Edited version of private advice

Authorisation Number: 1051515970989

Date of advice: 17 June 2019

Ruling

Subject: Work Related Expenses

Question 1

Are you entitled to a deduction for the portion of legal expenses you incurred in relation to defend the accusation that the amount paid to you was $XXXX not $XXXX and that it was required to be repaid?

Answer

Yes

Question 2

Are you entitled to a deduction for the portion of legal expenses incurred in relation to your claim for unlawful termination?

Answer

No

Question 3

Are you entitled to a deduction for the portion of legal expenses incurred in relation to your unpaid bonuses and annual leave?

Answer

Yes

Question 4

Are you entitled to a deduction for the portion of legal expenses incurred in relation to your loss of potential future earnings and bonuses?

Answer

No

Question 5

Are you entitled to a deduction for the portion of legal expenses incurred in relation to your loss of potential earnings from your previous employer?

Answer

No

Question 6

Are you entitled to a deduction for the portion of legal expenses incurred in relation to the imposition of a penalty following your termination?

Answer

No

Question 7

Are you entitled to a deduction for the portion of legal expenses incurred in relation to seeking orders in relation to declarations by the employer and the Managing Director of the contraventions made?

Answer

No

Question 8

Are you entitled to a deduction for the portion of legal expenses incurred when you suffered economic loss in relocating and lost value in your property?

Answer

No

Question 9

Are you entitled to a deduction for the portion of legal expenses incurred in relation to compensation being sought for suffering distress, hurt, humiliation, emotional upset, anxiety, feelings of inadequacy, depression and other emotional and psychological damage?

Answer

No

Question 10

Are you entitled to a deduction for the portion of legal expenses incurred in relation to your employer and the Managing director taking adverse action against you?

Answer

No.

This ruling applies for the following period(s)

Year ended 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You were an employee of the employer with a Managing director.

You were terminated from employment and entitlements not paid at this time.

You received legal letter advising that you had days to pay back a "loan" or you would be taken to court.

You enlisted lawyers and went to Fair work as your employer declined to pay entitlements and said they would pursue the payment as this was a loan, not a bonus.

You provided a payslip provided and advising that amount paid was $XXX, not $XXX as claimed, and, the amount had been taxed as a bonus and was stated as a bonus on the pays slip for this period.

You incurred Barrister fees of and lawyers' fees.

This has been fought in the Federal Court for years to

1.    Defend the accusation of the bonus and

2.    Claim back the taxable entitlements of notice in lieu and annual leave pay.

You provided a statement of claim outlining the circumstances and the various sections of the Fair Work Ac 2009 that you believe the employer had contravened. You claimed various losses including accrued but unpaid annual leave, loss of potential future earnings, relocation expenses and hurt and humiliation.

The employer lodged a cross claim in relation the amount paid to you as a loan.

The court found in your favour and awarded you an amount of compensation. The employer's cross claim was dismissed.

Summary

The legal expenses incurred in relation to defending the accusation of the bonus being a loan and in relation to your unpaid bonuses and annual leave while you were employed sufficiently relate to your day to day activities as an employee are an allowable deduction.

However, the legal expenses incurred in relation to your termination, future earnings, your loss of potential earnings from your previous employer, economic loss in relocating and lost value in your property, expenses incurred in relation to your employer and the Managing director taking adverse action against you, compensation being sought for suffering distress, hurt, humiliation, emotional upset, anxiety, feelings of inadequacy, depression and other emotional and psychological damage and legal action are either capital in nature or do not sufficiently relate to the earning of your assessable income and no deduction is allowed for the associated legal expenses.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

·         it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478),

·         there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

·         it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, in determining whether a deduction for legal expenses is allowable 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.

If expenses are incurred to dispute the receipt of income contractually owed under an employment contract, then the expenses are on revenue account and allowable as a deduction.

However, if the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the contract of employment 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. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible (Taxation Determination TD 93/29).

Bonuses and annual leave

Legal expenses incurred in recovering salary or wages are considered to be of a revenue nature and therefore deductible under section 8-1 of the ITAA 1997.

Similarly, legal expenses incurred in recovering unused annual leave are generally allowable as they directly relate to gaining or producing assessable income.

In your case you incurred legal expenses in relation to defending the claim that bonus paid to you was a loan not a bonus are deductible. These expenses relate directly to an amount that was included in your assessable income and are therefore deductible.

Additionally you incurred legal expenses to attempt to recover unpaid bonuses and annual leave that you would normally derive. It is considered that the associated legal expenses in relation to your unpaid bonuses and leave payments related sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

Termination, reinstatement and loss of future earnings

Taxation Determination TD 93/29 states:

If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for a breach of the contract of employment, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible.

The Courts, Boards and Tribunals have consistently held that the legal expenses incurred by taxpayers in defending themselves against dismissal from their employment are of a capital nature unless they are defending the way they carry out their day to day employment duties. This is because:

·         the legal expenses can be regarded as having been incurred once and for all, and

·         the advantage sought to be gained is the preservation of the taxpayers employment.

For example, in Case L26 79 ATC 126, a majority of the Board of Review No. 1 held that legal expenses incurred by a school teacher in appealing to a statutory board against her dismissal were not deductible.

In your situation, a portion of your legal expenses related to your unlawful termination claim and compensation for the loss of your employment position. Legal action was also taken to receive compensation for loss of future earnings.

Legal expenses incurred to receive compensation for loss of future earnings are not deductible as they are considered to provide an enduring advantage and are therefore capital in nature. The advantage sought by you in undertaking the action is the restoration of a capital asset, that is, your means of producing income. As such, the character of the legal expenses associated with this action are considered to be capital in nature and the expenses are not deductible under section 8-1 of the ITAA 1997 (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184).

Damages for stress and anxiety and medical costs

Medical expenses are generally regarded as private expenses. Additionally it is a long standing principle that a taxpayer does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some casual connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred in gaining or producing your assessable income (Lunney v Commissioner of Taxation (1958) 100 CLR 478). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3.

The deductibility of the expenses can also depend on whether the claims would have resulted in assessable income. Reimbursement of medical expenses or a payment for personal injury is not generally regarded as assessable income.

In your case, the legal expenses incurred in relation to your stress, anxiety and other medical costs do not have the required nexus with the derivation of assessable income and are of a private nature. Therefore, the associated legal expenses are not an allowable deduction under section 8-1 of the ITAA 1997.

Imposition of a penalty in relation to your termination

You sought an imposition of a penalty under the Workplace Relations Act in relation to your termination of your employment and the penalty imposed to be payable to you.

The imposition of a penalty on your former employer does not relate sufficiently to the earning of your assessable income. Although you also seek this payment to be made to you, such a payment in relation to your termination is generally regarded as being capital in nature. Consequently no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses incurred in relation to this matter.

Legal action after your termination

After your termination, you continued legal action and appealed to the Full Federal Court. As you were no longer an employee of the employer and there was no current employment agreement, the legal action taken is not considered to be sufficiently connected to your income earning activities. Furthermore, as highlighted above, action taken in relation to your termination is capital in nature. Therefore the legal expenses relating to action taken after your termination is not deductible under section 8-1 of the ITAA 1997.

Apportionment of expenses

As your legal expenses are not fully deductible, you will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

Where legal expenses are not broken up into the relevant parts by your solicitor, you will need to calculate the deductible portion. One way to apportion your expenses is according to the dollar value of the assessable amount as compared to the total amount being sought. The relevant percentage that relates to your assessable income can then be applied to the legal expenses incurred.

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