Edited version of your private ruling

Authorisation Number: 1011958701339

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for legal expenses incurred to seek advice in relation to performance management issues and your bullying and harassment claim while you were employed?

Answer

Yes.

Question 2

Are you entitled to a deduction for legal expenses incurred to make your unfair dismissal claim?

Answer

No.

Question 3

Are you entitled to a deduction for the full amount of your legal expenses incurred in relation to your workers' compensation claim?

Answer

No.

Question 4

Are you entitled to a deduction for a portion of your legal expenses incurred in relation to your workers' compensation claim?

Answer

Yes.

Question 5

Are you entitled to a deduction for your legal expenses incurred in relation to your common law claim for damages for personal injuries sustained in your employment?

Answer

No.

This ruling applies for the following periods:

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 Unfair Dismissal Remedy

· your statement regarding the workers' compensation claim, and

· letters from your solicitors which include the Deed of Release in relation to the workers' compensation claim and the Writ of Summons in relation to the common law claim for damages.

You began employment with your former employer several years ago.

A few years ago, you became subject to bullying and harassment from your manager.

You developed a physiological condition and had time off work at various stages.

Your condition subsided when the manager was promoted to a different office.

However after this time, you were subjected to a performance management process and received letters about your work performance.

You were later terminated from your employment. You were paid a sum for your outstanding entitlements under your employment contract.

You believed you were unfairly dismissed and therefore initiated, among others, an unfair dismissal claim with Fair Work Australia.

Under the Fair Work Act 2009, the remedies available for unfair dismissal are the ordering of a person's reinstatement or the payment of compensation in lieu of reinstatement. The remuneration that the person would have received, had they not been dismissed, is a factor that is taken into account when determining the compensation amount.

Regarding the unfair dismissal claim, you sought a compensation amount based on a portion of your pay and entitlements from your prior year income tax return.

You also believed that you should have received workers' compensation payments during the periods you were off work due to the stress, anxiety and physiological condition you suffered as a result of the workplace bullying and harassment. Therefore, you engaged a law firm to represent you in a workers' compensation claim. The compensation sought in this action was for:

· the periods of time that you were unfit for work because of your stress, anxiety and physiological condition, being paid in weekly instalments, and

· the medical expenses that you incurred.

The law firm also represented you in a common law claim against your former employer. The Writ of Summons prepared by the law firm states that your claim was for damages for personal injuries sustained in the course of your employment due to bullying and harassment.

You and your former employer agreed to settle the workers' compensation and common law claims. Under the Deed of Release, both claims were settled in exchange for a payment of a sum to you.

You incurred legal expenses in seeking advice during your employment in regards to the performance management issues. You also incurred legal expenses after the termination of your employment, to pursue the unfair dismissal, workers' compensation and common law claims.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

You are entitled to a deduction for the legal expenses you incurred, whilst employed, to seek advice regarding the bullying and harassment claim and performance management issues. These expenses are regarded as having a connection to your day to day income earning activities.

You are also entitled to a deduction for the portion of the legal expenses incurred in pursuing the workers' compensation claim, in regards to the weekly payments to compensate for the period of time where you were unfit to work. As the weekly payments are income amounts the legal expenses incurred in claiming these amounts are incurred in earning assessable income.

However, you are not entitled to a deduction for the legal expenses you incurred, after your employment was terminated, in bringing the following claims:

· unfair dismissal claim with Fair Work Australia,

· the part of your workers' compensation action relating to the claim for medical expenses, and

· the common law claim for damages for your personal injuries.

These claims are for amounts that are not income in nature. Therefore, the legal expenses relating to these claims are not expenses incurred in earning assessable income and are consequently not deductible.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or outgoing to the extent that it is incurred in gaining or producing assessable income, except where it is of a capital, private or domestic nature.

Therefore, in determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expense must be considered.

The nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses (Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634; (1946) 8 ATD 190). 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.

For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income, (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

Further, legal expenses are generally deductible if they arise out of the day to day income producing activities of the taxpayer (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169). The legal action must have more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).

