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Edited version of your private ruling
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Ruling
Subject: Legal expenses
Question 1
Are you entitled to a deduction for the legal fees incurred relating to your unpaid commissions?
Answer
Yes.
Question 2
Are you entitled to a deduction for the legal fees incurred relating to your unfair dismissal claim?
Answer
No.
This ruling applies for the following periods:
Year ended 30 June 2011
Year ended 30 June 2012
The scheme commences on:
1 July 2010
Relevant facts and circumstances
Your employment was terminated.
At the time your services were terminated you were owed unpaid commissions.
You commenced legal action to recover the unpaid commissions.
The legal action was principally taken to recover the outstanding commissions, however, in case the action was unsuccessful, there was also a secondary argument of unfair dismissal.
Prior to the matter going to court your employer made a payment for outstanding commissions and you also received an employment termination payment (ETP).
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Summary
The recovery of unpaid commissions are revenue in nature as they are considered to fall within the meaning of ordinary income.
As such, the legal and associated costs you incurred in pursuing your claims for unpaid commissions are an allowable deduction under section 8-1 of the ITAA 1997.
As the ETP payment you received as a result of your legal action is capital in nature, the expenses incurred in pursuing your claim and obtaining the ETP are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal and associated costs you incurred in pursuing this payment.
Detailed reasoning
Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a loss or an outgoing is an allowable deduction if it is incurred in producing assessable income or in carrying on a business for the production of assessable income unless that loss or outgoing is capital or of a private or domestic nature.
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). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. 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 which considers the deductibility of legal expenses states that where legal expenses are incurred by an employee (or a former employee) in pursuing a legal action against his/her employer (or former employer) to recover amounts owing of a revenue nature such as wages, the legal expenses are an allowable deduction.
Paragraph 5 of TD 93/29 provides the Commissioners view on the deductibility of legal expenses incurred in relation to a wrongful dismissal action. This paragraph states that the expenses:
· will be deductible to the extent to which they relate to a claim for items of a revenue nature such as unpaid salary or wages; but
· will not be deductible to the extent to which they relate to a claim for items of a capital nature such as damages for breach of contract of employment or for damages for wrongful dismissal.
In your situation, you commenced legal action primarily to recover unpaid commissions from your previous employer. You also had a secondary argument of unfair dismissal. The legal expenses you incurred were only partly in respect of the recovery of a revenue item as the subsequent settlement you received from your employer contained money by way of an ETP in respect of your termination.
The money you received by way of payment for outstanding commissions is considered to be ordinary income as it is paid directly as a result of the personal services you rendered for your previous employer. As this amount is considered to be assessable income, there is a clear connection between the income and the legal expenses you incurred. Therefore, you are entitled to a deduction under section 8-1 of the ITAA 1997 for this portion of the legal expenses you incurred.
However, the money you received as an ETP resulting from your termination from your previous employment is considered to be for compensation for the loss of your employment position. As this payment relates to the loss of the expectation of continuity of service, the payment is considered to be capital in nature (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184).
ETP's are subject to special tax treatment that may result in some or all of the amount being included in your assessable 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, the money relating to the ETP payment you received is capital in nature and subsequently, the portion of the legal expenses you incurred relating to obtaining this payment are also capital in nature. Accordingly, no deduction is allowable under section 8-1 of the ITAA 1997 for this portion of the legal expenses you incurred.
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