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Edited version of your private ruling
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Ruling
Subject: Legal expenses - unfair dismissal
Question
Are you entitled to a deduction for legal expenses?
Answer
No
This ruling applies for the following period:
Year ended 30 June 2012
The scheme commenced on:
1 July 2011
Relevant facts and circumstances
You were dismissed by your employer. Following your dismissal you were paid for your outstanding leave entitlements and also received a payment in lieu of notice.
You employed the services of a lawyer and incurred legal expenses.
You filed a complaint with the relevant regulatory authority claiming you were unfairly dismissed.
Following the complaint, you commenced conciliation discussions with your employer.
Your employer offered you a settlement in regards to the dispute.
You were paid an undissected eligible termination payment (ETP) in settlement of your claim.
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.
Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113). For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income, (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47).
Also, 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 (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.
Compensation for loss of employment, such as in an action for wrongful dismissal or loss of office, is a capital receipt (Scott v. Commissioner of Taxation (1935) 35 SR). Legal costs incurred in seeking such compensation are not deductible because the nature of the advantage sought is capital. This is so, even if the amount awarded is calculated by reference to unpaid salary or lost income, or is assessable as statutory income.
Further, paragraph 5 of Taxation Determination TD 93/29 provides the Commissioner's view on the deductibility of legal expenses 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
· will not be deductible to the extent to which they relate to a claim for items of a capital nature such as damages for wrongful dismissal.
In your case, you were dismissed by your employer following alleged misconduct. You filed a complaint claiming that you had been unfairly dismissed and incurred legal expenses. It follows that the advantage to be gained in incurring the legal expenses was capital in nature, being reinstatement of your employment position or damages for unfair dismissal. Following conciliation with your employer you were awarded an undissected lump sum settlement as an assessable ETP. The assessability of your ETP does not alter the capital nature of your legal expenses.
Accordingly, the legal expenses are not deductible under section 8-1 of the ITAA 1997 as they are capital in nature.
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