Edited version of private advice

Authorisation Number: 1052141977160

Date of advice: 27 July 2023

Ruling

Subject: Deduction - workcover

Question 1

Is the gross payment being the settlement sum received assessable income?

Answer

No.

Question 2

Is the payment received for retraining and finding alternative suitable employment in the future assessable income?

Answer

No.

Question 3

Is the payment received for accessing outplacement services to assist in finding future employment assessable income?

Answer

No.

Question 4

Are the legal fees paid deductible?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2022

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You were employed by Employer.

You sought legal advice in regard to a Workers Compensation claim for an injury that you suffered as a result of your employment with the Employer.

You lodged a Workers Compensation claim.

The Employer's Insurer rejected your claim for compensation pursuant to the Return to Work Act 2014

You filed an Application for Review disputing the rejection of your claim.

You resigned from your employment. A copy of your resignation letter was provided.

You considered your resignation was unrelated to the workers compensation dispute.

Your entitlements such as annual leave and long service leave were paid to you on upon termination of your employment.

A Release and Discharge Agreement (Agreement) was entered into between you and your Employer. Summary of key details:

Recitals

B. You submitted a claim for compensation asserting that you had suffered an injury, due to your employment.

C. Insurer for and on behalf of the Employer rejected your claim for compensation pursuant to the Return to Work Act 2014 (the Act). You filed an Application of Review disputing the rejection of his claim,in the relevant tribunal.

D. Employer denies that it has any liability to you.

E. The parties have agreed to settle the said complaint/claim and the differences between them on the terms of this Agreement.

1. Payments

1.1 Employer will pay to You a sum (settlement sum) less tax deducted at the appropriate rate, within fourteen days of it receiving a duly executed copy of this Agreement from you together with sealed orders filed at the tribunal in respect of your Application or Review.

1.2 Insurer will also pay a sum to assist you in retraining and finding alternative suitable employment in the future.

1.3 Insurer will pay you a sum to enable you to access services to assist you in finding future employment.

2. Release from claims

2.1 You acknowledge that Employer pays the settlement sum in full settlement of all claims against Employer from your employment with Employer and that the complaints described in Recitals B and C are settled with a denial of liability by Employer and solely to avoid further litigation. This Agreement must not be interpreted as an admission by Employer of liability to you for any matter.

2.2 You release absolutely and discharge Employer from all claims, actions, suits, causes of action, demands, liability, damages and costs arising in any way concerning or in the course of your employment with Employer or its cessation that you have now or may had in the future if the parties had not executed this Agreement.

2.3 Employer releases absolutely and discharges you from all claims, actions, suits, causes of action, demands, liability, damages and costs (whether at common law, at equity or, to the extent permitted, under any statute) arising in any way concerning or in the course of your employment with Employer or its cessation that you have now or may have had in the future if the parties had not executed this Agreement.

2.4 You and Insurer will execute consent orders to be filed at the tribunal to finalise your Application for Reviewand the terms of this agreement will not be effective until such time as the tribunal issues sealed orders.

2.5 You acknowledge that by reason of resignation, Employer is relieved of any obligation to offer suitable employment pursuant to the relevant Act.

The tribunal issued Consent Orders dated . The following orders were made:

1. The decision of the Respondent dated XX/XX/20XX rejecting the Applicant's claim for compensation in relation to an injury made pursuant to the Act is confirmed.

2. The Applicant is entitled to costs of the proceedings fixed at $X,XXX.XX inclusive of GST and reasonable disbursements, to be agreed or fixed by the Tribunal.

You engaged Lawyers in relation to the workers compensation matter and incurred legal fees.

You provided a copy of the itemised Tax Invoice. The invoice shows total invoice amount less representation costs and disbursements in the tribunal billed separately and to be paid by Insurers. Balance to be paid by you.

You will not seek to recover the costs from the other party.

