ATO Interpretative Decision

ATO ID 2002/665 (Withdrawn)

Income Tax

• This ATO ID is withdrawn from the database following the decision of the Full High Court in Federal Commissioner of Taxation v. Day (2008) 236 CLR 163; 2008 ATC 20-064; (2008) 70 ATR 14.
  This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

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 defending disciplinary charges brought by their employer?

Decision

No. The taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in defending disciplinary charges brought by their employer.

Facts

The taxpayer was an employee.

Disciplinary charges were brought against the taxpayer by their employer.

The activities to which the charges related were not authorised employment duties.

The outcome of the disciplinary charges determined whether the taxpayer retained their existing employment position.

The taxpayer incurred legal expenses that related specifically to defending the disciplinary charges.

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).

Legal expenses are generally deductible if the expenses arise out of the day to day activities of the taxpayer's business (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).

Similarly, in FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed their employment duties were allowable. The activities which produced the taxpayer's income were what exposed them to the liability against which they were defending themselves. No significance was placed by the court on the taxpayer's status as an employee.

In Case W94 89 ATC 792; AAT Case 5376 (1989) 20 ATR 4001, the Administrative Appeals Tribunal held that expenditure incurred on legal fees in circumstances where the conduct of the taxpayer was not related to their income earning activities, was not 'incidental and relevant' to the gaining or production of the taxpayer's assessable income.

The legal expenses were incurred by the taxpayer in defending disciplinary charges of misconduct. The activities to which the charges related were not authorised employment duties and the activities were not undertaken for the purpose of earning assessable income. The legal expenses were not incurred as a result of the taxpayer defending the manner in which they performed their employment duties.

As the taxpayer did not incur the legal expenses in defending the performance of their normal employment duties through which they earned assessable income, the legal expenses incurred are not deductible under section 8-1 of the ITAA 1997.

Year of income:  Year ended 30 June 2001

Legislative References:
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

Keywords
Deductions & expenses
Legal action
Legal expenses

Business Line:  Small Business/Individual Taxpayers

Date of publication:  26 June 2002

ISSN: 1445-2782