Edited version of your private ruling

Authorisation Number: 1051764581007

Date of advice: 17 May 2021

Ruling

Subject: Legal deductions

Question 1

Are the legal expenses you incurred when defending criminal charges arising from your employment activity deductible?

Answer

Yes

Question 2

Are the legal expenses you incurred when defending your employer's charges arising from your employment activity deductible?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You were involved in an incident while undertaking your employment duties.

Following this incident, you were suspended from your employment with pay pending investigations by your employer. You were also charged with a criminal offence.

You incurred expenses to obtain legal assistance in relation to the investigation conducted by your employer and to defend the criminal charge.

The criminal charges were dismissed.

After the criminal charges were dismissed and following their own investigation, your employer advised that you had been found guilty of misconduct and your employment was terminated.

You do not have Professional Indemnity Insurance and are not pursuing your employeror any person for recovery of legal expenses.

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, or relate to the earning of exempt income.

It is well established that the words 'incurred in gaining or producing assessable income' are to be understood as meaning 'incurred in the course of gaining or producing assessable income', and do not convey the meaning or outgoings incurred 'in connection with' or 'for the purpose of' deriving assessable income (Commissioner of Taxation v Payne [2001] HCA 3 and Commissioner of Taxation v Day [2008] HCA 53). Further, it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, what would be expected to produce assessable income (Ronpibon Tin NL v Federal Commissioner of Taxation (1949) 76 CLR 47).

Essential to the inquiry of whether expenses are incurred in gaining or producing assessable income is what it is that is productive of assessable income. A determination as to what is productive of assessable income in a particular case may need to take account of any number of positive and negative duties to be performed or observed by an employee or other salary-earner. It is that determination which provides the answer as to whether the occasion is provided for the expenditure in question.

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.

It is generally accepted that legal expenses will be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer and are relevant to the performance of the taxpayer's duties.

When determining the scope of your duties, it is necessary to consider that you were engaged to perform the tasks and duties set out in your contract of employment and you were also obliged to observe the standards of conduct set out in your employer's Code of Conduct. Failure to observe those standards of conduct exposed you to disciplinary proceedings which might have consequences for the retention of your office or salary.

The incident which resulted in an investigation being carried out and charges being made against you by your employer occurred while you were carrying out your employment duties. Accordingly, the legal expenses incurred as a consequence of defending the charges raised by your employer, arose out of your day to day duties. The occasion of your legal expenses can be found in your position as an employee.

Therefore, the legal expenses incurred in defending your employer's charges are deductible under section 8-1 of the ITAA 1997 (Commissioner of Taxation v Day [2008] HCA 53).

The incident also exposed you to criminal charges.

Legal expenses incurred with respect to criminal sanctions are generally private in nature and are not deductible. This is because the criminal law applies regardless of any employment obligation and the advantage sought to be gained in incurring the expenses is to avoid a prison sentence or to protect the taxpayer's personal reputation.

Accordingly, where a taxpayer commits a criminal offence outside the workplace, such as stealing a car or other property, or the offence is committed in the workplace but is wholly unrelated to the employee's duties of employment, the legal expenses incurred in defending the criminal charges won't be deductible even if the taxpayer will lose their job if convicted of the offence. The occasion of the outgoings in those circumstances is the taxpayer's private conduct and is unrelated to the taxpayer's employment duties (Schokker v Federal Commissioner of Taxation [1999] FCA 600).

However, where the legal expenses can be described as involuntary expenditure (meaning that the taxpayer's subjective motive for incurring the expenses is irrelevant) and they are incurred in defending the manner in which the taxpayer's professional practice has been conducted, they may be deductible (Herald & Weekly Times Ltd v Federal Commissioner of Taxation [1932] HCA 56; Putnin v Commissioner of Taxation (1991) FCR 506) where they are not of a private nature.

Although you were not employed to engage in criminal activity, the incident which gave rise to the criminal charge occurred while you were in the act of carrying out your employment duties and was done as part of your employment requirements. The legal expenses directly arose from the carrying out of your income producing activity and the need to defend the way you carried out that activitiy.

Your expenses of defending criminal charges had more than a temporal, location connection to your work, or criminal activity not directly attributable to performing your work duty, such as:

•         Fraudulent activity conducted during working hours or at a work location

•         Embezzlement of employer funds or accepting bribes to act inconsistent with work requirements.

Further, there was no private element to your actions, such as a personal dispute with a fellow worker or person leading to assault charges that merely happened to occur during work time or at a work location and did not directly arise from performing work activities.

Therefore, the legal expenses incurred in relation to defending the criminal charges are deductible under section 8-1 of the ITAA 1997.

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