It follows also that the character of legal expenses is not determined by the success or failure of the legal action.

Consequently, it is necessary to consider the reason why your legal expenses were incurred. The nature of each of the advantages sought from your legal proceedings is considered below.

Legal expenses incurred while employed

In FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred while a taxpayer was employed, in defending the manner in which he performed his employment duties, were deductible.

You were subjected to bullying and harassment in the work place, at the hands of your manager, which included performance management. These actions impacted your health and your ability to carry out your day to day duties. You sought legal advice about how best to approach the situation with your employer and to attend scheduled meetings. As the bullying and harassment had included performance management, it is considered that the legal expenses were incurred in relation to your day to day employment duties.

As the legal expenses were incurred to enable you to carry out your employment duties, there is more than just a peripheral connection to your income producing activities. You are therefore entitled to a deduction for the legal expenses incurred whilst you were employed.

Unfair dismissal claim - after termination of employment

The deductibility of legal expenses incurred in relation to an action for unfair dismissal was considered in Case L26 79 ATC 126; 23 CTBR (NS) Case 32 (Case L26). In that case, the taxpayer was employed as a music teacher by the Commonwealth Teaching Service. She was dismissed from her employment as a school teacher on the ground that she could not control classes. She was unsuccessful in her appeal to the Disciplinary Appeal Board against her dismissal. The taxpayer claimed a deduction for her legal expenses in relation to the appeal. It was held that although the expenditure was a necessary step prior to regaining income from the employment from which the taxpayer had been dismissed; it was not expenditure incurred in the course of gaining or producing such income. Thus, the expenditure was not deductible.

The decision in the above case is confirmed in Taxation Determination TD 93/29 which states that legal expenses relating to an action for wrongful dismissal are not deductible. The expenses are capital in nature and also are not incurred in order to gain an income amount.

In your case, you began an action with Fair Work Australia claiming to be unfairly dismissed from your employment. You sought to be compensated with an amount based on your pay and entitlements from your prior year income tax return.

Although the compensation amount you sought was calculated based on your previous rate of pay, compensation for unfair dismissal is a capital payment, that is, it is not a payment that is considered to be income.

As the payment you were seeking was not an income amount, the legal expenses you incurred to pursue the unfair dismissal claim are not deductible under section 8-1 of the ITAA 1997.

Workers' compensation claim and common law claim - after termination of employment

In making the workers' compensation claim, you were seeking to be paid weekly payments of compensation for the periods of time where you were certified unfit to work. You were also seeking compensation for your medical expenses.

Regarding the weekly payments, the advantage you sought was to receive payments that are income amounts. Therefore, the associated legal expenses are deductible.

However, a compensation payment for medical expenses is not considered to be an income amount. Therefore, the portion of your legal expenses that relate to your claim for compensation for medical expenses was not incurred in earning assessable income and consequently is not deductible.

You also made a common law claim for damages for personal injuries sustained in the course of your employment due to bullying and harassment. A payment for damages for personal injuries is not an income amount. Therefore, the portion of your legal expenses that relate to your common law claim for damages for personal injuries was not incurred in earning assessable income and consequently is not deductible.

You were represented by a law firm in your workers' compensation and common law claims. As discussed above, only the portion of their fees that relate to the claim for weekly workers' compensation payments is deductible. Therefore, a reasonable apportionment is required to determine the portion of their fees that are deductible.

TD 93/29 states that where a solicitor's account is itemised, one reasonable basis for apportionment would be the time spent involving the deductible claim, relative to the time spent on the non-deductible claim. If the solicitor's account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the deductible claim, or, where this is not possible, an apportionment on the basis of the monetary value of the deductible claim relative to the non-deductible claim. In your case, the deductible claim is the claim for weekly workers' compensation payments and the non-deductible claims are the claims for compensation for your medical expenses and damages for personal injuries.

You should apply the above principles in determining the portion of the legal fees that can be claimed as a deduction.