Edited version of private ruling

Authorisation Number: 1011688229926

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Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for legal expenses relating to a WorkCover claim?

Answer:

Yes.

Question 2

Are you entitled to a deduction for legal expenses relating to disagreements with your employer over your return to work program?

Answer:

Yes.

Question 3

Are you entitled to a deduction for interest incurred on a loan in your partner's name and used to pay your legal expenses?

Answer:

No.

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

In 200X you began an extended period of sick leave from your work due to work related stress.

In the subsequent year you lodged an Application for Compensation with WorkCover.

WorkCover undertook an investigation into the circumstances surrounding the Application for Compensation and provided you with written notice of its decision to reject your application for a psychological injury.

You returned to work in a subsequent year.

You lodged a complaint with the Ombudsman over the conduct of your employer.

There were considerable disagreements between yourself and your employer over your return to work program and you incurred legal expenses in relation to these disagreements.

In the recent year you lodged an official complaint with the relevant authority relating to the conduct of your employer.

You are in a long term de-facto relationship.

Your finances are combined with your de-facto partner's in accounts which are all in your partner's name.

The only account in your name is an unused account that you had to establish while on temporary disablement benefit.

You had insufficient savings to pay for the legal fees incurred so your partner drew down on the equity in your home which is solely in the partner's name, as is the corresponding loan. The property was purchased while you were together.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 on the Income Tax Assessment Act 1997 (ITAA 1997) provides that a loss or an outgoing is an allowable deduction if it is incurred in producing assessable income or in carrying on a business for the production of assessable income unless that loss or outgoing is capital or of a private or domestic nature.

Legal expenses relating to the WorkCover Claim

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 which is sought to be gained by incurring the expenses.

The legal expenses incurred by you in order to obtain the WorkCover compensation payment, if successful, would have resulted in you gaining assessable income. Thus, there is a clear connection between the assessable income and the expense. The amount received by you is to replace lost earnings and is therefore revenue in nature and not a capital receipt.

Accordingly, the legal expenses related to the WorkCover claim were incurred in gaining your assessable income and are deductible.

Legal expenses relating to disagreements with your employer over your return to work program

The courts on a number of occasions have determined legal expenses to be an allowable deduction if the legal expenses arise out of the day to day activities of the taxpayer's business. The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business and the expense may arise out of litigation concerning the taxpayer's profession.

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, an employee incurred legal expenses in defending the manner in which he performed his employment duties. The court accepted that such expenses were allowable and no significance was placed on the taxpayer's status as an employee.

The general principle is that a deduction is allowed where the legal expense has arisen as a consequence of the day to day activities of the business or employment whether or not the expenses are common or recurring (Herald and Weekly Times v FC of T 48 CLR 113; 2 ATD 169 Putnin v FC of T 91 ATC 4097; 21 ATR 1245).

In your case, you were absent from your employment for an extended period of time due to a medical condition. You incurred legal expenses in relation to matters that arose from your return to work program including issues raised with the Ombudsman and another relevant authority.

Although you were not directly defending the manner in which you performed your duties, the legal counsel you engaged was to assist in maintaining a safe environment to carry out those duties. Therefore, the expenses are deductible under section 8-1 of the ITAA 1997.

Interest expenses

In order for the interest expense to be deductible under section 8-1 of the ITAA 1997 the taxpayer must establish the essential character of the interest incurred was to gain or produce assessable income. In determining the essential character of an interest outgoing, regard must be had to its connection with the income producing activities of the taxpayer ( Federal Commissioner of Taxation v. Smith (1981) 147 CLR 578 at 586; 81 ATC 4114 at 4117; (1981) 11 ATR 538 at 542).

In your case, your partner drew down on the equity in your home, which is solely in the partner's name, to pay your legal expenses. The loan was solely in your partner's name, it is therefore your partner who incurs the interest expenses. This is irrespective of whether you contribute to the loan repayments. The loan is not in your name and therefore you cannot be considered to have incurred the expense.

As such you are not entitled to a deduction for the interest expense incurred for monies used to pay your legal expenses.