Edited version of private advice

Authorisation Number: 1051907937930

Date of advice: 20 October 2021

Ruling

Subject: Deductions - legal expenses

Question

Are you entitled to a deduction for your legal expenses incurred for unfair dismissal from your employment?

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

You were employed by your former employer.

You participated in a meeting with management, which allegations were made against you for:

•         The seriousness around lack of accountability, low levels of engagements with understanding of internal project governance and finance processes.

•         The inability to perform the inherent requirements of the role, lack of delivery and reputational risk to the company.

Your former employer advised your employment was being terminated effective immediately.

You engaged a legal practitioner to assist you in taking legal action against the dismissal to the Fair Work Commission.

You applied to the Fair Work Commission to commence unfair dismissal proceedings against your former employer on the grounds your dismissal was harsh, unjust, and unreasonable.

In your application, you have advised the outcomes you wish to seek by lodging an unfair dismissal application were:

•         Your letter of termination be retracted

•         An apology provided from the Board and senior management of your former employer

•         Your role be made redundant and on redundancy, in addition to the X weeks' notice and statutory entitlements, the following

­   Redundancy payment of XX weeks

­   Ex-gratia payment of XX weeks.

•         Your former employer to reimburse your legal costs

•         An agreed Statement of Service

•         Re-instatement.

You have advised you were seeking settlement for damages to your personal and professional reputation, stress and loss of income going forward.

Your action was settled with an agreement under a Deed of Release, which you received an ex-gratia amount of $XX. This was paid out to you approximately two weeks after settlement occurred.

You advised you received an additional ex-gratia payment of $XX paid on the same day.

You incurred legal expenses for representation in this case. You wish to claim your legal fees and associated costs as a deduction. The total you wish to claim is $XX.

You have provided copies of invoices from your legal practitioner for your legal fees which are categorised as various work associated with this claim.

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 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, or relate to the earning of exempt income.

In determining whether a deduction for legal expenses is allowable, the nature or character of the expenditure must be considered, that is, whether the legal expenses are incurred for a capital or a revenue purpose (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. For example, if the advantage to be gained is of a capital nature, then the legal expenses incurred in gaining the advantage will also be of a capital nature and are not deductible.

Compensation for unfair dismissal

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

Taxation Determination TD 93/29, paragraph 5 states:

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, the legal costs would not be deductible because they are capital in nature. For example, legal expense relating to an action for damages for wrongful dismissal are not deductible.

Tax 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.

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 taxpayer's employment.

Consequently, it is clear that your legal expenses that relate to your claim for damages including ex-gratia payments, retraction of termination, apology from the board & senior management of your former employer and agreed Statement of Service for unfair dismissal are not deductible as they are considered to provide an enduring advantage and therefore, capital in nature.

Redundancy payment

The nature of a redundancy payment was considered in Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184. In that case, it was held that a redundancy payment, being compensation for the loss of the expectation of continuity of service, is a payment that is capital in nature. The payment is made to compensate for the loss of employment position, that is, as compensation for the sterilisation of a capital asset, and thus is capital in nature.

Redundancy payments are treated as eligible termination payments and subject to special tax treatment that may result in some or the entire amount being included in the taxpayer's assessable income. However, the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

A redundancy payment received by a taxpayer is capital in nature and consequently the legal expenses incurred in seeking the redundancy payment are also capital in nature.

The legal expenses you incurred in seeking a redundancy payment are not deductible as they are expenses of a capital nature.

Reinstatement

The deductibility of legal expenses incurred in seeking reinstatement where the former employee claimed they were unfairly dismissed was considered in Case L26 79 ATC 126; 23 CTBR (NS) Case 32 (Case L26). In that case, the taxpayer was employed as a music teacher by the Commonwealth Teaching Service. She was dismissed from her employment as a school teacher on the ground that she could not control classes. She was unsuccessful in her appeal to the Disciplinary Appeal Board against her dismissal.

The taxpayer claimed a deduction for her legal expenses in relation to the appeal. It was held that although the expenditure was a necessary step prior to regaining income from the employment from which the taxpayer had been dismissed; it was not expenditure incurred in the course of gaining or producing such income. Thus, the expenditure was not deductible.

Also, expenditure incurred in seeking reinstatement is considered to be incurred in order to obtain an enduring advantage, being the regaining of the employment position, and therefore is an advantage of a capital nature.

Conclusion

In your case, you incurred expenses in taking legal action against your employer for unfair dismissal. Your legal action has gone beyond a claim for revenue hence the legal costs are not deductible, because they are capital in nature.

As your legal costs were all capital in nature and therefore in accordance with Commissioner's view expressed in TD 93/29 are not deductible under section 8-1 of the ITAA 1997.

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