Edited version of your written advice

Authorisation Number: 1012675867148

Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for legal expenses?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

You were employed under an employment contract for many years.

You were advised that your role needed to change. You were left to consider the new role which was a slightly lower level, but in the same location with the same wage.

In a meeting with the CEO, you agreed to accept the new role subject to three conditions including amendments to your employment contract.

The CEO agreed that they had to fix the contract but they had been busy. It was agreed that you mark up a copy of your contract in accordance with the agreement and send it to a nominated Director. You sent it to the Director and then followed up with an email.

In a discussion the CEO advised you that the previously offered role no longer existed. No redundancy was offered and you had to consider and discuss with another manager what other role might exist.

You discussed another role which you considered unsuitable.

It was discussed that your leaving the company was the best option, however, there was to be no modification of the contract contrary to previous agreements and no redundancy was available/applicable.

You were to take some time to consider your options. Whilst considering your options you received advice that you had been terminated.

You undertook legal action after you were terminated to seek a redundancy payment and to seek modification to your contract which included reducing the notice period and the restraint clause.

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.

In determining whether a deduction for legal expenses is allowed, the nature of the expenditure must be considered. 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.

Redundancy

Redundancy payments are treated as employer termination payments (ETP) and subject to special tax treatment that may result in some or the entire amount being included in the taxpayer's 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 the assessable income of the taxpayer.

In your case, you incurred the legal expenses in order to obtain an ETP. Although the ETP may be included in the assessable income, the ETP retains its character as a capital receipt.

As the legal expenses will be incurred in gaining a capital sum, they will also be of a capital nature and are therefore not deductible.

Employment contract

Taxation Ruling TR 2000/5 Income tax and fringe benefits tax: costs incurred in preparing and administering employment agreements sets out the Commissioner's view of the application of section 8-1 of the ITAA 1997 to costs incurred by employees and employers in preparing and administering employment agreements.

TR 2000/5 states at paragraph 14 that a deduction is not allowable for the costs of drawing up an employment agreement with a new employer or costs of drawing up an employment agreement upon re-employment with an employer following termination of a fixed term employment contract where the agreement makes no provision for renewal or extension.

In Federal Commissioner of Taxation v. Maddalena (1971) 2 ATR 541 (Maddalena's case) the Full High Court disallowed the costs of seeking employment by a taxpayer since they were not incurred in the course of gaining or producing income. In this respect, Menzies J stated at 549:

'Does then the expenditure in question fall within the description of an outgoing "incurred in gaining or producing" his assessable income, or was it an outgoing necessarily incurred in carrying on a business? I think not ... The expenditure would have been incurred in getting, not doing, work as an employee. It would come at a point too soon to be properly regarded as incurred in gaining assessable income. ... moneys spent to obtain a new employment are not allowable deductions for income tax purposes under s. 51 [Now section 8-1 of ITAA 1997].'

In your case, as your employment has been terminated, the legal expenses you will incur are in relation to drawing up a new employment agreement with your former employer. As with Maddalena's case, your expenses relating to obtaining a new employment agreement are considered to be at a point too soon. Consequently, no deduction is allowable for legal expenses.

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