Edited version of private advice

Authorisation Number: 1051906967127

Date of advice: 11 October 2021

Ruling

Subject: Legal expenses - worker's injury claim

Question 1

Are you entitled to a deduction for the portion of the legal expenses incurred in relation to you seeking compensation for your weekly WorkCover payments?

Answer

Yes.

Question 2

Are entitled to a deduction for the portion of the legal expenses incurred in relation to you seeking compensation for non-economic loss?

Answer

No.

Question 3

Are you entitled to a deduction for the portion of legal expenses incurred in relation to seeking compensation for economic loss or potential earnings?

Answer

No.

Question 4

Are you entitled to a deduction for the portion of the legal expenses incurred in relation to you seeking compensation for medical expenses?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

In August 20XX you sustained a personal injury while performing your work duties as a registered nurse.

You subsequently lodged a Worker's Injury claim with the Victorian WorkCover Authority for compensation for your personal injury.

In March 20YY you engaged the services of lawyers to investigate your potential entitlements to compensation, and in particular to investigate your potential claim for compensation for non-economic loss.

Lawyers are also assisting you in recovering your medical expenses in relation to the treatment of your personal injury.

You received weekly payments from your employer (WorkCover Payments) while you were unable to work as a result of your personal injury.

The WorkCover Payments ceased in February 20YY following a decision by your employer's insurer Allianz to terminate the payments.

You sought to have the decision to terminate the WorkCover Payments to be reconsidered and to have the WorkCover Payments back paid to July 20XX.

You and your employer agreed to settle the claim for compensation for non-economic loss (pain and suffering) and you received a settlement lump sum.

You sought compensation for economic loss or loss of potential earnings, but you were not successful in your claim because you were assessed by the Medical Panel (County Court) in respect of your personal injury and were deemed fit to work full-time as a registered nurse.

You incurred legal expenses in seeking compensation for your personal injury.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of Income Tax Assessment Act 1997 (ITAA 1197) 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.

Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income.

In determining whether a deduction for legal expenses is allowable 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.

Legal expenses are generally deductible if they arise out of the day to day income earning activities (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).

If the advantage to be gained does not have an immediate connection to the duties undertaken to derive income and has more of an enduring and consequently capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

Weekly WorkCover payments

In Tax 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? the Commissioner states that legal expenses incurred by an employee in recovering unpaid wages are deductible under section 8-1 of the ITAA 1997, as the expenses are directly incurred in the process of deriving assessable income.

In your case, the Workcover Payments ceased in February 20XX following a decision by your employer's insurer XXXX to terminate the payments. You incurred legal expenses in seeking to have the decision to terminate the WorkCover Payments to be reconsidered and to have the payments back paid. The WorkCover Payments represents a replacement of your salary and wages and are considered to be revenue in nature and assessable. The associated legal expenses in relation to you seeking to have the WorkCover Payments to be back paid relates sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

Non-economic loss (pain and suffering)

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; (1952) 10 ATD 82). Lump sum damages awarded for a personal injury, wrong or illness suffered, which is not direct compensation for loss of income, will usually be capital in nature.

This principle is confirmed in Taxation Ruling TR 2012/8. Paragraph 45 states:

Compensation for loss of employment, such as in an action for wrongful dismissal or loss of office, is a capital receipt (Scott v. Commissioner of Taxation). Legal costs incurred in seeking such compensation are not deductible because the nature of the advantage sought is capital. This is so, even if the amount of compensation awarded is calculated by reference to unpaid salary or lost income or is assessable as statutory income.

In your case, you sought a claim for compensation from the employer for an injury suffered during the course of your employment. You and your employer agreed to settle the claim. You incurred legal expenses in seeking the compensation for the pain and suffering you experience resulting from the personal injury. The essential character of the advantage or compensation sought did not relate to any revenue items such as salary or wages.

Whilst the legal expenses arose from your employment activities, they are of a capital nature because the principal reason for incurring the expenses was for the purpose of obtaining compensation for an injury suffered in your occupation. Compensation payments in respect of your personal injuries claim is of a capital nature. They were not incurred in seeking payment of an amount of ordinary assessable income.

As the nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses, the expenses you have incurred are considered to be of a capital nature and are not deductible.

Accordingly, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses incurred in obtaining the lump sum compensation in respect of your personal injury.

Economic loss (potential earnings)

Legal expenses incurred to receive compensation for economic or loss or loss of future earnings are not deductible as they are considered to provide an enduring advantage and are therefore capital in nature.

In your case, you incurred legal expense in seeking compensation for economic loss, albeit your claim was unsuccessful as you were deemed fit to work full-time by the Medical Panel. However, irrespective of the outcome of your claim, the advantage sought by you in undertaking the action is the restoration of a capital asset, that is, your means of producing income. As such, the character of the legal expenses associated with this action are considered to be capital in nature and the expenses are not deductible under section 8-1 of the ITAA 1997 (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184).

Medical expenses

Medical expenses are generally regarded as private expenses. It is a long-standing principle that a taxpayer does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some casual connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred in gaining or producing your assessable income (Lunney v Commissioner of Taxation (1958) 100 CLR 478). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3.

The deductibility of the expenses can also depend on whether the claims would have resulted in assessable income. Reimbursement of medical expenses is not generally regarded as assessable income.

In your case, the legal expenses incurred in relation to seeking compensation for your medical and treatment costs do not have the required nexus with the derivation of assessable income and are of a private nature. Therefore, the associated legal expenses are not an allowable deduction under section 8-1 of the ITAA 1997.

Apportionment of expenses

As outlined above, your legal costs relate partly to deductible legal action and partly to non-deductible legal action. Therefore, only the relevant portion of the associated legal expenses is an allowable deduction.

The portion of the legal costs incurred in relation to the WorkCover weekly payments are considered to be sufficiently connected to your assessable income and deductible. However, the portion that relates to the non-economic loss (lump sum settlement), loss of potential earnings and the medical expenses are capital in nature and no deduction is allowed for these associated legal expenses.

You will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.