10 Apr 08 Defamation damages not assessable as ordinary income - Sydney Refractive Surgery CentreThe Federal Court (Sackville J) has held that damages awarded to the taxpayer company in defamation proceedings instituted by it in the Supreme Court of New South Wales did not constitute "income according to ordinary concepts", for the purposes of s 6-5 of ITAA, even though the damages had been calculated by reference to lost income.
In accordance with the principles laid down in British Transport Commission v Gourley  UKHL 4;  AC 185, which were endorsed by a majority of the High Court in Atlas Tiles Ltd v Briers  HCA 37; (1978) 144 CLR 202, the trial judge in the Supreme Court considered that the damages awarded to the taxpayer would not be taxable as ordinary income. On this basis, the trial judge reduced the damages by an amount to take account of the notional tax the taxpayer would have had to pay on the net revenue it would have earned but for its loss of reputation.
Notwithstanding the fact that tax had already been taken into account in determining the amount of the damages awarded, the Commissioner sought to tax the reduced damages in the hands of the taxpayer. The Commissioner argued that the case was analogous to a damages award for loss of profits, which is treated as income in the hands of the successful plaintiff, rather than a damages award for loss of earning capacity, which is characterised as a receipt on capital account. The Commissioner's arguments in this regard were rejected by Sackville J. His Honour said: "The award made by [the trial judge] was not merely intended to fill a ‘hole in [the taxpayer's] profits’, Rather it was intended to compensate [the taxpayer] for the injury to its reputation; it was not an award of damages for loss of profits as such."
The Commissioner abandoned an attempt to tax the damages as a capital gain by reason of CGT event C2.
Sydney Refractive Surgery Centre Pty Ltd v FCT  FCA 454 (Federal Court, Sackville J, 9 April 2008).
For a copy of the decision, go here