Private ruling: Assessability of your lump sum compensation payment
Date of advice: 10 November 2016
Published: March 2017
Ruling period: Year ending 30 June 20YY
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are you entitled to claim a deduction for the portion of your legal expenses which relate to obtaining Compensation weekly payments that was originally denied? | A1: Yes. | Q2: If you receive a payment from your former employer towards your legal fees, will this amount form part of your assessable income? | A2: Yes in part.

Relevant facts and circumstances: You were involved in a workplace incident. You applied for Compensation and this claim was denied. You obtained legal representation. You applied for Compensation a second time and this claim was accepted. You now receive weekly Compensation payments which are continuing. You and your employer have entered into a deed of settlement and release where your employer will pay you a lump sum compensation payment for out of pocket expenses such as legal fees on the basis that you are to resign from your employment and give up your right to seek further legal action. Your lump sum compensation payment is not a part of redemption agreement or payment for medical expenses. The legal expenses you have incurred are less than the lump sum compensation amount you are being offered, as per letter from your legal representative.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 20-20

Reasons for decision: Summary: Legal expenses deductibility In determining whether a deduction for legal expenses is allowed, the nature of the expenditure must be considered ( Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. Legal expenses are generally deductible if the legal action has a peripheral connection to the taxpayer's income producing activities ( Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542). Therefore to determine whether you are entitled to a deduction for legal expenses incurred, it is first necessary to determine whether the advantage sought is included in assessable income. In your case, the Compensation payments you receive for income maintenance takes the character of that which they replace. That is, as the payments replace income amounts, they are also considered to be assessable income. Therefore, the legal expenses incurred by you in order to obtain the Compensation payments resulted in you gaining assessable income. Consequently there is a clear connection between the assessable income and the expenses. Therefore, you are entitled to a deduction for the legal expenses incurred in obtaining this income under section 8-1 of the ITAA 1997. Additionally your legal representative advised that your lump sum compensation payment will total more than the legal fees you will incur. Therefore a portion of the legal expenses will relate to obtaining assessable income from Compensation, which is deductable as advised above, and the remaining portion will relate to obtaining a capital amount outside the recoupment of your legal fees which is not deductable. Therefore, the legal expenses must be apportioned as they were incurred for payments that are both capital and revenue in nature. Assessable recoupment Taxation Ruling TR 2012/8 discusses the assessability of amounts received to reimburse legal costs. Legal costs take their character as an outgoing of capital or revenue nature from the cause or purpose of incurring the expenditure. If the advantage to be gained is of a revenue nature, then the costs incurred in gaining the advantage will also be of a revenue nature. Subsection 20-20(2) of the ITAA 1997 provides that an amount you receive as a recoupment of a loss of outgoing is an assessable recoupment if: ● you receive the amount by way of insurance or indemnity, and ● you can deduct an amount for the loss or outgoing for the year in which the reimbursed legal costs were received, or you have deducted or can deduct an amount for it in an earlier income year, under any provision of this Act. If an amount is recouped by way of settlement of a claim for legal costs, it will be an assessable recoupment under subsection 20-20(2) of the ITAA 1997 where the purpose of the settlement is to indemnify the recipient for professional legal costs actually incurred in the conduct of the litigation, where the legal costs were deductible. As discussed above, your legal fees are deductible. Therefore the recoupment of your legal expenses is considered as an assessable recoupment under subsection 20-20(2) of the ITAA 1997 as assessable income. Calculation of assessable recoupment The lump sum compensation payment will total more than the legal expenses you have incurred. Thus, you will need to apportion your assessable recoupment to be the same amount as your legal expenses. If the total legal expenses are equal to or more than an amount then the same amount is declared as an assessable recoupment.