Edited version of private ruling

Authorisation Number: 1011530525177

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Ruling

Subject: Legal expenses

1. Can you claim a deduction for the full amount incurred for legal expenses in relation to your compensation claim?

No.

2. Can you claim a deduction for a portion of the legal expenses incurred in relation to your compensation claim?

Yes.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You suffered a workplace injury.

Your employer's insurer accepted your compensation claim and began making weekly payments to you and paid your medical and like expenses.

You visited your family doctor who referred you to an orthopaedic surgeon who carried out some tests and determined that you required surgery and requested approval for the surgery from your employer's insurer.

The insurer sent you to their doctor to review your test results.

You were later notified by the insurer that you were no longer entitled to weekly payments, medical and like expenses, because the doctor's report had stated that you had a pre-existing underlying condition, not work related, which the work injury had aggravated.

The doctor also stated that the aggravation was temporary and you were fit for pre-injury duties.

You attended conciliation on the matter and, although the conciliation officer was unable to bring the parties to agreement, he was satisfied that there was a genuine dispute.

You made an application to the Magistrates Court and your solicitors settled your claim on the following basis:

· The insurer was required to pay weekly compensation payments, and

· The insurer was required to pay your medical and like expenses as well as the cost of surgery and any treatment received as a result of that surgery.

You incurred legal costs in relation to this action.

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.

Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income.

In Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436, the Court established that in determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. Dixon J stated at CLR 647 that:

...legal expenses...take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or purposes of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.

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.

In your case, you have incurred legal expenses for duel purposes. Firstly, in order to receive on-going compensation payments in the 2009-10 income year and, secondly, to receive a payment of compensation under the State Compensation Act for medical and like services. While the advantage sought in pursuing the compensation payments is of a revenue nature, the compensation payment for medical and like services, is of a capital nature.

Taxation Determination TD 93/29 discusses the deductibility of legal expenses incurred in recovering an amount for wages and states that if legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the contract of employment, the legal costs would not be deductible because they are capital in nature.

As the nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses, a portion of the expenses you have incurred are considered to be of a capital nature and are not deductible. Therefore, any deduction will need to be apportioned to reflect the dual purpose of the expenses incurred.

Apportionment of expenses

TD 93/29 also discusses the apportionment of legal expenses.

Where legal expenses are incurred in relation to proceedings that relate both to amounts that are revenue in nature as well as amounts which are capital in nature, there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income.

Where the solicitors account is itemised, one reasonable basis for apportionment would be the time spent involving the revenue claim, relative to the time spent on the capital claim.

If the solicitors account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim.

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