Edited version of private advice

Authorisation Number: 1051790014539

Date of advice: 15 January 2021

Ruling

Subject: Legal fees

Question

Are you entitled to a deduction for legal fees in relation to an unfair dismissal case against your former employer?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were terminated from your employment in early 20XX.

You received a termination payment early 20XX.

You took legal action against your former employer for unfair dismissal.

You engaged a lawyer to assist you in the action.

You sought the remedy of being reinstated or compensation.

Your former employer denied the unfair dismissal allegation made by you.

Your former employer and you settle on an amount which is the equivalent of X weeks base pay.

This amount is paid to you early 20XX.

This amount is prefilled in your tax return with the employment termination section with a code of R.

You state that this was a redundancy payment.

You incurred legal expenses of $X.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (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, 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.

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

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.

Taxation Determination TD 93/29 states:

If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the contract of employment where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible. For example, legal expense relating to an action for damages for wrongful dismissal is not deductible.

You took action against your former employer for unfair dismissal.

This resulted in your employer denying the allegation made by you, and you and your former employer settled on the amount of $X representing X weeks base salary according to the settlement deed.

This amount was prefilled in the termination payment section of your tax return at label R.

The legal fees are not an allowable deduction as they relate to your claim of unfair dismissal which is capital in nature.

If the payment you received was indeed a redundancy payment, the legal fees are still not deductible as a redundancy payment, being compensation for the loss of the expectation of continuity of service, is a payment that is capital in nature. Such a payment is made to compensate the taxpayer for the loss of their employment position and is regarded as a capital payment (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184).

Redundancy payments are treated as employment termination payments and subject to special tax treatment that may result in some or all of the amount being included in your income. 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 your assessable income.

Therefore, as a redundancy payment is capital in nature the legal expenses are not an allowable deduction under section 8-1 of the ITAA 1997.