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Ruling
Subject: Compensation payment
Question
Is the compensation payment you will receive, considered assessable income?
Answer
No.
This ruling applies for the following period:
Year ending 30 June 2013
The scheme commences on:
1 July 2012
Relevant facts and circumstances
Your employment was terminated.
You made a claim against your former employer.
Without admission of liability, both parties agreed to settle all issues between them.
Your employer has agreed to pay you a settlement being compensation for legal expenses and hurt feelings.
This compensation payment does not include wages.
A copy of the Deed of Settlement has been provided.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 82-130
Income Tax Assessment Act 1997 Paragraph 118-37(1)(b)
Reasons for decision
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.
Other characteristics of income that have evolved from case law include receipts that:
· are earned
· are expected
· are relied upon, and
· have an element of periodicity, recurrence or regularity.
You sought damages for a breach of contract and came to an agreement under a Deed of settlement and release to receive a lump sum compensation payment for legal expenses incurred and hurt feelings.
The payment 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 does not arise from a relationship to personal services performed.
Paragraph five of the Taxation Determination TD 93/29 states:
If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the contract of employment, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible.
The legal expenses that you incurred are considered capital in nature. It therefore follows that the payment for legal expenses included in your lump sum compensation payment is also capital.
Paragraph 8 of Taxation Ruling IT 2424 states that compensation payments in respect of unlawful acts of discrimination for personal injury, injury to feelings, humiliation, embarrassment, depression and anxiety, are payments of a capital nature. Therefore, the payment for hurt feelings included in your lump sum compensation payment is capital in nature.
Accordingly, the lump sum payment for legal expenses and hurt feelings is not ordinary income and is therefore not assessable under section 6-5 of the ITAA 1997.
Paragraph 118-37(1)(b) of the ITAA 1997 disregards 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'. Therefore, any CGT implications with regards to the payment you will receive will be disregarded.
Taxation Ruling IT 2424 states that a payment received as compensation for unlawful dismissal is taxable as an eligible termination payment (now called an employment termination payment). The payment you will receive will be compensation for legal expenses and hurt feelings rather than for unlawful dismissal. Therefore, the payment will not be an employment termination payment.
In summary, the payment will not assessable for tax as either ordinary income, a capital gain or an employment termination payment.