You provided the Lawyers Trust account authority confirming you authorise and request Insurer/employer to pay any monies due to you by way of compensation pursuant to the Act, retraining expenses or any lump sum payment of arrears of income maintenance and interest to the Lawyer's Trust Account.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 15-30

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 118-37

Reasons for decision

Question 1, 2 and 3

Detailed reasoning

Section 6-5 and section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that assessable income of an Australian resident includes ordinary and statutory income (for example, capital gains) derived directly and indirectly from all sources, whether in or out of Australia during the income year.

Ordinary Income

Section 6-5 of the ITAA 1997 refers to ordinary income however does not provide specific guidance on the meaning of ordinary income. Instead, we utilise case law which exists and can identify the characteristics of ordinary income. Amounts that are periodic, regular or recurrent and relied upon by the recipient for their regular expenditure are likely to be ordinary income, as are amounts that are the product of any employment of, or services rendered by, the recipient. Further, amounts which compensate for lost income or serve as a substitute for other income are themselves income according to ordinary concepts.

Taxation Determination TD 93/58 Income tax: under what circumstances is the receipt of a lump sum compensation/settlement payment assessable? outlines the circumstances under which the receipt of a lump sum compensation/settlement payment is assessable as ordinary income. TD 93/58 states that a lump sum will constitute assessable income:

(a) if the payment is compensation for loss of income only e.g. past year profits, and/or interest (even when the basis of the calculation of the lump sum cannot be determined); or

(b) 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]

Statutory Income

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 (for example, capital gains) and are also included in assessable income.

Amounts received as a lump sum are generally capital in nature and are potentially taxable as statutory income under the capital gains tax (CGT) provisions of the ITAA 1997.

Part 3-1 of the ITAA 1997 contains the capital gains and capital loss provisions commonly referred to as the CGT provisions. You make a capital gain or capital loss if a CGT event happens in respect of a CGT asset.

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts discusses the capital gains tax implications for compensation receipts. Paragraph 70 of TR 95/35 provides that in determining the most relevant asset in respect of which the compensation has been received, it is often appropriate to adopt a 'look-through' approach to the transaction which generates the compensation receipt.

The 'look-through' approach is defined in paragraph 3 of TR 95/35 to be the process of identifying the most relevant asset. It requires an analysis of all the possible assets of the taxpayer to determine the asset to which the compensation amount is most directly related. It is also referred to as the underlying asset approach.

Section 104-25 of the ITAA 1997 provides that CGT event C2 happens on the ending of the right to seek compensation, that is, the right to take legal action.

If the capital proceeds from the CGT event (that is, the payment received) is more than the costs associated with that event, you will make a capital gain.

However, a capital gain or loss made upon the ending of a CGT asset acquired on or after 20 September 1985 is disregarded under subparagraph 118-37(1)(a)(i) of the ITAA 1997, if the CGT event is in relation to compensation or damages received for any wrong or injury you suffer in your occupation.

Example 16 of TR 95/35 (paragraphs 301 to 302) outlines an example where compensation received by an individual as part of a settlement for a wrong or injury suffered in their occupation is exempt from CGT:

Question 1 - Settlement Sum

You entered into an agreement to accept a payment in full settlement of any claims arising from your action for compensation for an injury.

From the information provided, it is considered that no part of the payment can be identified as being of an income nature. It does not appear the payment has been paid to you as compensation for lost salary and wages. We do not consider the payment is ordinary income. Therefore, the payment is not assessable under section 6-5 of the ITAA 1997.

In your case, the amount received is considered capital in nature and potentially taxable as statutory income under the CGT provisions of the ITAA 1997.

The relevant asset is the right to seek compensation for the personal injury. The settlement sum received is a payment for the ending of this right. Therefore, CGT event C2 happened on the signing of the Agreement and receiving the payment. The receipt of the settlement sum may give rise to a capital gain (statutory income).

We consider the settlement sum/compensation relates to a wrong or injury you have suffered in your occupation and any capital gain or loss is disregarded under subparagraph 118-37(1)(a)(i) of the ITAA 1997 and the payment will not be assessable as statutory income.

