Edited version of private ruling

Authorisation Number: 1011642560235

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Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for legal expenses?

Answer:

No.

This ruling applies for the following period/s:

Income year ended 30 June 2005

Income year ended 30 June 2006

Income year ended 30 June 2007

Income year ended 30 June 2008

The scheme commences on:

1 July 2004

Relevant facts and circumstances

You were an employee

Your employer was taken over by another entity.

Your employer had a redundancy policy.

Any redundancy pay was in addition to payment in lieu of notice and similar entitlements.

You were given a period of notice of termination of your employment.

You were given no reason for this termination.

Prior to completion of your notice, you were required to vacant your employer's offices immediately and you were paid a lump sum in respect of payment in lieu of your termination notice.

You were not paid any redundancy payment.

You were not paid superannuation in relation to your notice period.

Your superannuation entitlement had formed part of your total remuneration package and prior to your termination was made via a salary sacrifice agreement.

You were not paid the redundancy payment on the basis your employer had dismissed you for misconduct.

You commenced legal action claiming an entitlement to be paid redundancy payments and payment of unpaid superannuation the court disallowed your claims

You appealed this decision.

You incurred costs relating to this legal action.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1936 section 23L

Reasons for decision

Summary

You are not entitled to a deduction for legal expenses as these expenses are capital in nature, or relate to income which is not included in your assessable income or is exempt income.

Detailed reasoning

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.

In determining whether a deduction for legal expenses is allowed, the nature of the expenditure must be considered. 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.

Where the advantage sought is the recovery of an amount on revenue account, that is unpaid wages, the character of the legal expenses is also of a revenue nature.

Romanin

In Romanin v FC of T 2008 ATC 20-055; [2008] FCA 1532 (Romanin) the court considered the deductibility of legal expense incurred by the taxpayer for proceedings at the Industrial Relations Commission. In the proceedings, the taxpayer argued that an employment contract existed where they were entitled to 12 months notice, or a payment in lieu of this notice. The employer had denied such a contract existed and had given seven days notice.

The proceedings found in favour of the taxpayer and the employer was ordered to pay them the total value of the employment package for the period of 12 months less any salary and other earnings that they had earned in alternative employment during the 12 months following the termination of his employment.

The legal expenses were found not to be capital in nature because the character of the advantage which the taxpayer sought in bringing the proceedings was on revenue account, namely receipt of his contractual entitlement to salary he would have received had he been given 12 months notice.

Legal expenses incurred to recover income payments such as were at issue in Romanin - that is, salary that would have been derived during the notice of termination period, had it been given - will be deductible, even if the receipt was paid as a lump sum and subject to assessment as an eligible termination payment.

This case can be distinguished from cases in which legal expenses are incurred in seeking compensation for loss of employment, such as in an action for wrongful dismissal or loss of office where the advantage sought is of a capital nature. In such cases, the legal expenses are of a capital nature, even if the amount awarded is calculated by reference to unpaid salary or lost income, or is assessable as statutory income.

Rowe

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.

Redundancy

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 the taxpayer for the loss of their employment position

Redundancy payments are treated as eligible termination payments and subject to special tax treatment that may result in some or all of the amount being included in your 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 your assessable income.

Superannuation

When an employee enters into an 'effective' salary sacrifice arrangement, they forgo an expected entitlement to an amount of salary and wages before it is earned in return for benefits of a similar value, that is, a fringe benefit (Taxation Ruling TR 2001/10, paragraph 77).

Section 23L of the Income Tax Assessment Act 1936 examines situations where certain benefits in the nature of income are not assessable. Income derived by way of the provision of a fringe benefit is not included in your assessable income. Where the benefit is an exempt benefit, the amount is exempt income. Therefore salary sacrificed superannuation is either not included in your assessable income or is exempt income.

Conclusion

In your situation, it is considered that the advantage you were seeking by way of the legal action was to recover a redundancy payment and superannuation entitlements to which you believed you were entitled. You were required to defend the way in which you performed your duties only as a mechanism with this outcome as your principle consideration.

The redundancy payment you were seeking was not related to an amount unpaid as payment in lieu of notice. A redundancy payment is capital in nature and your superannuation entitlement under your salary sacrifice agreement is not included in your assessable income or is exempt income.

Accordingly you are not entitled to a deduction for legal expenses as the nature of these expenses follows that of the advantage sought, which are capital in nature, or relate to income which is not included in your assessable income or is exempt income.