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Ruling

Subject: Legal expenses

Question:

Are legal expenses incurred in contesting your 'constructive dismissal' an allowable deduction?

Answer:

No.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

You were a permanent, full time employee of your employer for a period of time, ending in the relevant financial year.

After voicing a concern about your working environment, your employment contract was altered and you were given alternative work below your level of expertise.

Both you and your solicitor considered this to be a deliberate action to force a resignation, which is what you ultimately did.

You lodged a claim with Fair Work Australia (FWA) for wrongful/constructive dismissal.

Pursuant to a Deed of Settlement, you ultimately accepted an ex-gratia payment from the employer in return for withdrawing/discontinuing your claim with FWA and as full and final settlement of the matter.

You incurred legal expenses in relation to this matter.

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 or outgoings to the extent to which they are incurred in gaining or producing assessable income. However, where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income they will not be deductible.

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

Expenses incurred in relation to the underlying profit yielding structure are considered to be capital in nature and will not be deductible.  

In Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859, a solicitor was denied a deduction for legal expenses incurred in defending certain allegations before the Statutory Committee of the Law Society of New South Wales, concerning the solicitor's trust account. The Committee ordered the taxpayer be suspended from practice for a period of twelve months, and to pay the costs of the Law Society. The Administrative Appeals Tribunal (AAT) held that the payments made by the taxpayer were not deductible under subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as the payments were characterised as capital expenditure.  

Further, in Case X84 90 ATC 609; AAT Case 6528 (1990) 21 ATR 3721, the AAT held that legal expenses incurred by a medical practitioner in defending charges brought against him at a Medical Disciplinary Tribunal inquiry, were not deductible under subsection 51(1) of the ITAA 1936 because the expenditure was incurred to protect a structural asset, that is, their registration as a medical practitioner, and was of a capital nature.

In your case, you incurred legal expenses in relation to a claim lodged with FWA for wrongful/constructive dismissal after being forced to resign from your employment. As your employment had already ceased, the advantage you were seeking in incurring this expense was either reinstatement of your employment, a profit yielding structure, or an amount of compensation. These are considered to be advantages of a capital nature. As discussed above, the nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses. Therefore, the expenses you have incurred are considered to be of a capital nature and are not deductible under section 8-1 of the ITAA 1997.  

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