Edited version of private advice

Authorisation Number: 1052247530285

Date of advice: 9 May 2024

Ruling

Subject 1: Assessability of compensation payments

Question

Is the payment you received for income maintenance payments included in your assessable income?

Answer

Yes.

Subject 2

Deductibility of legal expenses

Question

Are you entitled to claim a deduction for a portion of the legal expenses you incurred?

Answer

Yes.

This ruling applies for the following period:

Income year ending XX XXXX 20XX

The scheme commenced on:

XX XXXX 20XX

Relevant facts and circumstances

You were employed by the Employer and during this time suffered various injuries, both physical and psychological, due to your employment.

In XXXX 20XX, you sought legal advice in relation to a worker's compensation claim.

In XXXX 20XX, a conference was held, at which the various injuries obtained were discussed and a compensation negotiated. The outcome was that it was accepted you had incurred a physical injury while working for the Employer.

On XX XXXX 20XX, the Tribunal issued Orders formalising the settlement with the Employer. The matter settled on the following basis:

•         $X lump sum compensation pursuant to section 58 of the Return to Work Act 2014 (SA) (RTW Act).

•         $X for income maintenance payments between XX XXXX 20XX and XX XXXX 20XX, pursuant to section 39 of the RTW Act.

•         $X for re-training allowance.

Your claim was accepted for income maintenance payments from XX XXXX 20XX and XX XXXX 20XX on the following basis:

•         Your average weekly earnings were $X gross per week.

•         You received $X gross per week between XX XXXX 20XX and XX XXXX 20XX (being 100% of your average weekly earnings for the first 52 weeks, a total of $X).

•         You received $X gross per week between XX XXXX 20XX and XX XXXX 20XX (being 80% of your average weekly earnings for the last 13 weeks, a total of $X).

•         You received total arrears of $X on XX XXXX 20XX.

No tax was withheld from any of the payments and no PAYG payment summary was issued.

You incurred legal fees of $X in relation to your worker's compensation matter. Your legal expenses were not itemised.

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 6-20

Income Tax Assessment Act 1997 section 8-1

Return to Work Act 2014 (SA) section 39

Return to Work Act 2014 (SA) section 58

Reasons for decision

Issue 1

Assessability of compensation payments

Question

Is the payment you received for income maintenance payments included in your assessable income?

Summary

The lump sum amount you received for income maintenance payments is assessable as ordinary income under section 6-5 of the ITAA 1997 in the income year in which it was received.

Detailed reasoning

Section 6-5 and section 6-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the 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.

The ITAA 1997 does not provide specific guidance on the meaning of ordinary income. However, a substantial body of case law exists which identifies its likely characteristics. Amounts that are periodic, regular or recurrent and relied upon by the recipient for their regular expenditure are likely to be ordinary income. So too 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.

A lump sum payment representing the payment of arrears of weekly payments is also regarded as assessable income. The fact that the payment is received in one lump sum does not change its revenue character.

Taxation Determination TD 2016/18 Income tax: is a redemption payment received by a worker under the Return to Work Act 2014 (SA) assessable income of the worker? states that a payment made under section 39 of the RTW Act is ordinary income of the worker and is therefore assessable under section 6-5 of the ITAA 1997 in the income year in which it is received.

Paragraph 23 of TD 2016/18 provides that these redemption payments are also considered to be income according to ordinary concepts, since they represent a recoupment, replacement or compensation for income that would otherwise be derived in the form of weekly payments.

Paragraph 24 of TD 2016/18 also provides that the character of a redemption payment of this kind was considered in Brackenreg and Federal Commissioner of Taxation [2003] AATA 824. There the taxpayer received weekly compensation payments from Comcare, which took into account her normal weekly earnings. Comcare's liability to make these payments was subsequently redeemed for a lump sum. The AAT found that the taxpayer's weekly compensation was income since it was in substitution for and was paid for loss of earnings; and the character of that compensation did not change upon being redeemed by the payment of a lump sum.

However, paragraph 3 of TD 2016/18 provides that in a series of private rulings, issued over several years, the Commissioner has accepted that amounts substantially similar to those covered by this Determination are not assessable for income tax purposes.

As such, paragraph 4 of TD 2016/18 provides that this determination only applies to redemption payments made under agreements entered into on or after 10 August 2016.

Application to your circumstances

In your case, you entered into your redemption settlement agreement after 10 August 2016. You accepted an offer from the Employer to receive a lump sum payment in arrears of $X for your entitlement to weekly maintenance payments pursuant to Section 39 of the RTW Act. As such, the principles outlined in TD 2016/18 will apply to your circumstances. The lump sum amount you received is assessable as ordinary income under section 6-5 of the ITAA 1997 in the income year in which it was received.

As the $X is assessable as ordinary income, there is no need to consider capital gains tax.

Issue 2

Deductibility of legal expenses

Question

Are you entitled to claim a deduction for a portion of the legal expenses you incurred?

Summary

The legal expenses you incurred taking legal action against your former employer to obtain compensation are partly deductible. There is no deduction for the expenses relating to the lump sum payment for injury and the retraining allowance because the advantage you sought is exempt income. However, you are entitled to a deduction for the legal expenses associated with obtaining the arrears of income maintenance payments because the advantage you sought is ordinary income.

An acceptable method to apportion your expenses is according to the dollar value of the assessable amount as compared to the total amount being sought. The relevant percentage that relates to your assessable income can then be applied to the legal expenses incurred.

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] HCA 72). 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 they arise out of the day to day income earning activities (Herald and Weekly Times Ltd v Federal Commissioner of Taxation [1932] HCA 48). In addition, the legal action must have more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v Federal Commissioner of Taxation [1980] FCA 150).

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] HCA 86). Lump sum damages awarded for a personal injury, wrong or illness suffered, which is direct compensation for loss of income, will usually be income 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 38 of TR 2012/8 states:

Legal costs take their quality 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.

Application to your circumstances

You claimed compensation from the Employer for an injury suffered during your employment. You also claimed compensation for arrears of weekly maintenance payments relating your employment. You agreed to settle your claim on the terms of an agreement approved by the Tribunal. The settlement included a lump sum for your injury and a retraining allowance in addition to the lump sum amount for the arrears of income maintenance payments.

You incurred legal expenses part of which related to obtaining the lump sum for your injury and the retraining allowance and part of which related to obtaining the arrears of income maintenance payments.

The lump sum payments for your injury and the retraining allowance are exempt income. There is no deduction for the legal fees incurred obtaining these because the advantage sought was exempt income. Section 8-1 of

ITAA 1997 specifically excludes deductions which relate to the earning of exempt income.

The lump sum amount you received for arrears of income maintenance payments is assessable as ordinary income. The nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses. As the advantage you sought in obtaining the arrears was to obtain assessable income, a deduction is allowable under section 8-1 of the ITAA 1997.

Apportionment of expenses

As your legal expenses are not fully deductible, you will need to apportion the expenses.

Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

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 8-1 of the Income Tax Assessment Act 1997? offers advice on apportionment of legal expenses, at paragraph 7:

If the solicitor's account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim.

As your legal expenses have not been itemised by your lawyer, you will need to calculate the deductible portion.

An acceptable method to apportion your expenses is according to the dollar value of the assessable amount as compared to the total amount being sought. The relevant percentage that relates to your assessable income can then be applied to the legal expenses incurred.

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