Edited version of your written advice

Authorisation Number: 1051453662035

Date of advice: 26 November 2018

Ruling

Subject: Deductions, legal expenses, misconduct allegations

Question

Are you entitled to claim a deduction for legal expenses incurred in defending employment misconduct allegations?

Answer

No

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

In 20xx you began full time employment with Company A.

On 20xx, you received a letter advising that you were suspended, without loss of pay, pending an investigation of misconduct charges not related to your employment duties. As a result, you engaged the services of a Lawyer A

You provided a copy of your employment contract which states that if an employee engages in serious misconduct, the employment may be terminated without notice.

Company A engaged the services of Lawyer B to investigate the allegations.

Lawyer A worked few months to clear your name and reputation and to enforce you entitlement to your rights under your employment agreement.

During your period of suspension, you received your salary and your superannuation contributions were paid.

You provided the amounts of the legal expenses paid to Lawyer A.

You signed a Deed of Release which ended the investigation with no adverse findings against you.

There have been no writs, pleadings, or letters of demand.

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.

The courts on a number of occasions have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer's business. The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's income earning activities or professional conduct.

In Case W94 89 ATC 792; AAT Case 5376 (1989) 20 ATR 4001, the Administrative Appeals Tribunal held that expenditure incurred on legal fees in circumstances where the conduct of the taxpayer was not related to their income earning activities, was not 'incidental and relevant' to the gaining or production of the taxpayer's assessable income.

In the more recent High Court decision, Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064, Mr Day was charged with breaching the standards of conduct and failing to fulfil his duty as an officer. It was found that the requisite connection with his assessable income was present and that he was exposed to the charges by reason of his office. The majority approach in this case was that an expense will satisfy the test outlined in paragraph 8-1(1)(a) of the ITAA 1997 if the occasion of the expense is found in whatever is productive of actual or expected income. They indicated that a broad approach should be taken in determining what activities produced the actual or expected assessable income, and that it is not only the day to day tasks performed by the employee that gain or produce this income.

Taxation Determination TD 93/29 Income tax: if an employee incurs legal expenses recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997? states that if the legal action goes beyond a claim for a revenue and constitutes an action for breach of employment contract where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible.

The ATO view is that where legal expenses are incurred in defending a taxpayer's actions or conduct arising from their income earning activities, the expenditure will, generally, be deductible under section 8-1 of the ITAA 1997.

In each case the nature of the alleged misconduct, the scope of a taxpayer's income earning activities and other existing circumstances, will determine whether the legal expenses are a deductible expense.

In your case, although your potential termination from your employment might have been an indirect consequence of any findings against you, it was not the object of your legal actions. Your legal expenses related to misconduct allegations brought against you that were outside the scope of your employment duties. You sought to clear your name and reputation.

As the legal expenses were not incurred in relation to your employment duties and did not relate to actions undertaken for the purpose of earning your assessable income, it follows that your legal expenses are private and domestic in nature and are not deductible under section 8-1 of the ITAA 1997.

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