Is unfair dismissal compensation taxable?

Posted on January 30th, 2017

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Is Unfair Dismissal compensation taxable? Mullane and Lindsay SolicitorsThis issue can be of real practical importance, particularly to a dismissed worker, because knowing how much will be received “in the hand” is often an important factor in trying to negotiate settlements in unfair dismissal claims.

The reality is that whether or not a payment is taxable often depends on the nature of the payment. As a general proposition, compensation for wrongful dismissal is regarded as “capital” in nature and is not taxable but that is not universally the case. If a settlement includes components for unpaid wages or payment in lieu of notice (as well as compensation for wrongful dismissal) the whole of the payment can potentially be taxable unless the different component parts are clearly identified.

If compensation is being paid only for unpaid wages or leave entitlements, those payments are in substitution for what would otherwise have been received as income and therefore are usually taxable, even if received in the context of a claim for termination of employment.

The tax treatment of compensation payments is generally a ‘mirror’ of the tax treatment for legal costs incurred in obtaining compensation. That is, as a general proposition, if the compensation is for amounts that otherwise would have been received as income, then the costs of deriving the compensation will be tax deductible (but the compensation will be taxable). Conversely, if the compensation is of a “capital” nature, it will generally not be taxable but neither will the legal costs of obtaining it be tax deductible.

It is important to understand the nuances of the tax treatment of payments and legal costs if the “in the hand” figure is central to any decision to settle a claim for compensation for termination of employment.

Tony Cavanagh Director at Mullane & Lindsay Solicitors NewcastleTony Cavanagh is a Director at Mullane & Lindsay Solicitors and practises extensively in Commercial dispute resolution and litigation, and employment law. If you require any assistance in these areas please contact Tony Cavanagh or contact our Newcastle or Sydney office. 

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