Termination of employment: Legal Costs

The ATO has released a tax ruling which considers whether employees who are terminated, who then successfully sue their (former) employer for wrongful dismissal and receive a reimbursement for their legal costs, need to include that amount in their assessable income.

Basically, an amount received in relation to a dispute concerning termination of employment is not an 'eligible termination payment' (ETP), nor forms part of an ETP, where that amount is capable of being identified as relating specifically to the reimbursement of legal costs.

However, if the amount of a settlement or court award received is a lump sum and the component relating to legal costs has not been and cannot be determined, then the whole amount is treated as being received in consequence of termination of employment (and, therefore, an ETP).

The only other way for the legal costs to be included in assessable income is where the former employee is able to claim a deduction for the legal costs (e.g., where they are suing for lost income, rather than just for wrongful dismissal), in which case the settlement or award for legal costs will be included in their assessable income as an 'assessable recoupment' (i.e., it basically offsets the deductions they could otherwise claim).

In addition, the ruling concludes that the reimbursement of a former employee's legal costs by their former employer should not be a 'fringe benefit' and no fringe benefits tax should apply.