Court Decisions
Compensatory damages not ordinary income
19.12.2008
The Full Federal Court (Ryan, Edmonds and Gordon JJ) has unanimously held that compensatory damages received by the taxpayer company for defamation and which were calculated solely by reference to lost profits attributable to the defamatory publications were not assessable as ordinary income (FCT v Sydney Refractive Surgery Centre Pty Ltd [2008] FCAFC 190). The decision affirms the decision of Sackville J at first instance.
In a joint judgement, their Honours pointed out that an injury that does not impair a taxpayer’s ability to earn, but instead simply frustrates its receipt of certain moneys (ie reduces its revenue) will be assessable. That principle did not apply in the present case because a claim for defamation damages based on an injury to business reputation is a claim, regardless of how measured, for compensation for lost earning capacity resulting from damage to a capital asset.
Their Honours said that it is true that the most appropriate method of measuring loss of earning capacity due to injury to a capital asset will of course depend on the circumstances. For example, in some cases there will be evidence of the corporation’s value as a going concern before the injury (eg valuation, fair market sale, market capitalisation as reflected in share price) and after the injury (eg subsequent arm’s length sale of the business as a going concern, later share price or valuation). In those cases, it might be best to assess damages based on the difference in value (assuming that there are no other confounding or contributing factors that could account for the difference).
In other cases, however, such evidence may not exist (eg where the company ceases to trade), and thus a lost profits method may be the best or only approach that can be taken. However, the nature of the injury itself (and thus the character of the payment received by the taxpayer in compensation for it) does not and cannot change according to the way in which the resultant loss is measured or the evidence which is adduced based on the fortuitous or unfortuitous occurrence of subsequent events.
