Edited version of private advice

Authorisation Number: 1012688726909

Ruling

Subject: Ex-gratia payment and legal expenses

Question 1

Is the ex-gratia payment you received assessable as ordinary or statutory income under either section 6-5 or 15-2 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is any part of the payment ex-gratia payment under a deed of release an employment termination payment (ETP) under section 82-130 of the ITAA 1997?

Answer

No.

Question 3

Are the legal expenses you incurred in seeking the ex-gratia payment deductible under section 8-1 of the ITAA 1997?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

You have been employed with the same employer for a large number of years.

You received a letter from your employer advising you that your employment was to be terminated because your position was abolished and you had not been redeployed to a new position.

Your employer invited you to make a submission in writing in relation to the proposal to terminate your employment.

You commenced legal proceedings in the Federal Circuit Court.

You incurred legal expenses

You signed a Deed of Release in which you received an ex-gratia payment.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Subsection 6-10(2)

Income Tax Assessment Act 1997 Subsection 82-130(1)

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

The ex-gratia payment you received is not an ETP and is not assessable under any other provision.

Your legal expenses are considered to be incurred to provide an enduring advantage and are not deductible.

Ex-gratia payment

The assessable income of an Australian resident includes ordinary income and statutory income derived directly or indirectly from all sources, in or out of Australia, during the income year (subsection 6-5(2) and subsection 6-10(2) of the ITAA 1997).

Ordinary income is not clearly defined in the legislation and therefore the courts have identified a number of factors that indicate whether an amount has the character of income according to ordinary concepts.

It has been determined that a frequent characteristic of income receipts is an element of periodicity, recurrence or regularity (Federal Commissioner of Taxation v. Dixon (1952) CLR 540; (1952) 10 ATD 82). Other characteristics of income that have evolved from case law also include receipts that:

• are earned

• are expected, and

• are relied upon.

Statutory income is not ordinary income but is included in assessable income by a specific provision in the tax legislation (subsection 6-10(2) of the ITAA 1997). 

Subsection 82-130(1) of the ITAA 1997 states that:

A payment is an employment termination payment if:

(a) it is received by you:

(i) in consequence of the termination of your employment; or

(ii) after another person's death, in consequence of the termination of the other person's employment; and

(b) it is received no later than 12 months after that termination (but see subsection (4)); and

(c) it is not a payment mentioned in section 82-135.

The payment made to you under a Deed of Release is not an ETP as the payment was not made in consequence of termination of your employment.

Legal expenses

Section 8-1 of the ITAA 1997 allows a deduction for a loss or outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature or relates to the earning of exempt income.

In determining whether a deduction for legal expenses is allowed, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage that is sought to be gained 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.

Taxation Determination TD 93/29 Income tax: if an employee incurs legal expenses recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997? 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 where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible. For example, legal expense relating to an action for damages for wrongful dismissal are not deductible.

The Courts, Boards and Tribunals have consistently held that the legal expenses incurred by taxpayers in defending themselves against dismissal from their employment are of a capital nature unless they are defending the way they carry out their day to day employment duties. This is because:

• the legal expenses can be regarded as having been incurred once and for all, and

• the advantage sought to be gained is the preservation of the taxpayers employment.

In Commissioner of Taxation v Shane Day [2008] HCA 53 (Days Case) the concern was with the deductibility of legal expenses incurred by a public servant in defending charges in respect of conduct which occurred outside the course of taxpayer's normal day-to-day duties.

In your case, the legal expenses do not relate to actually doing your day-to-day duties. Rather, your expenses relate to preserving your employment. Therefore, Days Case does not apply in your circumstances.

In your situation, you incurred legal expenses challenging the basis for the proposed termination of your employment. Such expenses are not deductible as they are considered to provide an enduring advantage and are consequently capital in nature. Therefore, you are not entitled to a deduction for the legal expenses.