Edited version of private ruling

Authorisation Number: 1011648403717

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Ruling

Subject: Legal expenses, compensation payment

1. Are you required to pay tax on the lump sum you received as a result of a personal injury claim for a workplace incident?

No.

2. Are you entitled to claim a deduction for the cost of the legal and Medicare expenses you incurred while seeking compensation for the personal injury sustained at your place of work?

No.

This ruling applies for the following period

1 July 2009 to 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You suffered a workplace injury.

After the accident you received Workcover payments from your employer for approximately seven months.

You sought compensation from Workcover for your personal injury.

You were awarded an undissected lump sum payment.

This amount was reduced by repayments to Workcover.

You paid legal fees in relation to the workplace injury.

There were costs for Medicare for benefits received in relation to the workplace injury.

You received the balance of the lump sum.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 6-5.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Assessable Income

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts. 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.

The lump sum you received was not earned by you as it does not relate to services performed. The payment is also a one off payment and thus it does not have an element of recurrence or regularity. Although the payment can be said to be expected, and perhaps relied upon, this expectation arises from the pain, suffering and medical treatment required resulting from the injury, rather than from a relationship to personal services performed.

Compensation receipts which substitute for income have been held by the courts to be income under ordinary concepts. Amounts received in respect of personal injury which is not for reimbursement of medical expenses, or direct compensation for loss of income will usually be capital in nature and are potentially taxable as statutory income under the capital gains tax provisions of the ITAA 1997. Medical expenses are private expenditure of the taxpayer. Therefore, reimbursement of this amount does not give rise to assessable income.

McLaurin v. Federal Commissioner of Taxation (1961) 104 CLR 381; (1961) 12 ATD 273; (1961) 8 AITR 180 raised the proposition that where a lump sum compensation payment can be dissected into its constituent income and capital components, the income may be assessable.

Where you receive an undissected lump sum which includes assessable and non-assessable components that cannot be identified or quantified, the whole of the lump sum amount is treated as a non-assessable receipt.

The undissected lump sum payment in satisfaction of your claim against Workcover for your personal injuries claim is not assessable. Therefore your legal and medical expenses are not deductible under section 8-1 of the ITAA 1997.

A capital gain made from a CGT event where the amount relates to compensation or damages received for any 'wrong, injury or illness you ... suffer personally' is disregarded.

Legal and Medical 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, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, in determining whether a deduction for legal expenses is allowable the nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses.

It has been previously determined that the payment you received was not assessable and the capital gain arising from the compensation amount would be disregarded.

As the legal expenses were incurred in gaining a capital sum which included medical expenses, they will also be of a capital or private nature and are therefore not deductible under section 8-1 of the ITAA 1997.