Edited version of your written advice

Authorisation Number: 5010046640155

Date of advice: 30 November 2017

Ruling

Subject: Legal expenses

Question 1

Are the legal expenses incurred in relation to the lodgement of a Fair Treatment Form and resolving the workplace issues an allowable deduction?

Answer

Yes

Question 2

Are the legal expenses incurred in relation to your Workers’ Compensation claim an allowable deduction?

Answer

No

Question 3

Are the legal expenses incurred in relation to your redundancy an allowable deduction?

Answer

No

Question 4

Are the legal expenses incurred in relation to a payment as reasonable notice of termination an allowable deduction?

Answer

No

Question 5

Are the legal expenses incurred in relation to your settlement sum and Deed of Release an allowable deduction?

Answer

No

This ruling applies for the following period(s)

Year ending 30 June 2017

Year ending 30 June 2018

The scheme commences on

01 July 2016

Relevant facts and circumstances

You commenced employment

You sought medical consultation for work-related stress.

You are absent from work due to stress.

You began to experience inter personal conflict with a colleague. You and the colleague were in the same team. You did not report to the colleague and they did not report to you.

Informal Mediation took place.

Follow up mediation occurred as you advised it was difficult to do your job effectively.

There was a performance management and counselling meeting.

Formal diagnosis of Disorder was confirmed by a doctor.

There was a Personal Effectiveness Review

You were directed to attend a meeting to discuss and implement a Performance Management Plan.

You commenced absence from work due to a medical condition.

You lodged a Workplace Complaint through legal representative, raising bullying and harassment allegations in relation to the management of work performance. Your position stated on this form was Supervisor.

After seeking legal advice, you lodged a Workers Compensation claim with your employer’s insurer, seeking compensation for work related stress.

Employer provided a response to his workplace complaint and issued First Written Warning.

You submitted a signed witness statement to the Insurer, as requested.

Offer to resolve the issues with employer, through legal representative requesting to resolve all issues and for settlement of all claims with the exception of worker’s compensation, negligence and superannuation as per the following:-

1. Our client separates from his employment on the grounds of redundancy;

2. Employer pays to our client a settlement sum comprised as follows:

a. $XXXX to be taxed as a bona fide redundancy payment (equivalent to one year’s wages);

b. $XXXX payment as reasonable notice of termination (equivalent to 6 months wage);

c. $XXXX general damages for hurt, humiliation and distress; and

d. $XXXX being a contribution towards his legal fees.

Workers Compensation claim was rejected as it was out of time.

You requested a review for the rejected claim.

You, through legal representative, lodged an application to the Fair Work Commission to deal with a dispute. The Fair Treatment Form was part of the Fair Work Commission Dispute.

Your employment ceased.

Without any admission of liability by either party, you and the employer agreed to finalise all matters arising out of or related to the Employment, the Complaint, the Application and the Cessation of Employment on the terms set out in the Deed of Release.

You received $XXXX which comprises of a settlement sum and payment in lieu of statuary notice, which was taxed as an employment termination payment.

Under the Deed of Release, you must discontinue the Fair Work Commission application.

You are receiving income protection insurance payments from your superannuation fund, for a period of two years.

You have incurred approx. $XXXX in legal fees.

The Fair Treatment Form is part of the Fair Work Commission Dispute.

The WorkCover Claim relates to the Fair Work Commission Dispute.

You and your colleague were in the same team.

You did not report to the colleague and the colleague did not report to you.

Assumption(s)

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Your legal expenses incurred in relation to resolving the bullying in the workplace while you were employed sufficiently relate to your day to day activities as an employee and are an allowable deduction.

However, the legal expenses incurred in relation to your redundancy termination payment, Deed of Release, hurt, humiliation and stress are capital in nature or do not sufficiently relate to your employment duties and no deduction is allowed for the associated legal expenses.

Legal Expenses and Workplace Issues.

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.

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business or employment duties (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).

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties, in order to defend the threat of dismissal, were allowable. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income.

In your case, you allege that other’s actions and inappropriate behaviour hindered the performance of your day to day employment duties. You incurred legal expenses in relation to bullying in your work place and possible ways to remedy the situation.

The associated legal expenses in seeking advice about your current employment situation and possible ways to restore or improve your day to day working conditions were a consequence of defending your rights under your current employment situation. It is considered that this portion of your legal expenses was a consequence of your day to day activities as an employee from which you derived assessable income. Therefore the associated legal expenses incurred are deductible under section 8-1 of the ITAA 1997.

For Work Related Stress Through A Workers Compensation Claim.

You have suffered a work related injury and incurred legal fees in seeking damages. The damages sought do not relate to any lost earnings.

Relevantly, in these circumstances, irrespective of the outcome of the legal action and notwithstanding that the legal expenses arose from your employment activities, they are of a capital nature as they are incurred for the purpose of obtaining compensation or damages for a wrong or injury suffered in his occupation. They are not incurred in seeking payment of an amount of ordinary assessable income (or an amount in lieu of such income)

Consequently, your legal expenses are not deductible under section 8-1.

Redundancy, Termination and Deed of Release.

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.

In your situation, although you were not dismissed, much of your legal expenses related to negotiating a suitable termination package and preparing the Deed of Release. Legal expenses incurred in negotiating a termination package and preparing your Deed of Release do not sufficiently relate to your day to day employment duties. Furthermore, such expenses are not deductible as they are considered to provide an enduring advantage and are therefore capital in nature (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184). Although the employment termination payment you received is subject to special tax treatment that results in the amount being included in assessable income, this does not change the character of the payment.

No deduction is allowable under section 8-1 of the ITAA 1997 for the associated legal expenses.

Apportionment of expenses

As outlined above, your legal costs relate partly to deductible legal action and partly to non-deductible legal action. Therefore only the relevant portion of the associated legal expenses is an allowable deduction.

The portion of the legal costs incurred in relation to your employment duties are considered to be sufficiently connected to your assessable income and deductible. However, the portion that relates to your injuries termination package and Deed of Release are capital in nature and no deduction is allowed for these associated legal expenses.

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 income amount as compared to the total amount agreed to under your termination package. The relevant percentage can then be applied to the legal expenses incurred.

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