequence of the termination of your employment; or (ii) after another person's death, in consequence of the termination of the other person's employment; and (b) it is received no later than 12 months after the termination (but see subsection (4)); and (c) it is not a payment mentioned in section 82-135. Subsection 82-130(2) of the ITAA 1997 states: A life benefit termination payment is an employment termination payment to which subparagraph (1)(a)(i) applies. Based on the information provided, it is evident the payment was made in consequence of the termination of your client's employment with Company 1. Thus, subparagraph 82-130(1)(a)(i) of the ITAA 1997 has been satisfied. Of particular importance is the requirement in paragraph 82-130(1)(b) of the ITAA 1997; that is, the ETP must be received within 12 months subsequent to the termination of employment. The 12 month rule To qualify as an ETP, the payment must be received no later than 12 months after the termination of the taxpayer's employment (paragraph 82-130(1)(b) of the ITAA 1997). Payments received more than 12 months after the termination of the employment do not qualify as ETPs and will be taxed as ordinary income at marginal tax rates under the terms of section 83-295. However, by virtue of paragraph 82-130(4)(a) of the ITAA 1997, the 12 month rule prescribed in paragraph 82-130(1)(b), will not apply to a taxpayer if they are covered by a determination made by the Commissioner under either subsection 82-130(5) or subsection 82-130(7). Determination made by the Commissioner The Employment Termination Payments (12 months rule) Determination 2007 (SPR 2007/1) is a legislative instrument made by the Commissioner of Taxation pursuant to subsection 82-130(7) of the ITAA 1997. This instrument applies to ETPs received after 30 June 2007. This instrument makes a payment received more than 12 months after termination of a person's employment an ETP, if the delay in the payment was due to the commencement of legal action concerning either or both: (a) the person's entitlement to the payment; (b) the amount of the person's entitlement; and the legal action was commenced within 12 months of the termination of employment. According to SPR 2007/1, legal action is intended to cover any Court, Tribunal, and other procedures of a judicial or quasi-judicial nature which may result in the payment in consequence of the termination of a person's employment. In this case your client's employment ceased in early 2009. Your client's legal action/proceedings in relation to your client's payment commenced in the first quarter of the 2009-10 income year. In the 2010-11 income year, the payment was made to your client under a Deed of Release (the Deed) in settlement of a Federal Court matter concerning the termination of your client's employment. Accordingly, your client's legal action was commenced within 12 months of your client's termination of employment. Having regard to all of the above, the Commissioner has determined that the delay in payment in this case is reasonable given that it arose as a result of a legal dispute over the entitlement. Accordingly, the Commissioner's discretion under subsection 82-130(7) of the ITAA 1997 has been allowed, meaning that paragraph 82-130(1)(b) has no application in relation to the payment in question. Section 82-135 of the ITAA 1997 specifically excludes certain payments from being ETPs. These payments include any accrued annual and long service leave and the tax-free parts of a genuine redundancy payment or an early retirement scheme payment as well as other types of payments which do not apply to an employment termination payment. As stated in the facts of this case, the payment was made after your client's termination of employment and commencing legal action in a Federal Court. Accordingly, the amount is to be treated as an ETP under subsection 82-130(1) of the ITAA 1997. | Detailed Reasoning - Transitional termination payment: Some employment termination payments made between 1 July 2007 and 30 June 2012 are subject to transitional arrangements. To qualify as a transitional termination payment, the payment must be a life benefit termination payment (as defined in subsection 82-130(2) of the ITAA 1997) that meets the requirements of section 82-10 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA). Section 82-10 of the ITTPA states: (1) This Division applies in relation to a life benefit termination payment received by you on or after 1 July 2007 if: (a) the payment is received by you because you are entitled to it under a written contract, a law of the Commonwealth, a State, a Territory or another country, an instrument under such a law, a collective agreement within the meaning of the Fair Work (Transitional Provisions and Consequential Amendments) Act 2009 or an AWA within the meaning of that Act; and (b) the entitlement is provided for under that contract, law, instrument or agreement as in force just before 10 May 2006. (2) However, this Division does not apply in relation to a life benefit termination payment received by you on or after 1 July 2012 (except to the extent provided by Subdivision 82 - E. (3) This Division applies in relation to a life benefit termination payment only to the extent that the contract, law or agreement as in force just before 10 May 2006 specifies the amount of the payment, or a way to work out a specific amount of the payment. (4) For the purpose of subsection (3), a specific amount can be worked out in ways including either or both of the following: (a) by a method or formula for working out the amount; (b) by provision for you or another person (or entity) to make a choice between forms of payment allowing amounts to be worked out as provided by subsection (3) and paragraph (a) of this subsection. Example : For paragraph (b), a specific amount of a life benefit termination payment that you receive on 1 July 2007 can be worked out from the terms of your written contract if the contract provided (just before 10 May 2006) for you to choose between payment in the form of a cash amount of $100,000 or the transfer to you of 10,000 shares in a specified company. (5) To the extent that this Division applies to a life benefit termination payment, Subdivision 82-A of the Income Tax Assessment Act 1997 does not apply to the payment (subject to Subdivision 82-E of this Act). (6) In this Division: transitional termination payment means: (a) a life benefit termination payment to which this Division applies; or (b) if this Division applies to only part of a life benefit termination payment - that part of the payment. On the basis of the information provided the ETP was made to your client to settle all claims under the terms set out in the Deed. Under the terms of the Deed the payment was made in respect of your client's claims concerning payments made on your client's termination of employment due to redundancy. However, the Deed refers to the entire agreement and at a specified clause stated that the Deed contains the entire agreement between the parties with respect to its subject matter. It sets out the