Edited version of private ruling

Authorisation Number: 1011906488334

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Ruling

Subject: legal expenses and compensation

Question 1

Are you entitled to a deduction for your legal expenses incurred as a result of action taken against your employer?

Answer

Yes.

Question 2

Is the amount you received from your out of court settlement assessable income?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling,

· copy of the Deed of Release,

· copy of application alleging unlawful discrimination, and

· copy of trust statement, trust account receipt, solicitor's letter and pay advice.

You took legal action against your employer for sex discrimination. You claimed that your employer unjustly demoted you and refused you full time employment on your return from leave.

In your legal action you sought:

1) Financial compensation for loss of income as a result of being demoted, refusal of full time employment and loss of job status leading to no career progression;

2) An apology; and

3) Re-instatement of set shifts as per your employment agreement.

You and your employer agreed to settle out of court. Under the Deed of Release your employer agreed to pay you an amount with respect to your legal costs and an amount with respect to the damages you had claimed. Under the Deed of Release you and your employer also agreed to the hours you were to work.

The total amount was paid into your solicitor's trust account.

Your solicitor deducted their legal fees before transferring the balance into your account.

Your employer sent you a payslip with the settlement amount recorded as income (with no tax paid).

Every payslip since then has had the settlement amount added on as annual income.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.
Income Tax Assessment Act 1997 Section 6-5.
Income Tax Assessment Act 1997 Section 20-20.
Income Tax Assessment Act 1997 Section 20-30.
Income Tax Assessment Act 1997 Section 20-35.

Reasons for decision

Summary

Your legal expenses were incurred in order to obtain compensation for loss of income and also to resolve a dispute concerning your employment conditions. It is accepted that the legal expenses were incurred in earning your assessable income and they are therefore deductible.

The amount you were paid with respect to the damages you had claimed is compensation for loss of income and therefore considered to be assessable income. The amount you were paid with respect to your legal costs is a recoupment of an expense that is deductible. Consequently it is included in your assessable income as an assessable recoupment.

In summary, you are entitled to a deduction for your legal expenses and you are required to include the total settlement amount in your assessable income.

Detailed reasoning

Legal expenses

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. 

TR 2000/5 states that expenses incurred by an employee to settle a dispute with their current employer over their employment conditions are incurred in earning assessable income and therefore deductible.

In your case, the legal expenses were incurred in order to obtain compensation for loss of income and also to resolve a dispute concerning your employment conditions. Consequently, you are entitled to a deduction for your legal expenses.

Assessable Income

Section 6-5 of the ITAA 1997 provides that the assessable income of an Australian resident includes all ordinary income derived directly or indirectly from all sources.

Taxation Ruling IT 2424 deals with compensation payments in respect of unlawful acts of discrimination. It discusses compensation agreed upon by the parties under a settlement agreement. It states at paragraph 18 that:

Compensation paid to make up for salaries and allowances that would have been received but for the discriminatory conduct of the employer is considered income and liable to income tax in the year of receipt.

It further states:

Where there has been a denial of opportunities for training, transfer, rotation, etc, and this has resulted in the employee being passed over for promotion, compensation may be paid to make up for the additional income that might otherwise have been earned. A payment of this nature is considered to be income and is liable for tax.

In your case, under a settlement agreement your employer agreed to pay you an amount with respect to your legal costs and an amount with respect to the damages you had claimed.

The damages you had claimed was for loss of income as a result of being demoted, refusal of full time employment and loss of job status leading to no career progression. As per IT 2424, the amount you received with respect to the damages you had claimed is compensation for loss of income and therefore considered to be assessable income.

Under Subdivision 20A of the ITAA 1997 where a taxpayer receives an amount as a recoupment of a loss or outgoing and the taxpayer is entitled to a deduction for the loss or outgoing under section 8-1 of the ITAA 1997 then the amount is included in the taxpayer's assessable income as an assessable recoupment.

As you are is entitled to a deduction for your legal costs, the amount you received as a recoupment of some of those costs, is included in your assessable income.

In summary, the total amount you received as part of your settlement with your employer forms part of your assessable income and therefore must be included as income in your 2010-11 tax return.