In summary, as the settlement sum payment or any portion thereof is not assessable as either ordinary or statutory income, you are not required to include the total amount in your assessable income on your tax return.

Question 2 - Retraining

You are in receipt of an amount paid for retraining expenses. This amount refers to a legislative responsibility of the employer to assist in the retraining of a worker. This amount is not ordinary or statutory income and not a compensation payment. This amount will not recur in the future and is a contribution towards a private expense. You are therefore not required to include the amount in your assessable income.

Question 3 - Accessing outplacement services

You are in receipt of an amount paid for accessing outplacement services. This amount also refers to a legislative responsibility of the employer to assist in the retraining of a worker. This amount is not ordinary or statutory income and not a compensation payment. This amount will not recur in the future and is a contribution towards a private expense. You are therefore not required to include the amounts in your assessable income.

Question 4 - Legal expenses

Detailed reasoning

Section 8-1 of 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.

Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income.

In determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, 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. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Legal expenses are generally deductible if they arise out of the day to day income earning activities (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).

Further, legal expenses are generally deductible by employees and former employees if they arise out of:

•         recovering unpaid wages, unused annual leave and unused long service leave in accordance with the principles contained in Taxation Determination TD 93/29 Income tax: if an employee incurs legal expenses recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 9-1 of the ITAA 1997

•         instituting proceedings and settling disputes arising out of employment agreements, such as to enforce a contractual entitlement

•         preventing redundancy or dismissal

•         defending the manner in which employment duties are performed.

In contrast, legal expenses incurred in seeking compensation for loss of employment, such as in an action for wrongful dismissal, are not deductible. It is irrelevant if any amount awarded to the employee is calculated by reference to unpaid salary or lost income. As outlined at paragraph 5 of TD 93/29, legal expense relating to an action for damages for wrongful dismissal are not deductible as the claim is of a capital nature.

If the advantage to be gained does not have an immediate connection to the duties undertaken to derive income and has more of an enduring and consequently capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

An amount paid to compensate for 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; (1952) 10 ATD 82). Lump sum damages awarded for a personal injury, wrong or illness suffered, which is not direct compensation for loss of income, will usually be capital in nature.

This principle is confirmed in Taxation Ruling TR 2012/8 Income tax and fringe benefits tax: assessability of amounts received to reimburse legal costs incurred in disputes concerning termination of employment. Paragraph 45 states:

Compensation for loss of employment, such as in an action for wrongful dismissal or loss of office, is a capital receipt (Scott v. Commissioner of Taxation). Legal costs incurred in seeking such compensation are not deductible because the nature of the advantage sought is capital. This is so, even if the amount of compensation awarded is calculated by reference to unpaid salary or lost income or is assessable as statutory income.

Application to your circumstances

You sought a claim for workers compensation from your Employer for an injury that you suffered as a result of your employment with the Employer. The claim was rejected by the Employer's Insurer for compensation pursuant to relevant legislation. You filed an Application for Review disputing the rejection of your claim. You and your Employer agreed to settle the complaint/claim on the terms of the Agreement. You engaged Lawyers in relation to the workers compensation matter and incurred legal fees.

As mentioned, the essential character of the advantage sought in undertaking the legal proceedings determines whether the legal expenses are on revenue or capital account. Based on the information provided the principal reason for incurring the legal expenses was for the purpose of obtaining compensation for a personal injury suffered in your employment.

The legal expenses are of a capital nature because the principal reason for incurring the expenses was for the purpose of obtaining compensation for an injury suffered in your employment. Compensation payments in respect of your personal injuries claim is of a capital nature. They were not incurred in seeking payment of an amount of ordinary assessable income.

Even if a capital payment is specifically brought to account as assessable income, this will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in assessable income.

As the nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses, the expenses you have incurred are considered to be of a capital nature and are not deductible. Accordingly, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses incurred in seeking compensation for a personal injury compensation.

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