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Ruling

Subject: Compensation payment and deductions

Question 1

Is your lump sum compensation payment assessable?

Answer

Yes

Question 2

Are the legal expenses associated with the recovery of your compensation lump sum deductible?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2012

The scheme commences on:

1 July 2011

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 made an out of court settlement with your former employer.

This payment represents a number of weeks of weekly payments at the current work capacity rate.

You incurred legal expenses to recover this payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Is your payment assessable?

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).

Ordinary income has generally been held to include 3 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.

Payment of salary and wages is income according to ordinary concepts and included as assessable income under section 6-5 of the ITAA 1997.

The courts have held that amounts paid to compensate for a loss generally acquire the character of that for which they are substituted. Therefore compensation payments which substitute for loss of earnings are also income under ordinary concepts (FC of T v. Inkster 89 ATC 5142, 20 ATR 1516; Tinkler v. FC of T (1979) 10 ATR 411; 79 ATC 4641).

The compensation payment you received represents a number of weeks weekly payments at the current work capacity rate. The lump sum payment is to replace salary and wage income and is income according to ordinary concepts.

Therefore, the lump sum payment you received is ordinary income and is therefore assessable under section 6-5 of the ITAA 1997.

Are your legal expenses deductible?

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.

To be deductible under this section an expense must have the essential character of an expense incurred in gaining or producing assessable income or, in other words, of an income-producing expense.

Legal expenses can be characterised as an outgoing of a revenue nature or an outgoing of a capital nature depending on the cause or purpose for which the legal expenses are incurred (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190).

The nature or character of the legal expenses follows the advantage that you seek to gain by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

The legal expenses that you incurred in order to obtain your compensation payment resulted in you gaining assessable income. There is a clear connection between the assessable income and the expense. The amount you received represents a number of weeks of salary and is therefore revenue in nature and not a capital receipt.

Accordingly, you incurred the legal expenses in gaining your assessable income and they are deductible under section 8-1 of the ITAA 1997.