Edited version of private advice

Authorisation Number: 1051590390918

Date of advice: 6 November 2019

Ruling

Subject: Deductibility of a professional services expense and apportionment of a lump sum

Question 1

Are the professional services expenses incurred to negotiate a payment deductible in your 20XX income tax return?

Answer

No

Question 2

Can the ex gratia lump sum payment received be apportioned over two to three financial years?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were employed by a company who nominated you for Income Protection Insurance.

The following year you changed employers and believed that your Income Protection Insurance cover was transferred to another arm of the insurer. You paid the premiums for the income protection cover and were issued with statement reports for the policy.

Several years later you injured yourself and are now permanently disabled and have been declared medically unfit to work again.

You believed that you had a right to make a claim under a valid policy and initially submitted a claim to the insurer for periodic payments over the period you were unable to work.

The insurance company disputed your claim on the premise you were not entitled to have the policy. They said that it was a precondition to eligibility under the policies that you be employed on a permanent rather than a casual basis. You sought assistance from your financial planner to negotiate a settlement which resulted in you receiving an ex gratia payment. It was paid in two instalments:

·                     the initial instalment was made prior to the Deed of settlement was in place

·                     the second payment was paid once the Deed of Settlement was signed.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-25

Reasons for decision

The 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.

In your case, the ex gratia payment that you received has the characteristics of a capital receipt (not an income receipt) as you did not earn it and it does not directly relate to services that you performed. The payment is also a one-off payment (it does not have the elements of periodicity, recurrence or regularity). Any expectation and reliance upon the payment arises from the investment in the policy.

The ex gratia payment was not paid to compensate you for future income maintenance payments under the policy. Rather, the ex gratia payment was paid to you in full and final settlement of any claims, cost and interest against the policy. As such, you received the ex gratia payment as compensation for giving up your capital rights.

Accordingly, the ex gratia payment is not considered ordinary income and therefore, not assessable as ordinary income.

Your right to seek compensation is an intangible capital gains tax (CGT) asset (acquired at the time the right arose to take action against your insurer) and your ownership of that asset ended when you accepted the lump sum to settle your claim. At that time CGT event C2 happened. CGT event C2 happens if your ownership of an intangible CGT asset ends in certain ways, including being released, discharged, satisfied or cancelled (subsection 104-25(1) of the ITAA 1997). In your case, the lump sum payment represents capital proceeds from your CGT event C2 occurring. The expenses paid to your financial planner to assist in obtaining this payment would form part of the cost base for the calculation.

The net capital gain is the cost of the asset when you acquired it, plus certain other costs associated with the acquisition, less the cost base. This is the amount that goes on your income tax return.

In your case, the professional services fees paid to the financial planner forms part of the cost base of the ex gratia payment.

Apportioning the lump sum

As the ex gratia payment was paid to you in full and final settlement of any claims, cost and interest against the policy and not to replace income, it is assessable in the income year of receipt.