Edited version of private advice

Authorisation Number: 1052312319318

Date of advice: 22 October 2024

Ruling

Subject: Legal expenses - total and permanent disability claim

Question 1

Are the legal expenses of $X you incurred to gain a total permanent disability (TPD) payment through your super fund deductible?

Answer

No.

Question 2

Given a portion of the TPD payment is assessable income, is the portion of legal expenses associated with assessable income deductible?

Answer

No.

This ruling applies for the following period

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX.

Relevant facts and circumstances

In MM 20XX, you sustained a workplace injury.

You subsequently engaged X Lawyers to represent you to make a claim on your TPD insurance through your superannuation fund.

On or around DD MM 20XX, your TPD claim was accepted.

On or around early MM 20XX, you received a lump sum of $X which is your insured benefit from your superannuation fund:

$ lump Sum X allocated as below:

•         $X assessable income for year ending 30 June 2024.

•         $X less pay as you go (PAYG) withholding.

•         $X tax free component.

You incurred legal expenses of $ X related to your TPD claim.

You do not have professional indemnity insurance.

You will not seek to recover costs from the other party.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Summary

You incurred the legal expenses to pursue your TPD claim with your superannuation fund. Your claim for TPD was approved and you received your disability superannuation benefit, which is a capital receipt. It follows that the legal expenses you incurred in relation to your claim for full entitlement to your superannuation benefits are capital in nature. Capital expenses are not deductible.

Consequently, no deduction is allowable under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the legal expenses of that were incurred in order to obtain the superannuation benefit. Although the taxed element of your superannuation benefit is included in your assessable income, the superannuation benefit retains its character as a capital receipt.

Detailed reasoning

Section 8-1 of the 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.

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenses must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses, that is, whether the legal expenses are incurred for a capital or revenue purpose. The outcome of the legal action does not affect the deductibility of the legal expense, rather the nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses.

ATO Interpretative Decision ATO ID 2001/667 Income Tax Legal Expenses - to recoup full entitlement to a superannuation lump sum payment explains that 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. Whether a capital payment is specifically brought to account as assessable income does 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. Therefore, as the legal expenses were incurred in gaining a capital sum, they were also of a capital nature and therefore not deductible under section 8-1 of the ITAA 1997.

Application to your circumstances

In your case, you incurred legal expenses of $ X in order to obtain full entitlement to your superannuation benefit, which is a capital receipt. It follows that the legal expenses you incurred in relation to your claim for full entitlement to your superannuation benefits are capital in nature.

The taxation of superannuation payments is determined by specific legislative provisions. Superannuation capital payments, or parts of such payments, may nevertheless be included in assessable income by those specific legislative provisions.

As in ATO ID 2001/667, the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. That is, an amount that is capital in nature will remain capital even though it is specifically included as assessable income. Although the taxed element of your superannuation benefit is included in your assessable income, the superannuation benefit retains its character as a capital receipt.

As the total permanent disability benefit received is capital in nature, the expenses incurred in relation to your claim are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses you incurred in relation to your disability benefit as expenditure of a capital nature is expressly excluded under section 8-1 of the ITAA 1997.

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