It may seem trite to say, but no one likes paying tax. This dislike is now a factor in workers’ compensation matters and it may have some practical consequences for employers.

Until recently, the view, at least in Western Australia under the old Workers’ Compensation and Injury Management Act 1981 (WA), was that lump sum settlements paid in return for an injured worker foregoing further entitlements to compensation for their injury, were paid without deduction of taxation by the employer/insurer and generally accepted as an amount which did not need to be declared by the worker as part of their taxable income.

A recent class ruling from the Australian Taxation Office (ATO) in relation to the Workers Compensation and Injury Management Act 2023 (WA) (WCIM Act 2023) (Ruling) changes the approach to one component of lump sum settlements – the amount paid for income compensation.

Under the Ruling, the following compensation components are not assessable as ordinary income:

1. Medical and health expenses compensation;
2. Miscellaneous expenses compensation;
3. Workplace rehabilitation expenses;
4. Permanent impairment compensation; and
5. Dust disease impairment compensation.

If a lump sum is paid pursuant to a settlement agreement under s149 of the WCIM Act 2023, the component which is attributable to income compensation is assessable as ordinary income under taxation legislation.

There are two practical effects of this Ruling. Firstly, injured workers engaged in compensation negotiations will now need to consider the income tax implications on the component paid for income compensation. Workers are being advised to seek the grossed up amount to compensate them for this tax obligation. This has resulted in higher overall settlements and has also removed an important incentive that employers and insurers previously had to settle claims early (in that they were previously able to reduce overall claim costs by negotiating on net terms).

Secondly, PAYG tax is normally deducted from a worker’s income by the employer and remitted to the ATO on the worker’s behalf. Generally, lump sum payments for workers’ compensation are paid by the insurer to the worker directly, so will insurers have the capacity and information needed to deduct an appropriate amount of PAYG tax and remit it to the ATO? If not, will the income be taxed in the hands of the worker? Or will insurers now pay the lump sum to the employers to deduct the PAYG tax before paying the balance to the worker? Both options present difficulties.

The expectation of grossed up or higher income compensation and possible administration expenses of managing the tax obligations for the income component of lump sum payments may then have an impact on premiums. It has also seen some insurers pause settlement negotiations which involve the payment of income compensation while a solution is found.

We have not yet seen the full impact of the Ruling on workers’ preparedness to settle their workers’ compensation claims and their expectation about the amount of income compensation, but early indications are that it is taking some time for workers, their representatives and insurers to digest the Ruling.

THE IMPORTANCE OF CERTAINTY

When settling an employment claim with an employee who has, or may have, a claim for workers’ compensation, it is very important to ensure exactly what claims the employee is releasing the employer from.

As a general rule, employers and employees cannot contract out of workers’ compensation provided for in workers’ compensation legislation and it is very common to have this exclusion noted in the release provision in a deed of settlement. It is not always clear, however, exactly what ‘workers’ compensation’ claim is excluded.

This issue was recently considered by the Queensland Supreme Court. This decision concerned a settlement deed signed in 2017 by an employee (Ms Bakhit) and her former employer (Hartley Healy, HH). Ms Bakhit alleged that she had been sexually harassed in her employment and had made a claim for workers’ compensation. She then withdrew this claim and pursued her employer through a complaint to the Australian Human Rights Commission (AHRC).

During conciliation in the AHRC, Ms Bakhit reached a settlement with HH which included a payment to her of $30,000.00. Relevantly, the settlement deed included a release from all claims except for any claim for statutory benefits under the Workers’ Compensation and Rehabilitation Act 2003 (Qld).

In 2021, Ms Bakhit commenced proceedings against HH alleging a breach of duty of care and breach of contract because of the same sexual harassment allegations. She argued that because the workers’ compensation legislation controlled who can sue employers and the calculation of damages for workplace injuries, then her claims were ‘statutory benefits’ and so within the settlement’s exception.

The Court rejected Ms Bakhit’s argument, finding that the workers’ compensation act distinguished between compensation (amounts payable under the legislation for no-fault weekly payments, medical expenses and lump sums allowed for under the act) and damages (money owed where an employer’s legal liability created an obligation to pay damages).

Compensation under workers’ compensation legislation is a statutory benefit created under that legislation, common law damages are not.

Ms Bakhit’s attempt to seek common law damages which were not within the exception expressly included in the settlement meant that her claim was barred by the settlement deed. She was also required to pay HH’s legal costs because the settlement deed included an indemnity clause for legal costs. The legal costs she was required to pay would almost certainly exceed the $30,000.00 settlement sum that she had previously received.

This case illustrates the importance of a well-drafted settlement deed, particularly in ensuring that the exclusion of workers’ compensation claims from the release is limited to what the law requires. An effective indemnity clause to recover all legal costs is also important in the event of a barred claim being pursued.

This article was written by Erica Hartley, Partner, Bronte Lawrence, Partner and Rochelle Airey, Special Counsel.