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Edited version of private ruling
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Ruling
Subject: Deductibility of legal expenses
Question and answer:
Are you entitled to a deduction for legal expenses relating to the claim made against your former employer?
No.
This ruling applies for the following periods:
Year ended 30 June 2009
Year ended 30 June 2010
The scheme commenced on:
1 July 2008
Relevant facts and circumstances
You were employed by your former employer for a number of years.
Your former employer terminated your employment in the income year ended 30 June 2009.
You received a number of weeks pay in lieu of notice, along with a payout of leave entitlements and a severance payment.
You believe that the number of weeks is inadequate as a reasonable period of notice for termination of employment given your number of years of service and your senior position.
You engaged the services of solicitors to take action against your former employer to increase the period of notice.
You have incurred legal fees in relation to these services.
You did not have a written contract of employment or letter of appointment with your former employer.
Your employment was not governed by any industrial award or workplace agreement.
Your solicitor has informed you that under section 661 of the Workplace Relations Act 1996 you were entitled to a minimum of four weeks' notice of termination, however, at common law your former employer is obliged to provide you with reasonable notice of termination or make a payment in lieu of such notice.
You believe that you are entitled to a deduction for legal expenses according to the principles set out in ATOID 2010/131.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Income Tax Assessment Act 1997 Section 105-8.
Reasons for decision
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 your case you have incurred legal expenses relating to a claim made against your former employer. The issue is whether these expenses are capital in nature.
ATO Interpretative Decision ATO ID 2010/131 states that a taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in seeking entitlements under an employment contract for payment in lieu of notice on termination of employment. In this case, which is supported by the Federal Court decision in Romanin v. Commissioner of Taxation [2008] FCA 1532; 2008 ATC 20-055; (2008) 73 ATR 760 (Romanin's case), the taxpayer was legally entitled to six months' pay in lieu of notice on termination of employment, and took legal action when the employer refused to make the payment, as agreed under the employment contract. The legal expenses in this situation are deductible as the lump sum payment that the taxpayer was seeking would otherwise be income by way of regular payments, and therefore ordinary income.
The facts in your case are distinguishable from those in ATO ID 2010/131 and Romanin's case. In your case, you received a lump sum payment upon your employment being terminated. You did not have an employment contract that stipulated what notice was to be given by your employer. The lump sum you received was above the minimum amount prescribed in the Workplace Relations Act 1996.
The legal action you have taken is not to recover an amount that you are contractually entitled to as ordinary income, rather, it is an action in which you are arguing that you were entitled to a greater amount of 'reasonable notice' than was given by your former employer. You are contesting that you are entitled to additional legal or equitable rights due to your years of service and your senior position.
A legal or equitable right is included in the definition of a CGT asset (section 105-8 of the ITAA 1997) and therefore the right is capital in nature.
As the expenses relate to a capital asset, they are not deductible under section 8-1 of the ITAA 1997.