Private ruling: Assessability of compensation payment and deductibility of legal expenses
Published: August 2017
Ruling period: Year ended 30 June 2016 | The scheme commences on | 1 July 2015

Ruling: Questions and answers: | Is the lump sum compensation payment that you received from Company XYZ for loss of future wages due to reputational damage incurred assessable as ordinary income? | Yes. | Is the lump sum compensation payment that you received from Company XYZ for loss of future wages due to reputational damage incurred a capital payment? | No. | Are you entitled to claim a deduction for legal expenses incurred as a result of the legal proceedings against Company XYZ? | Yes.

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: The application for private ruling; Originating Federal Court of Australia application F8C General Protections Application General Protections Application Involving Dismissal application Settlement Agreement Background By Key Events Private Ruling Application You commenced casual employment with Company XYZ, and shortly after, you commenced full-time employment with Company XYZ. After a number of years, a number of changes occurred in relation to employment conditions. During the preceding years you became concerned with the changes that were being made by your employer to your employment conditions. Shortly after, you engaged legal representation to commence legal proceedings against your employer. This lead to your employment with Company XYZ being terminated. During the subsequent years you, your legal representatives and your ex-employer engaged in a number of mediation and legal proceedings. After a number of years, a settlement agreement was executed between you and Company XYZ. Contained within your settlement agreement was the following: 2 Company XYZ Obligations As consideration for Mr X entering into and abiding by the terms of this agreement, Company XYZ will, within 7 days of receiving a properly executed copy of this Agreement and of the Deed Poll from Mr X, pay to Mr X a sum as compensation for loss of future remuneration as a result of reputational damage. You incurred total legal expenses as a result of the legal proceedings.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 6-5 | Income Tax Assessment Act 1936 Section 6-10 | Income Tax Assessment Act 1936 Section 8-1

Reasons for decision: Detailed Reasoning - Ordinary Income: Subsection 6-5(2) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Other characteristics of income that have evolved from case law include receipts that are earned, are expected, are relied upon, and have an element of periodicity, recurrence or regularity. For income tax purposes, an amount paid to compensate for a loss generally acquires the character of that for which it is substituted ( Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments which substitute income have been held by the courts to be income under ordinary concepts ( Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; (1989) 20 ATR 1516; 89 ATC 5142, Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641, and Case Y47 (1991) 22 ATR 3422; 91 ATC 433). On the other hand, if the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income. In your case, you engaged in legal proceedings to reach a resolution between you and your employer in relation to changes to your employment conditions. After protracted legal proceedings you were awarded a lump sum compensation for loss of future remuneration. As the compensation was paid to substitute you for the loss of future earnings it will assume the character of income according to ordinary concepts. Accordingly, the lump sum compensation payment that you received is income according to ordinary concepts, and therefore assessable under subsection 6-5(2) of the ITAA 1997. | Detailed Reasoning - Capital gains: Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income and are also included in assessable income. As it has been determined that the lump sum compensation payment that you received from Company XYZ is income according to ordinary concepts, the capital gains tax provisions do not apply. | Detailed Reasoning - Deduction - legal expenses: Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. Taxation Ruling TR 2000/5 Income tax and fringe benefits tax: costs incurred in preparing and administering employment agreements , discusses the Commissioners view of the application of section 8-1 of the ITAA 1997 to costs incurred by employees and employers in preparing and administering employment agreements. Paragraph 2 of TR 2000/5 states; 2. The following costs incurred by an employee are an allowable deduction: Costs of drawing up an employment agreement with an existing employer to replace an award or in accordance with a provision in the existing agreement; Costs associated with settlement of disputes arising out of an existing employment agreement including the cost of representation; Costs of changing the conditions of an existing employment agreement with the same employer - providing the existing agreement allows for changes - be it a variation, re-negotiation of an existing agreement or upon a promotion; and Costs of renewing or extending a fixed term agreement which has a provision allowing for renewal or an extension at the end of a term. In your case, while employed with Company XYZ a dispute occurred in relation changes to your employment conditions ultimately leading to your eventual dismissal. Over the subsequent years a protracted legal proceeding occurred resulting in you incurring legal expenses. Consistent with the principles established in TR 2005/5, as the expenses that have been incurred were associated with the settlement of your dispute arising out of when you were an existing employee they will be a an allowable deduction. Accordingly you are entitled to a deduction for the legal expenses that you have incurred in relation to your dispute with Company XYZ under section 8-1 of the ITAA 1997.