Edited version of private ruling

Authorisation Number: 1011884611719

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Ruling

Subject: Legal Expenses

Question 1

Are you entitled to a deduction for all of your legal expenses?
Answer

No.

Question 2

Are you entitled to a deduction for the portion of legal expenses which relate to the payment of unpaid bonuses and car allowances component of your claim?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling;

· the statement of claims; and

· plaintiff's summary of damages claimed.

You were the managing director of a company.

Your employment was terminated on the basis of not fulfilling your contract.

Your previous employer stated reasons for termination were performance related which you rejected and then undertook legal action.

You took legal action against your former employer on the basis of breach of contract, entitlement to an unpaid bonus and loss of future earnings.

Your statement of claim details the particulars of your claim from your previous employer as:

· Car allowance (3 months proportion)

· Health Insurance (3 months proportion)

· Bonus (for 20XX)

· Superannuation (3 months proportion)

· Superannuation on bonus (for 20XX)

· Damages

· Interest and

· Costs.

Included in your claim for damages were amounts for:

· Loss of reputation and career prospects, distress, disappointment, vexation and inconvenience

· Lost opportunity damages regarding ongoing and future employment

· General damages for distress, disappointment and vexation

· Damages regarding notice term

· Damages regarding bonus term

· Lost opportunity damages seeking employment from position of employment

· Equitable compensation

· Lost opportunity damages regarding opportunity to negotiate higher salary

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Summary

It is only legal expenses incurred in the process of claiming assessable income that will be an allowable deduction.  When a legal claim includes amounts that would not have been included in your assessable income, such as superannuation and damages, the legal expenses relating to the claim of these amounts will not be deductible.  In your case only the legal expenses incurred in claiming your unpaid bonus and car allowance will be deductible as these amounts would have formed part of your assessable income.

Detailed Reasoning

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.

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.

Bonus and Car Allowance

Legal expenses incurred in recovering salary or wages are considered to be of a revenue nature and therefore deductible under section 8-1 of the ITAA 1997.

Similarly, legal expenses incurred in recovering unused bonuses are generally allowable as they directly relate to gaining or producing assessable income.

In your case you incurred legal expenses in relation to unpaid bonuses and a car allowance that you would normally derive. It is considered that the associated legal expenses in relation to your unpaid bonuses and car allowance related sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

Health Insurance

Fringe benefits do not form part of your assessable income and therefore any legal expenses incurred relating to unpaid health insurance is not deductible under section 8-1 of the ITAA 1997.

Superannuation contribution

Mandatory employer superannuation contributions do not form part of your assessable income. They are paid as a requirement of the Superannuation Guarantee (Administration) Act 1992. Although you may have suffered a loss as a result of the non payment of these contributions the loss cannot be said to be a loss or outgoing incurred in order to earn your assessable income. The amount of your assessable income is not affected by the non payment of superannuation employer contributions.

In your case part of your legal costs related to recovering unpaid superannuation payments. As the superannuation payments are not considered part of your assessable income it cannot be said that the legal expenses were incurred in the process of deriving assessable income. As such you are not entitled to a deduction under section 8-1 of the ITAA 1997 for the associated legal expenses.

Damages

Taxation Determination TD 93/29 at para. 5 states:

However, 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 expenses relating to an action for damages for wrongful dismissal are not deductible.

In your case a large part of your claim related to damages, in particular lost opportunity damages regarding ongoing and future employment. The damages you were seeking would have been a capital amount. The legal expenses incurred were not related to the earning of assessable income and are therefore not deductible under section 8-1 of the ITAA 1997.

Apportionment of expenses

As your legal expenses are not fully deductible, 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 amount as compared to the total amount (including damages) being sought. The relevant percentage that relates to your assessable income can then be applied to the legal expenses incurred.