Edited version of private ruling

Authorisation Number: 1011821606692

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Ruling

Deduction for legal expenses in relation to redundancy

Questions and Answers

Are you entitled to a deduction for legal expenses you incurred in relation to your redundancy?

No.

Are you entitled to a deduction for legal expenses you incurred in relation to your compensation claim for pain and suffering?

No.

Are you entitled to a deduction for legal expenses you incurred in relation to your accrued/untaken annual and long service leave?

Yes.

This ruling applies for the following period

1 July 2009 to 30 June 2011

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You commenced employment with an organisation.

Following incidents at work you enlisted the services of a lawyer.

You complained to the Human Rights and Equal Opportunity Commission of the organisation.

At your lawyer's suggestion, you returned to work and demanded your rightful position under your existing employment agreement.

You filed a Statement of Claim with the Federal Court of Australia.

You settle out of court and entered into a Deed of Release.

You incurred legal expenses in relation to:

· $X redundancy,

· $Y compensation for pain and suffering, and

· amount received for accrued/untaken annual and long service leave.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Subsection 6-10(2)

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 10-5

Income Tax Assessment Act 1997 Section 102-5

Reason for Decision

Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that ordinary income is income according to ordinary concepts

Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of ordinary income that have evolved from case law include receipts that;

· Are earned

· Are expected

· Are relied upon, and

· Have an element of periodicity, recurrence or regularity.

Subsection 6-10(2) of the ITAA 1997 provides that an amount is statutory income if it is not ordinary income but is included in assessable income by another provision.

Section 10-5 of the ITAA 1997 lists those provisions about assessable income. Included in this list is section 102-5 of the ITAA 1997 which deals with capital gains. Section 102-5 of the ITAA 1997 provides that a taxpayer's assessable income includes the taxpayer's net capital gain, if any, for the income year.

Income or capital

Whether a lump sum compensation payment is income or capital depends on what the amount was designed to compensate for.

A lump sum compensation payment is assessable where the payment is compensation for loss of income only; or a portion of the lump sum payment is identifiable and quantifiable as income.

If the compensation is paid for the loss of a capital asset or amount then it will be regarded as a capital receipt and not ordinary income.

A compensation payment to make up for lost earnings, or in substitution for income which would otherwise have been earned, is in the nature of income and is liable to income tax.  On the other hand a payment to compensate for personal injury, injury to feelings, humiliation, embarrassment, depression, anxiety, etc. It is a payment of a capital nature.

Redundancy

A redundancy payment, being compensation for the loss of the expectation of continuity of service, is a payment that is capital in nature. The payment is made to compensate the taxpayer for the loss of their employment position.

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.

Legal expenses

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.

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) 3 AITR 436; (1946) 8 ATD 190, 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.

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

It is considered that you incurred legal expenses in seeking to obtain compensation for loss of the expectation of continuity of service (a redundancy payment) and for pain and suffering.

The legal expenses you incurred in gaining these capital sums will also be of a capital nature and are therefore not deductible under section 8-1 of the ITAA 1997.

However; the legal expenses you incurred in relation to any accrued/untaken annual and long service leave are deductible under section 8-1 of the ITAA 1997 as these amounts are assessable.

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