When do equitable damages NOT amount to assessable income?

In Howard v Commissioner of Taxationi [2012] FCAFC 149, the Federal Court had to determine whether equitable damages Howard had recieved were assessable income for the purposes of taxation.

Howard had earlier been awarded equitable damages by the Supreme Court of Victoria arising out of a failed joint venture where the joint venturers failed in their fiduciary duties.

In essence, the directors of Distronics Pty Ltd and two others (Edmonds and Cahill) formed a joint venture to purchase a golf course.  Distronics was involved merely as an “equity participant” – to provide the money.  However, due to a resolution of the directors of Distronics, the company would only agree to provide the funds if the equity required was less than $1.5 million.

Whilst the negotiations between the venturers regarding the involvement of Distronics were being conducted, Edmonds and Cahill joined up with another person and purchased the golf course.

The three directors of Distronics sued Edmonds and Cahill in the Supreme Court of Victoria, alleging that they were in breach of their fiduciary duty to the joint venture.

Ultimately, the Supreme Court held that Edmonds and Cahill were in breach of their fiduciary duty, and ordered that Edmonds and Cahill pay equitable damages, Howard’s share of which was $861,853.35.

Howard failed to report this as income to the ATO, who took action against him in the Federal Court.

Howard argued that he received the damages on trust for Distronics, and as such it was not his personal income.

What fell to determination by the Court was whether Howard, when his claim arose, acted personally or on behalf of Distronics.

The Court held that Distronics only had legal capacity to enter into the deal if certain conditions were met.  As the equity did not fall below $1.5 million, and Edmonds and Cahill did not accept Distronics as an equity partner in the joint venture, Distronic’s involvement never crystalised and never had any formal involvement in the joint venture.  Therefore, the damages recieved by Howard were recieved by him personally.

This case raises a number of concerns for litigants, especially when they are acting in capacities other than their own.  Advice should be sought from your Lawyer as well as your Accountant should you believe an issue such as the above may have arisen.

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