Decision impact statement

Falk and Commissioner of Taxation

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Court Citation(s):
[2015] AATA 392
2015 ATC 10-395

Venue: Administrative Appeals Tribunal
Venue Reference No: 2012/2459
Judge Name: Justice Kerr, President & Deputy President S E Frost
Judgment date: 4 June 2015
Appeals on foot: No
Decision Outcome: Favourable to the Commissioner

Impacted Advice

Relevant Rulings/Determinations:

• None

Subject References:
Assessable recoupment
Indemnity
By way of indemnity
Ex gratia payment

Précis

Outlines the ATO's response to this case which concerns whether a payment made to a taxpayer in consideration for him compromising a claim for deductible legal costs was an assessable recoupment within the meaning of subsection 20-20(2) of the Income Tax Assessment Act 1997 (ITAA 1997) notwithstanding that the amount was paid to him in the form of an ex gratia payment.

Brief summary of facts

1. In 2006, Dr Falk's employment at the Canberra Hospital was terminated. Dr Falk subsequently commenced proceedings against the Australian Capital Territory (ACT), on behalf of ACT Health, in the Australian Industrial Relations Commission ("AIRC") seeking reinstatement. Dr Falk was successful in the proceedings and the AIRC ordered his reinstatement with continuity of employment and payment of lost salary from the date of his dismissal.

2. Dr Falk and the Commissioner agreed that the whole of Dr Falk's legal costs in pursuing those proceedings were properly deducted by Dr Falk in the 2006-2009 income years.

3. Dr Falk made an application to the AIRC for the legal costs he had incurred in pursuing his wrongful dismissal application in the AIRC (the Cost Application).

4. Dr Falk and legal representatives of the ACT entered into negotiations regarding the terms of Dr Falk's reinstatement and the payment of his legal costs in the AIRC proceedings.

5. The outcome of these negotiations was that the ACT agreed to pay Dr Falk the whole of his legal costs in the AIRC in return for Dr Falk agreeing to withdraw the Cost Application.

6. The ACT Treasurer then exercised his authority under section 130(1) of the Financial Management Act 1996 (ACT) to approve an act of grace payment equal to the amount of the costs as previously agreed and subject to two conditions: (a) that Dr Falk withdraw his Cost Application in the AIRC; and (b) that he release the ACT from all actions and claims arising from the AIRC proceedings.

7. The ACT relied on the device of an act of grace payment authorisation to pay the agreed settlement it having formed the view it did not otherwise have the legal authority to pay the agreed settlement because Dr Falk's application was still pending in the AIRC and, as such, the ACT did not have a 'present legal liability' to meet Dr Falk's costs.

8. Subsequently Dr Falk executed a Deed of Release, the ACT paid Dr Falk the agreed amount and Dr Falk withdrew his Cost Application to the AIRC.

9. The Commissioner included the whole of the amount received by Dr Falk from the ACT in his assessable income for the 2009 income year, pursuant to subsection 6-10(4) and 20-35 of the ITAA 1997, on the basis that the amount was an assessable recoupment within the meaning of section 20-20(2)(a) of the ITAA 1997.

10. Test case funding was provided to Dr Falk.

Issues decided by the tribunal

The question was whether the payment received by Dr Falk from the ACT was a recoupment that had been received by Dr Falk by way of indemnity pursuant to paragraph 20-20(2)(a) of the ITAA 1997.

An argument put on Dr Falk's behalf that the payment was not a 'recoupment' within the extended definition of that term in subsection 20-25(1) was readily dismissed by the Tribunal (at [45]).

The case then turned on two issues:

•

whether the payment received as compensation for past losses, was received 'by way of indemnity', notwithstanding there was no obligation to make good the loss at the time it was suffered, and

•

whether the payment, despite being received in the form of an ex gratia payment, was nevertheless a payment received 'by way of indemnity'.

Can an indemnity be created in respect of losses already suffered even if there was no obligation to make good the loss at the time it was suffered?

The question of whether a payment received as compensation for past losses, can be received 'by way of indemnity', despite there being no obligation to make good the loss at the time it was suffered was raised by the conflicting authorities of Walters J in Goldsborough Mort & Co Ltd v FCT (1976) 14 SASR 591 (preferred by the Commissioner) and Hunt J in Commercial Banking Company of Sydney Ltd v Federal Commissioner of Taxation (1983) 70 FLR 433 (preferred by Dr Falk).

