Falk vs Commissioner of Taxation

In this case the tribunal ruled that the character of a transaction is more important than any particular name it happens to be given when determining its nature under the income tax assessment act(s).

The Australian Capital Territory (ACT) government labelled a payment given to an employee in respect of legal costs incurred during a dispute between himself and the government as an 'act of grace' payment, but the tribunal ruled that the transaction was clearly made on the condition of Mr Falk dropping all claims against the ACT government in regard to those costs.  A payment made on such conditions is difficult be construed as an 'act of grace'.  A payment made in compensation of legal costs can only be considered 'ex gratia' (an act of grace) if there is no legal liability on behalf of the payee to make the payment - whereas the key distinction in this case was that the taxpayer dropped current legal proceedings against the ACT government in return for the payment.

The case rested upon the definition of the word 'indemnity', and also, what particular characteristics of a payment constitute the label 'ex gratia'.  The tribunal held that payments of indemnification are made in respect of losses that have already occurred (as opposed to losses that 'may' occur).  In regard to ex gratia payments, the tribunal suggested that compensation for legal costs offered after legal proceedings have commenced do not bear the character of an 'act of grace'.

The ruling drew upon a long debate about the word "indemnify".

"There is no general principle that an amount received as compensation for, or reimbursement of, a deductible expense is assessable income. The proposition that a general principle of that kind exists was rejected by the High Court in Commissioner of Taxation v Rowe [1997] HCA 16."  (p 41)

"Finally, in relation to the ordinary meaning of ‘indemnity’ reaching to indemnification in respect of losses already incurred in the context of legal costs, we note the following statement of the High Court (Mason CJ, Brennan, Deane, Dawson and McHugh JJ) in Cachia v Hanes [1994] HCA 14; (1994) 179 CLR 403 at 410:

"It has not been doubted since 1278, when the Statute of Gloucester (6 Edw.I c.1.) introduced the notion of costs to the common law, that costs are awarded by way of indemnity (or, more accurately, partial indemnity) for professional legal costs actually incurred in the conduct of litigation.""  (p 54)

"For those reasons the Tribunal will proceed on the basis that the views of Walters J in Goldsbrough Mort correctly state the law. That however is the beginning of the required analysis, not its end. In Batchelor, Edmonds and Pagone JJ stated that it is the character of a receipt which determines whether what the taxpayer has received may relevantly bear the description as being ‘by way of insurance or indemnity’.[30] An ex gratia payment does not fit that language. In a passage the Tribunal adopts, their Honours said at [13]:

"It may be accepted that the words “by way of insurance or indemnity” are, and are intended to be, wide, but they must be applied as intended. Generally speaking a payment will not be regarded as an indemnity (whether the word is taken alone or in combination in the composite phrase “by way of insurance or indemnity”) unless the entitlement to its receipt precedes the event in respect of which it is paid. An ex gratia payment, for example, is not apt to be regarded as indemnification of a loss or outgoing notwithstanding that its receipt may be said, from the point of view of economic equivalence, to compensate the recipient for a loss which had been suffered or an outgoing which had been incurred. Similarly, a refund would not ordinarily be regarded as an indemnification notwithstanding that its receipt may be said to have rendered a taxpayer harmless, from an economic point of view, for an antecedent loss or outgoing.""  (p 55-56)

"The reasoning of the plurality in Batchelor therefore requires the Tribunal to determine the character of the receipt Dr Falk received. Neither its form nor its economic equivalence can be determinative of its character."  (p 58)

"(If if was found) that the device of an act of grace payment was required only to comply with ACT internal procedures. We would find that the payment was made (adopting the language of the Chief Solicitor) ‘in return for [Dr Falk] withdrawing his application to the AIRC for costs and providing a release of the Territory in relation to the AIRC and associated costs’."  (p 80)

"An ex gratia payment necessarily must be a payment made for reasons not compelled by law but that does not require its maker to be credulous or indifferent to his or her interests and a potential double recovery."  (p 84)

The case is here [2015] AATA 392:  http://www.austlii.edu.au/au/cases/cth/AATA/2015/392.html