ATO Interpretative Decision

ATO ID 2002/656 (Withdrawn)

Income Tax

Legal Expenses - entitlements under an employment contract
FOI status: may be released
  • This ATO ID is withdrawn and replaced by ATO ID 2010/131
    This document has changed over time. View its history.

Status of this decision: Decision Withdrawn 18 June 2010
CAUTION: This is an edited and summarised record of a Tax Office decision. This record is not published as a form of advice. It is being made available for your inspection to meet FOI requirements, because it may be used by an officer in making another decision.

This ATOID provides you with the following level of protection:

If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.

Issue

Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in seeking entitlements under an employment contract on termination of employment?

Decision

No. The taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in seeking entitlements under an employment contract on termination of employment.

Facts

The taxpayer was employed under an employment contract that provided for a lump sum payment in lieu of notice on termination of their employment.

The taxpayer terminated their employment and their employer refused to make the lump sum payment provided for under the employment contract.

The taxpayer took legal action to recover the lump sum payment in lieu of notice of termination plus interest and costs. The case was dismissed.

The taxpayer incurred legal expenses in relation to this matter.

Reasons for Decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

It follows also that the character of legal expenses is not determined by the success or failure of the legal action.

A lump sum payment in lieu of notice is considered to be a capital amount paid as compensation for the loss of the means of producing income (Scott v. Commissioner of Taxation (1935) 35 SR (NSW) 215; (1935) 3 ATD 142). Such an amount is also considered to be an eligible termination payment (ETP) as it is a payment made in consequence of the termination of employment.

As an ETP, a lump sum payment in lieu of notice is included in assessable income under specific provisions of the Income Tax Assessment Act 1936. However, the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

As the taxpayer incurred legal expenses attempting to obtain a capital payment, the legal expenses are also capital in nature and are therefore not deductible under section 8-1 of the ITAA 1997.

Date of decision:  28 February 2002

Year of income:  Year ended 30 June 2001

Legislative References:
Income Tax Assessment Act 1936
   1

Income Tax Assessment Act 1997
   section 8-1

Case References:
Hallstroms Pty Ltd v. Federal Commissioner of Taxation
   (1946) 72 CLR 634
   (1946) 3 AITR 436
   (1946) 8 ATD 190

Scott v. Commissioner of Taxation
    (1935) 35 SR (NSW) 215
   (1935) 3 ATD 142

Related ATO Interpretative Decisions
ATO ID 2001/667
ATO ID 2002/657

Keywords
Deductions & expenses
Eligible termination payments
Legal action
Legal expenses
Employment contracts

Business Line:  Small Business/Individual Taxpayers

Date of publication:  25 June 2002

ISSN: 1445-2782

history
  Date: Version:
  28 February 2002 Original statement
You are here 18 June 2010 Withdrawn