Edited version of private advice

Authorisation Number: 1051600660403

Date of advice: 29 October 2019

Ruling

Subject: Deduction of legal fees and receipt of insurance payments

Question 1

Are you entitled to a deduction for legal expenses incurred when taking legal action to recover payments due under an income protection policy?

Answer

Yes.

Question 2

Is the lump sum payment received under the income protection policy assessable as ordinary income in the year of receipt?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You received a lump sum payment of $X in the 20XX-XX financial year.

The lump sum amount is back pay for previous years from your income protection insurance policy

that you had.

You hired lawyers to assist you in receiving your income protection payments and incurred legal fees of $X.

You have received a PAYG payment summary showing the lump sum amount as assessable

income and an amount of tax withheld.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Question 1

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a person to claim a loss or outgoing that is incurred in gaining or producing assessable income so long as the loss or outgoing is not of a capital, private or domestic nature.

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered: 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 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.

In your case, you incurred legal expenses in order to obtain the income protection insurance payments resulting in you gaining assessable income. Thus, there is a clear connection between the assessable income and the legal expenses incurred. Accordingly, you are entitled to a deduction for the legal expenses incurred under section 8-1 of the ITAA 1997.

Question 2

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (FC of T v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443;10 ATD 82). Compensation payments which substitute income have been held by the courts to be income according to ordinary concepts (FC of T v. Inkster 89 ATC 5142; (1989) 20 ATR 1516 and Tinkler v. FC of T 79 ATC 4641; (1979) 10 ATR 411).

Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings sets out the Commissioner's policy on the derivation of income. Paragraph 42 of TR 98/1 states that income from employment would normally be assessable on a receipts basis. Salary, wages or other employment remuneration are assessable on receipt even though they relate to a past or future income period.

As your income protection payments replace salary, it is considered that the receipts basis is the correct method in your case. That is, the insurance payments are assessable when received.