Having considered those authorities, together with the decision at first instance in Batchelor and Commissioner of Taxation [2013] AATA 93, and on appeal to the Full Court of the Federal Court at (2014) 219 FCR 453, and the decision of Mason CJ, Brennan, Deane, Dawson and McHugh JJ in the High Court in Cachia v Hanes (1994) 179 CLR 403, the Tribunal concluded (at [55]) that Walter J's views in Goldsbrough Mort correctly stated the law. That is a payment received as compensation for past losses, can be received 'by way of indemnity', despite there being no obligation on the payer to make good the loss at the time it was suffered.

Was the payment received by way of indemnity, despite taking the form of an ex-gratia payment?

The Tribunal concluded (at [74]) that the payment was received by Dr Falk by way of indemnity because its character in his hands was as consideration for him compromising the application for costs that he had submitted to the AIRC and for him providing a release to the ACT in relation to all actions and claims arising from the AIRC proceedings.

The fact that the payment was received in the form of an act of grace payment did not alter the character of the receipt in Dr Falk's hands. The device of an act of grace payment was merely a mechanism to facilitate the payment (see [80] and [83]); it could not in fact be properly characterised as an ex gratia payment (see [81]).

To be an ex-gratia payment a payment must be made for reasons otherwise than on account of a legal liability (see [66]), whether that liability be a presently existing liability or a future liability.

An amount that is properly characterised as an ex gratia payment would not be received by way of indemnity (see [55]-[57]).

In considering the character of a receipt, neither its form nor its economic equivalence will necessarily be determinative, rather regard must be had to the circumstances under which it is received. However, the fact that a payment is expressed to be an act of grace payment may be accepted as prima facie evidence that it was an ex gratia payment (see [58]).

Conclusion: Was the payment a recoupment received by way of insurance or indemnity?

The Tribunal found that the payment was a recoupment of a deductible outgoing (being Dr Falk's legal costs) and, further, that the payment was received 'by way of indemnity' with the meaning of paragraph 20-20(2)(a). Thus, the recoupment was an assessable recoupment that was to be included in Dr Falk's assessable income pursuant to section 20-35 of the ITAA 1997.

ATO view of decision

The ATO accepts the Tribunal's decision and will adopt its reasoning, where applicable, when determining whether an amount is received 'by way of ... indemnity' for the purposes of paragraph 20-20(2)(a) of the ITAA 1997.

The decision may also have relevance for other provisions of the ITAA 1997, the Taxation Administration Act 1953 and the Income Tax Assessment Act 1936 that deal with indemnities.

Administrative Treatment

Implications for impacted ATO precedential documents (Public Rulings, Determinations, ATO IDs)

The decision confirms the Commissioner's view as set out in paragraph 54 of Taxation Ruling TR 2012/8 that payments in settlement of a claim for legal costs are received by way of indemnity.

It otherwise has no impact on any other ATO precedential documents.

Implications for impacted Law Administration Practice Statements

The decision has no impact on Law Administrative Practice Statements.

Legislative References:
Income Tax Assessment Act 1997
6-10(4)
20-20(2)
20-25(1)
20-40

Financial Management Act 1996 (ACT)
130(1)
130(3)

Income Tax Assessment Act 1936
Former s 26(j)

Case References:
Batchelor v Commissioner of Taxation
[2014] FCAFC 41
(2014) 219 FCR 453
2014 ATC 20-450

Cachia v Hanes
(1994) 179 CLR 403
[1994] HCA 14

Commercial Banking Company of Sydney Ltd v Federal Commissioner of Taxation
(1983) 70 FLR 433
83 ATC 4208
(1983) 14 ATR 142

Federal Commissioner of Taxation v Rowe
(1997) 187 CLR 266
[1997] HCA 16
97 ATC 4317
(1997) 35 ATR 432

Edwards v Skyways Ltd
[1964] 1 All ER 494

Federal Commissioner of Taxation v Wade
[1951] HCA 66
(1951) 84 CLR 105

Goldsbrough Mort & Co Ltd v FCT
(1976) 14 SASR 591
[1964] 1 WLR 349

Re Batchelor and Commissioner of Taxation
[2013] AATA 93
(2013) 92 ATR 416
2013 ATC 10-297