Edited version of your private ruling

Authorisation Number: 1012608041367

Ruling

Subject: Settlement payment - breach of contract

Question 1:

Are the monies you received from a settlement payment as a result of breach of contract taxable as assessable as income according to ordinary concepts

Answer:

No.

Question 2:

Are the monies you received from a settlement payment as a result of breach of contract taxable under the capital gains tax (CGT) legislation?

Answer:

Yes.

Question 3:

Are the legal fees you incurred included in the cost base?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2013.

The scheme commences on

1 July 2012.

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 were employed by company A.

Your employment agreement with company A contained provisions which prevented you from engaging in certain conduct for a period after the cessation of employment with company A (restrictive convenants).

During a specified period you entered into discussions with company B regarding the possibility of you taking up employment with them.

You did not advise company B of the existence of the restrictive convenants.

On or about a specified date you ceased employment with company A in order to take up employment with company B.

On or about a month later company A became aware of the restrictive convenants.

A couple of days later, company A informed you that it no longer intended to employ you.

On a specified date, you made certain allegations against company B including threatening to bring proceedings against them under the Australian Competition and Consumer Act 2010.

Without admission or concession, you and company B have agreed to settle all issues.

Approximately 18 months ago you signed a Deed of Release.

Under the Deed of Release you would receive a specified amount being a number of month's base salary.

No tax was taken from this payment.

Company B directed a specified amount to your barrister/solicitor to cover your legal fees.

You received the balance.

You have provided copies of the following documentation to support your application and this documentation is to be read with and forms part of your application of the purposes of this ruling:

• Deed of Release

• Settlement Description, and

• Tax Invoice from legal representative.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 104-25.

Income Tax Assessment Act 1997 Section 110-25.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Ordinary income

Assessable income of a taxpayer who is a resident of Australia for taxation purposes includes the ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

The courts have identified a number of factors which indicate whether an amount has the character of income according to ordinary concepts.

A frequent characteristic of income receipts is an element of periodicity, recurrence or regularity (Gorton v FC of T (2008) ATC 10-018).

One or more of the following characteristics will combine with periodicity to give an amount an income nature: 

• it is made in substitution of income

• it is made to provide financial support, for example, as an income supplement, or

• it is received in circumstances where the recipient has an expectation of receiving the payment on a regular basis so that the recipient is able to depend upon the payment for his or her regular expenditure.

In your case, you never commenced employment with company B and the amount you received was compensation you for the cancellation of your employment contract with them.

Therefore, the monies you received are not included in your assessable income under the ordinary income concepts, they are of a capital nature and CGT provisions will apply.

CGT

Taxation Ruling TR 95/35 deals with the tax treatment of compensation receipts. A CGT asset in which compensation may be received may include an underlying asset, right to seek compensation or a notional asset. A CGT asset includes legal and equitable rights that are not property.

Where there is no relevant underlying asset, as in your case, your CGT asset is your right to seek compensation.

A right is acquired at the time of its creation, which is the right to seek compensation is acquired at the time of the compensable wrong or injury and includes all of the rights arising during the process of pursuing the compensation claim. The time of acquisition of your right was June 2012, when company B informed you that it no longer intended to employ you.

CGT event C2 happens when the ownership of an intangible CGT asset ends by the asset being satisfied or surrendered. The C2 event occurred on the date you entered into the Deed of Release with company B.

You will make a capital gain if the capital proceeds from the ending of your right to seek compensation is more than the cost base of the asset.

The capital proceeds from the CGT event is the total of the money you received in respect of the event happening. Your capital proceeds will be the amount of compensation you received.

The cost base of an asset is made up of five elements:

1. money or property given for the asset

2. incidental cost of acquiring the CGT asset or of the CGT event

3. costs of owning the asset

4. capital costs to increase or preserve the value of your asset or to install or move it, and

5. capital costs of preserving or defending your ownership of or rights to your asset.

Taxation Ruling TR 95/35 provides guidance on the calculation of the cost base of the right to seek compensation. Generally the cost base is its acquisition costs plus any incidental costs.

In your situation, the first element of your cost base is nil, your incidental costs will include legal fees and charges connected with the proceedings and incurred during the course of proceedings. .

As you have held the asset for less than 12 months you will use the 'other' method to calculate your capital gain. You simply subtract your cost base from your capital proceeds. The amount of proceeds left is your capital gain.

Further information is available on our website - www.ato.gov.au.