Edited version of your written advice

Authorisation Number: 1051381246358

Date of advice: 4 June 2018

Ruling

Subject: Settlement sum – unfair dismissal – motor vehicle accident claim

Question 1

Are you entitled to a deduction for legal expenses incurred in an unfair dismissal claim against your former employer?

Answer

Yes

Question 2

Is the lump sum compensation payment on your motor accident claim assessable?

Answer 2

No

This ruling applies for the following periods:

Year ended 30 June 20xx

Year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Unfair Dismissal

You made an application to Fair Work Australia for a remedy alleging unfair dismissal against your former employer.

Your employer denied the allegation.

You agreed to fully and finally settle the matter in consideration of a payment for lost pay.

In this proceeding, you engaged legal practitioners to assist you in taking the matter to the Fair Work Commission.

You incurred legal expenses in this matter.

You have provided a copy of the invoice from your solicitor to an amount of $x which covers professional fees and disbursements.

Motor vehicle accident

You were involved in a motor vehicle accident while on work duties.

A bus operated by X hit your car and you sustained injuries as a result of the accident.

You initiated a motor accident claim against X in the Court.

You were advised to accept a highly compromised out of court settlement by your legal representatives.

You have agreed to a settlement amount of $x inclusive of costs and disbursements.

The insurer for X paid the amount to your trust account and the law firm disbursed the compensation payment as follows:

● Legal fees, costs and disbursements $x

● Settlement monies to claimant $x

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 paragraph 118-37(1)

Reasons for decision

Unfair Dismissal

Section 8-1 of the Income Tax Assessment Act 1997 (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.

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.

Generally, legal expenses incurred in an unfair dismissal action (seeking reinstatement and/or damages) are of a capital nature and therefore, not deductible.

Paragraph five of Taxation Determination TD93/29 states:

If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the 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 your case, you incurred expenses in taking legal action against your employer for unfair dismissal. The advantage that you sought in undertaking these proceeding was compensation for lost wages and compulsory superannuation payments. As all these items are revenue items, the legal expenses incurred in pursuit of these items are deductible expenses.

Accordingly, you are entitled to a deduction for the legal expenses that you have incurred under section 8-1 of the ITAA 1997.

Motor Accident Claim

Compensation payments resulting from injury can represent a disposal of an asset for CGT purposes, being your right to sue. The disposal of an asset gives rise to a CGT event (section 104-35 of the ITAA 1997). However, payments or receipts where the amount relates to compensation or damages a taxpayer receives for personal wrong, injury or illness are disregarded for CGT purposes because of paragraph 118-37(1)(a)(ii) of the ITAA 1997.

Taxation Ruling TR 95/35 is about capital gains and the treatment of compensation receipts. In having regard to sections 104-25 and 118-37 of the ITAA 1997, paragraphs 18 to 20 of TR 95/35 state:

If the amount of compensation received is an undissected lump sum, the whole amount is treated as being consideration received for the disposal of the right to seek compensation.

Compensation received by an individual for any wrong or injury suffered to his or her person or in his or her profession or vocation is exempt from CGT…

Exemption…is available if the taxpayer receives compensation in an undissected lump sum which relates wholly to the personal wrong or injury suffered by the taxpayer.

In your case, the compensation payment you received relates wholly to the right to seek compensation for the injuries you sustained in a motor vehicle accident. The settlement sum of is exempt from capital gains tax under subsection 118-37(1) of the ITAA 1997.

Therefore, no part of the compensation amount is required to be included in your income tax return.

As the settlement money is not assessable income, you are not entitled to claim for the legal expenses you incurred against your assessable income for financial year ended x.

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