Edited version of your written advice

Authorisation Number: 1013080673224

Date of advice: 30 August 2016

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for legal expenses associated with seeking legal advice regarding dismissal from an employment position?

Answer

No.

Question 2

Are you entitled to claim a deduction for legal expenses associated with the legal advice regarding your conditions of employment and your employment contract?

Answer

Yes.

Question 3

Are you entitled to claim a deduction for legal expenses associated with the legal advice regarding your unpaid wages?

Answer

Yes.

This ruling applies for the following periods:

Year ending 60 June 20YY

Year ending 60 June 20ZZ

Year ending 60 June 20XY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You have experienced discriminatory conditions with your previous employer.

You were underpaid for your services compared to other employees.

You obtained legal representation with the intention of having your employment conditions restored.

You obtained a medical condition and you had a medical certificate.

You applied for WorkCover compensation for this period however this was denied.

You are currently receiving Sickness Benefits from Department of Human Services.

Your employer terminated your employment. You expanded your legal action to include recovering unpaid wages and unfair dismissal.

You have changed legal firms to represent you.

Your matter is still ongoing and not currently resolved.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Further issues for you to consider

If you receive a payment when the matter is resolved, the amount may be assessable depending on what it is paid for. Any payment received for unpaid salary and wages will be assessable as ordinary income. Payments for other reasons may be assessable as employment termination payments or under the capital gains tax provisions of the tax legislation. We recommend you contact the Tax Office when your matter has been resolved.

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 allowed, 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.

Unfair dismissal

Generally, legal expenses incurred in an unfair dismissal action (seeking reinstatement and/or damages) are of a capital nature and therefore, not deductible.

In your case the matter is not yet resolved and generally in unfair dismissal cases the former employee may receive a compensation payment from the former employer. A compensation payment made by an employer to a former employee in settlement of an unfair dismissal action qualifies as an employment termination payment (ETP), as it is considered to be made 'in consequence of the termination of any employment of the taxpayer' (Taxation Ruling IT 2424, paragraph 24).  For this reason, an ETP, whether it is made in one lump sum or through several amounts, is capital in nature and your legal fees are generally considered when a compensation payment is offered.

As part of your legal expenses relate to items which were capital in nature, the legal expenses are also considered to be capital in nature. Therefore the legal expenses associated with the unfair dismissal are not deductible under section 8-1 of the ITAA 1997.

Employment contract and conditions of employment

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; (1932) 39 ALR 46; (1932) 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).

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).

Similarly, in FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable.

In your case, you were subject to discriminatory conditions in the workplace. You incurred legal expenses in respect of action to cease the discriminatory conditions and to successfully undertake your employment duties. When obtaining the legal representation, you were not aware at the time that your employer would later terminate your employment. While you were not directly defending the way in which you perform your duties, you were seeking to restore the conditions and environment of your workplace. It is accepted that part of the legal expenses are incidental and relevant to earning your assessable income.

Unpaid wages

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; 10 ATD 82). Compensation payments, which substitute income, have been held by the courts to be income under ordinary concepts (Federal Commissioner of Taxation v. Inkster (1989) 24 FCR 53; 89 ATC 5142, (1989) 20 ATR 1516). The payment retains the characteristics of ordinary income even though paid as a compensation amount.

In your case, the legal matter changed to compensation for unpaid wages after you were unexpectedly terminated from your employment without receiving your entitled four weeks' pay in lieu of notice of termination. You also were underpaid for your services compared to other employees.

Therefore, it is accepted that part of the legal expenses linked to unpaid wages are incidental and relevant to earning your assessable income and are an allowable deduction in part under section 8-1 of the ITAA 1997.

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