Edited version of private advice

Authorisation Number: 1051806282772

Date of advice: 23 February 2021

Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for the legal expenses incurred?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2020

The scheme commences on:

1 July 2019

Relevant facts and circumstances

You engaged the services of a Solicitor to seek compensation from your former employer for a personal injury that occurred at work.

You provided an itemised Tax Invoice from your Solicitor. You incurred legal expenses.

You provided a Release and Discharge Agreement (Agreement) between you and your former employer.

You provided a Pay Advice from the Employer showings payments made as per the Agreement.

You provided a Pay Advice from the Employer showing a portion of the tax previously deducted from your pay was repaid.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of 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.

Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income.

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.

Legal expenses are generally deductible if they arise out of the day to day income earning activities (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) 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 80 ATC 4542; (1980) 11 ATR 276).

If the advantage to be gained does not have an immediate connection to the duties undertaken to derive income and has more of an enduring and consequently capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

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; (1952) 10 ATD 82). Lump sum damages awarded for a personal injury, wrong or illness suffered, which is not direct compensation for loss of income, will usually be capital in nature.

This principle is confirmed in Taxation Ruling TR 2012/8. Paragraph 45 states:

Compensation for loss of employment, such as in an action for wrongful dismissal or loss of office, is a capital receipt (Scott v. Commissioner of Taxation). Legal costs incurred in seeking such compensation are not deductible because the nature of the advantage sought is capital. This is so, even if the amount of compensation awarded is calculated by reference to unpaid salary or lost income or is assessable as statutory income.

In your case, you sought a claim for compensation from the Employer for an injury suffered during the course of your employment. The claim was rejected, and you disputed the rejection of your claim. You and the Employer agreed to settle the claim on the terms of the Agreement. You incurred legal expenses in seeking the compensation for the personal injury. The essential character of the advantage or compensation sought did not relate to any revenue items such as salary or wages.

Whilst the legal expenses arose from your employment activities, they are of a capital nature because the principal reason for incurring the expenses was for the purpose of obtaining compensation for an injury suffered in your occupation. Compensation payments in respect of your personal injuries claim is of a capital nature. They were not incurred in seeking payment of an amount of ordinary assessable income.

As the nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses, the expenses you have incurred are considered to be of a capital nature and are not deductible. Accordingly, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses incurred in obtaining the personal injury compensation.

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