only conduct relied on by the parties and, to the full extent permissible by law, supersedes all earlier conduct made by or existing between the parties with respect to its subject matter. Therefore, it cannot be said that the payment made to your client was received because of your client's entitlement to it under a written contract, a law, an instrument under a law, a collective agreement or an Australian workplace agreement (AWA) as in force just before 10 May 2006 as required under subsection 82-10(1) of the ITTPA. Hence, as the payment was not made under a contract, law, instrument or an agreement in force just before 10 May 2006, it is not a transitional termination payment. Accordingly the payment does not meet the requirements of section 82-10 of the ITPPA to be a transitional termination payment. Consequently, the payment made to your client in the 2010-11 income year is not transitional termination payment. Deductibility of Legal Expenses In order to determine the deductibility of your client's legal expenses, it is necessary to examine the relevant provisions of the ITAA 1997. The deductibility of legal expenses is governed by the general deduction provisions of section 8-1 of the ITAA 1997. It states: (1) You can deduct from your assessable income any loss or outgoing 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. (2) However, you can not deduct a loss or outgoing under this section 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 (d) a provision of this Act prevents you from deducting it. (3) A loss or outgoing that you can deduct under this section is called a general deduction. Therefore, in summary the legal expenses your client has may be allowable if they can be shown to have been necessarily incurred in gaining or producing assessable income and are not a loss or outgoing of a capital nature. Justice Dixon made the following comment in Hallstroms Pty Ltd v. Commissioner of Taxation (Cth) (1946) 20 ALJ 277; [1946] ALR 434; (1946) 8 ATD 190; (1946) 72 CLR 634 ( Hallstroms Case ): The claim is to deduct legal expenses, and legal expenses, we may assume, take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them. In Hallstroms case , the object of the legal expenses was to obtain a compensation payment for wrongful termination of employment. Justice Dixon determined that because the compensation received was a capital sum, the legal expenses incurred were also of a capital nature. For that reason they were excluded from being deductible under subsection 51(1) of the ITAA 1936, the predecessor of section 8-1 of the ITAA 1997. Taxation Determination TD 93/29 (TD 93/29) confirms the above by stating the following: However, if the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of contract of employment, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible. In accordance with the precedent set by Justice Dixon in the Hallstroms case and TD 93/29, legal expenses which were incurred by your client are considered to be capital in nature and as such, are excluded from being deductible in accordance with section 8-1 of the ITAA 1997.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Relevant facts: In the 2005-06 income year, your client commenced employment with a company (Company 1). | Under the terms and conditions of your client's employment your client's salary is expressed as Total Employment Cost (TEC). | In the 2007-08 income year, Company 1 and another company (Company 2) jointly announced that they had signed an agreement for a proposed merger of the two companies. | In a letter dated early 2009, your client was advised by the Chief Executive of Company 1 that your client's position had been made redundant and therefore your client's employment would be terminated effective from the close of business that day. | The letter stated that your client's severance benefit, calculated in terms of Company 1's redundancy policy (the Policy), plus your client's leave entitlements were provided in the redundancy calculation spreadsheet. The redundancy calculation spreadsheet shows your client's TEC amount. | The calculation redundancy spreadsheet for your client included a specified number of weeks redundancy pay and a specified number of weeks notice pay. | Company 1 made a PAYG payment summary - employment termination payment to your client for the year ending 30 June 2009. The payment summary shows a taxable component with an amount of tax withheld. | An income tax return was lodged for your client for the 2008-09 income year where the employment termination payment was assessed as a transitional termination payment. | Company 1's Policy provided that if your client's position was made redundant your client would receive, in addition to the notice, a specified number of weeks redundancy payment for specified number of years service. | Your client disagreed with the amount calculated regarding your client's redundancy entitlements made on the termination of employment. | In the first quarter of the 2009-10 income year, a Statement of Claim was received in a Federal Court of Australia, in a State District Registry, to commence proceedings against Company 1. | In the claims it was alleged that your client's total remuneration, being a fixed salary plus the previous year's bonus, should have been the basis of the redundancy payment. | Discussions were held between both parties. Company 1 denied the allegations and claims made by your client as stated in the proceedings. | In a Deed of Release (the Deed) Company 2 and your client agreed to settle all claims on the terms set out in the Deed. | In the Deed it stated that at a specified date, a total transfer of the business of Company 1 was effected and that Company 2 became the successor in law to Company 1 and all assets and liabilities of Company 1 became the assets and liabilities of Company 2. | The Deed also stated that a payment to your client within a specified number of days of the making of the consent orders by the specified court, that Company 2 will make an eligible termination payment to your client less applicable taxes in respect of your client's claims concerning payments made on your client's redundancy. Under the Deed, your client releases Company 2 and their related bodies corporate from any claim arising from or connected with the employment, the termination of employment, the proceedings, the circumstances or allegations referred to in the proceedings or any claim which could reasonable have been known to your client as at the date of the Deed. | Furthermore, with reference to a specified paragraph in the Statement of Claim, Company 1 admits they had an obligation to pay your client in accordance with the Policy. | A PAYG payment summary - employment termination payment for the year ending 30 June 2011, made by Company 2 to your client, shows a taxable component with an amount of tax withheld. The payment made in the 2010-11 income year, indicates it is related to a prior payment for the same termination and indicates that the payment is not a transitional termination payment. | Your client is under the age of 55 years.