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Ruling

Subject: legal expenses

Question

Are you entitled to a deduction for legal expenses?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2011

Year ending 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You were employed under an employment agreement.

Your employment was terminated by your employer.

You were paid four weeks pay in lieu of notice.

You took legal action against your employer for unlawful termination and engaged a lawyer and barrister.

A statement of claim was issued seeking 26 weeks payment in lieu of notice and two weeks annual leave under the terms of your employment agreement.

You agreed to a settlement prior to the court hearing.

You received a payment less tax at the employment termination payment rate.

You incurred legal expenses.

You have provided copies of the following documents that support your claim:

· Lawyers letter to your employer

· Statement of claim

· Release agreement

· Lawyers letter confirming outcome

· Invoices for legal expenses

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

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.

For legal expenses to constitute an allowable deduction it must be shown that they were incidental and relevant to the production of the taxpayer's assessable income (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR47; (1949) 4 AITR 236; (1949) 8 ATD 431).

In determining whether a deduction for legal expenses is allowed, 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 expense incurred in gaining the advantage will also be of a capital nature.

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

Taxation Ruling TR 2000/5 sets out the Commissioners view on the cost incurred in preparing and administering employment agreements. Paragraph 2 of this ruling provides that costs incurred by an employee that are associated with the settlement of disputes arising out of an existing employment agreement including cost of representation are deductible.

In Romanin v. Commissioner of Taxation [2008] FCA 1532; 2008 ATC 20-055 (Romanin's Case), the taxpayer was pursuing his entitlement under his employment contract to receive 12 months notice or payment in lieu after his employment was terminated on seven days notice. Had the taxpayer received the appropriate notice required under his contract, he would have worked out the 12 months and been assessed on that income.

The Federal Court held that the fact that the taxpayer recovered that income as a lump sum payment, which was then assessed as an eligible termination payment, did not change its character to one of a capital nature. The Tax Office accepts that the taxpayer was entitled to a deduction for the legal expenses because the occasion of the expenditure was the enforcement of his contractual entitlement as an employee to income (in the form of payment in lieu of notice). However, the deductibility of legal expenses incurred in obtaining such a payment will depend upon the particular circumstances of each case.

In your case, your legal expenses were incurred to settle a dispute arising out of your existing employment agreement and your entitlements under that agreement. This included pursuing an entitlement to 26 weeks income that would have been derived had your employer allowed you to work out the period of notice as per your employment agreement.

The legal expenses incurred by you in order to obtain your 26 weeks salary and wage entitlement are sufficiently connected to your assessable income. The character of this payment is income in nature. As in Romanin's Case, it is accepted that the legal costs to obtain your income entitlements that were contractually owed to you under your employment agreement are deductible under section 8-1 of the ITAA 1997 in the income year in which the costs were incurred.