Edited version of private ruling

Authorisation Number: 1011671909422

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Ruling

Subject: Legal expenses and lump sum in arrears tax offset

1. Are you entitled to a lump sum in arrears tax offset?

Yes.

2. Does section 59-30 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to your repaid Centrelink benefits?

No.

3. Are you entitled to claim a deduction for your legal expenses?

Yes.

This ruling applies for the following periods

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You suffered a medical condition as a result of your work and you engaged a lawyer to claim compensation through WorkCover.

Your lawyer was engaged on a 'no win no charge' agreement.

In 2010, your claim was finalised and you were awarded a lump sum payment.

You were also awarded an amount for interest on your claim which you received in the 2009-10 income year.

From the total amount awarded, a portion was used to repay both taxable and non taxable Centrelink benefits both you and your spouse had received while your claim was being assessed.

You received the balance of the lump sum covering a three year period.

Your employer issued a payment summary for the 2009-10 income year showing the net lump sum amount you received.

You were provided with a statement showing the total lump sum amount awarded accrued over three income years and the amount attributable to each year.

The amount of the lump sum payment you received is greater than 10% of your taxable income for the 2009-10 income year after deducting the amount of the eligible lump sum that accrued in earlier years.

You incurred legal costs in the 2009-10 income year in relation to your claim.

Reasons for decision

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the income year.

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) 10 ATD 82; (1952) 5 AITR 443; (1952) 10 ATD 82). Compensation payments that substitute for income have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; 89 ATC 5142; (1989) 20 ATR 1516). The payment retains the characteristics of ordinary income even though it is paid as a lump sum.

Income is assessable for income tax purposes, under subsection 6-5(4) of the ITAA 1997, when the person is taken to have derived it. The term derived is explained in the subsection to mean that the amount is derived when it is received or applied or dealt with in any way at the person's direction. In the case of interest or investment income, the general principle is that it is only derived, or arises, when it is received or credited.

In your case, you received a lump sum payment in the 2009-10 income year. The lump sum amount represented a back-payment of periodic WorkCover payments that substitute for income and interest on the back-payment amount. As this amount was received in the 2009-10 income year it is fully assessable in the 2009-10 income year. This is the case even though part of the payment relates to earlier income years.

Lump sum in arrears tax offset

Individual taxpayers, who receive certain assessable lump sum payments containing an amount that accrued in earlier income years, may be entitled to a lump sum in arrears tax offset under section 159ZRA of the Income Tax Assessment Act 1936 (ITAA 1936). The tax offset is intended to overcome the problem of the lump sum attracting more tax in the year of receipt than would have been payable if the payment had been taxed in each of the years in which it accrued.

To be eligible for the rebate, the amount of the eligible lump sum must not be less than 10% of the taxable income of the year of receipt after deducting the amount of the eligible lump sum that accrued in earlier years and other income. Other income includes, abnormal income, net capital gains, Eligible Termination Payments (ETPs) and lump sum payments on termination of employment in lieu of annual leave or long service leave.

In your case, the lump sum payment you received accrued in earlier income years and is greater than 10% of your taxable income, therefore, you are entitled to the lump sum in arrears tax offset.  

Repaid Centrelink payments

Section 59-30 of the ITAA 1997 provides that amounts that were previously treated as assessable income and that must be repaid are not assessable income.

In your case, you received a tax exempt pension from Centrelink in earlier income years while your claim was being assessed. As it was not treated as assessable income in the years it was received, section 59-30 of the ITAA 1997 does not apply to these payments.

You did receive a small assessable benefit from Centrelink in one of the income years.

Subsection 59-30(3) of the ITAA 1997 states that this section does not apply to an amount you must repay because you received a lump sum as compensation or damages for a wrong or injury suffered in your occupation.

In your case, the lump sum payment you received was as a result of an injury suffered in your occupation, and part of the amount you were award was used to repay the assessable benefit you received. Therefore, section 59-30 of the ITAA 1997 does not apply and the assess benefit remains assessable income in the income year it was received. However, as this was the only assessable income you received in this year no tax is payable on this amount as it is below the $6,000 tax free threshold.

Legal 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, 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 Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436, the Court established that in determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. Dixon J stated at CLR 647 that:

...legal expenses...take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or purposes of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.  

If the advantage to be gained is of a revenue nature then the expenses incurred in gaining the advantage will also be of a revenue nature.

In your case, you have incurred legal expenses in order to receive WorkCover payments accrued over three income years. The advantage sought in pursuing the WorkCover payments was of a revenue nature, therefore, the legal expenses you incurred are an allowable deduction under section 8-1 of the ITAA 1997.