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Ruling

Subject: Reimbursement of legal expenses

Question

Does a court ordered reimbursement of legal fees form part of your assessable income?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You took legal action against your former employer and incurred legal costs.

Your former employer was ordered to pay you legal costs.

Your former employer considered the payment to be an employment termination payment (ETP) and withheld tax which was remitted to the ATO.

You requested amendments to your tax returns to include deductions for legal expenses.

The ATO did not allow the deductions.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 20-20

Income Tax Assessment Act 1997 Subsection 20-20(2)

Income Tax Assessment Act 1997 Section 82-130

Reasons for decision

Summary

The court ordered reimbursement of legal fees does not form part of your assessable income as the payment is not considered to be ordinary income, an assessable recoupment or an employment termination payment (ETP).

Detailed reasoning

Reimbursement of legal costs as ordinary income

Subsection 6-5(2) of the Income Tax Assessment Act 1997 (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.

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.

In your case, you have not earned the reimbursement of your legal costs as it does not relate to services performed. The payment is a one-off payment and thus does not have an element of periodicity, recurrence or regularity.

Therefore, the reimbursement is not considered to be ordinary income and is not assessable under section 6-5(2) of the ITAA 1997.

Reimbursement of legal costs as an assessable recoupment

Section 6-10 of the ITAA 1997 provides that amounts that are not ordinary income but are included in assessable income by another provision, are called statutory income.

Assessable recoupments are a form of statutory income.

Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as a recoupment of a loss or outgoing is an assessable recoupment if:

· you received the amount by way of insurance or indemnity, and

· you can deduct an amount for the loss or outgoing for the current year, or you have deducted or can deduct an amount for it in an earlier income year, under any provision of this Act.

You previously applied to the ATO to have the legal expenses the reimbursement relates to included as deductions in your tax returns. The ATO did not allow the deductions.

As you have not deducted, nor are you entitled to deduct, the legal expenses the reimbursement of your legal expenses does not meet the requirements of subsection 20-20 of the ITAA 1997.

Therefore, the reimbursement is not considered to be an assessable recoupment and is not assessable under section 20-20 of the ITAA 1997.

Reimbursement of legal costs as an ETP

Statutory income includes ETPs which are governed by the provisions contained within Division 82 of the ITAA 1997.

Section 82-130 of the ITAA 1997 states a payment is an ETP if it is received by you in consequence of the termination of your employment.

Taxation Ruling TR 2003/13 explains the Commissioner's view of the meaning of 'in consequence' in relation to ETPs. In relation to settlement of litigation proceedings, the ruling states at paragraph 31:

It is clear from the decision in Le Grand [Le Grand v. Federal Commissioner of Taxation (2003) 51 ATR 139, 2002 ATC 4907], that when a payment is made to settle a claim brought by a taxpayer for wrongful dismissal or claims of a similar nature that arise as a result of an employer terminating the employment of a taxpayer, the payment will have a sufficient causal connection with the termination of the taxpayer's employment. The payment will be taken to have been made in consequence of the termination of employment because it would not have been made but for the termination.

Legal cost awards are paid to reimburse the expenses incurred in engaging in legal proceedings. Although an award for legal costs may be paid in relation to litigation concerning the termination of employment, an award for legal costs is not paid 'in consequence of termination' of employment.

The award of legal costs and the quantum of those costs are generally subject to the discretion of the Court. An award of costs is an action in itself rather than part of the underlying object of any proceeding. The award of particularised legal costs is to ensure the successful party is not out of pocket for their legal expenses as a result of being required to bring or defend an action.

In your case you were awarded legal costs relating to the legal action against your former employer. Whilst you received an ETP as a result of the original legal action, the award of legal costs is not considered to be in consequence of the termination of your employment.

Therefore, the reimbursement of your legal costs is not considered to be an ETP and does not form part of your assessable income.