Edited version of private ruling

Authorisation Number: 1011573103588

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Ruling

Subject: Legal expenses

1. Are you entitled to a deduction for legal expenses relating to allegations of misconduct in the way you performed your employment duties?

Yes.

2. Are you entitled to a deduction for legal expenses relating to allegations of sexual harassment?

No.

This ruling applies for the following period

Year ended 30 June 2008

The scheme commenced on

1 July 2007

Relevant facts

You are an employee.

Allegations were made against you relating to the manner in which you carried out your employment duties.

Allegations were made against you that you had sexually harassed another employee.

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 a loss or outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature, or relates to the earning of exempt income.

In determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered.

The character of legal expenses is not determined by the success or failure of the legal action (Case B31 70 ATC 148; 15 CTBR (NS) Case 93).

The nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436). 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.

Legal expenses are generally deductible if the expenses arise out of the day to day activities of a taxpayer's employment duties. For example, in Federal Commissioner of Taxation v. Rowe (1995) 60 FCR 99; 95 ATC 4691; (1995) 31 ATR 392 (Rowe's case), the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable.

Conversely, in Case W94 89 ATC 792; AAT Case 5376 (1989) 20 ATR 4001 (Case W94) the taxpayer, a public servant incurred legal fees in defending and then appealing against disciplinary charges of improper conduct resulting from his compulsive gambling. It was found that the expenses incurred where not incidental or relevant to the gaining of the taxpayer's assessable income. It was the conduct of the taxpayer through his compulsive gambling which led to the charges which, in turn, led to him incurring legal costs. The expenses incurred were not incidental or relevant to the gaining of the taxpayer's assessable income.

We consider that the allegations relate to the way in which you performed your employment duties and the allegations of sexual harassment relate to your personal conduct.

Therefore, as in Rowe's case, expenses relating to the allegations of misconduct are deductible. However, as in Case W94, expenses relating to the allegations of sexual harassment are not deductible. You can apportion the expense in a fair and reasonable manner based on the time spent by your solicitor on each allegation.

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