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Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for a portion of the legal expenses incurred in respect of pursuing your X claims?

Answer

Yes?

This ruling applies for the following periods

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on

1 July 2009

Relevant facts and circumstances

You made a workers compensation claim through X for a work-related condition, the application was denied.

You appealed the decision through the Administrative Appeals Tribunal (AAT) and the AAT found that you were entitled to be paid compensation.

You were paid two lump sum payments by X. A portion of these payments related to previous financial years.

You made a second claim through X for Permanent Impairment (PI), this claim was also denied.

You appealed the decision through the AAT and the AAT decided that the degree of impairment arising from the injury was permanent.

You received a sum in relation to the injury for non-economic loss.

You sought legal advice and engaged a number of legal professionals in relation to your dispute against your employer and X, as you undertook multiple legal actions.

You incurred multiple invoices in regards the X dispute the AAT cases.

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, or relate to the earning of exempt income.

In determining whether a deduction for legal expenses is allowable, the nature or character of the expenditure must be considered, that is, whether the legal expenses are incurred for a capital or a revenue purpose (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.  For example, if the advantage to be gained is of a capital nature, then the legal expenses incurred in gaining the advantage will also be of a capital nature and are not deductible.

It also follows that the character of legal expenses is not determined by the success or failure of the legal action.

When the principal reason for incurring the legal expenses is defending the actions of the taxpayer in carrying out their employment duties through which they gain or produce assessable income, such expenses are characterised as being of a revenue nature and are deductible (Inglis v. FC of T 87 ATC 2037; and Case V116 88 ATC 737; AAT Case 4502 (1988) 19 ATR 3703).

Compensation paid to make up for salaries, bonuses, allowances, etc. that would have been received but for the actions of the employer is considered to be in the nature of income and liable to income tax in the year of receipt.

A payment to compensate the employee for damages suffered as a result of poorer working conditions for example, anxiety suffered because of lack of employment security or injury to feelings due to a demotion is not considered to be income and is of a capital nature and is excluded from assessable income.

In your case, your original claim for X payments was denied and you took legal action that resulted in the payment of lost earnings. Accordingly, your legal expenses attributable to this claim are of a revenue nature and would be deductible in the year you incurred them.

You also took legal action that resulted in compensation for non-economic loss. Your legal expenses attributable to this claim are of a capital nature and would not be deductible.

Apportionment

Taxation Determination TD 93/29 discusses the deductibility of legal expenses and states that in situations 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 apportionment of the extent of the outlay to assessable income.

In relation to the apportionment of legal expenses, TD 93/29 states:

Where the solicitor's 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 solicitor's 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.

You are eligible for a deduction for as much of your legal expenses as are attributable to your claim for lost earnings. In claiming this deduction, you may apportion your fees between your claims on a reasonable basis. An example of a reasonable basis would be the amount of time spent by your solicitor on each claim.

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