Edited version of your private ruling

Authorisation Number: 1011977101177

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 the portion of legal expenses incurred relating to the recovery of annual leave entitlements and normal pay for time in lieu, on termination of employment?

2. Are you entitled to a deduction for the portion of legal expenses incurred relating to the payment of an additional employment termination payment (ETP), being compensation for a loss of future income earning capacity?

Answer

1. Yes

2. No

This ruling applies for the following periods:.

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You were employed full time.

In 2011 your employer terminated your employment on the basis that it was a legitimate redundancy.

At the same time your employer made a number of roles and people in the organisation redundant. However your role still existed.

You believe that your termination was illegal.

You have received communication from Fair Work Australia which indicated that your situation appears to be one of illegal termination.

Further, senior managers of your former employer at the time of your termination have informed you that it was an illegal termination.

You have incurred legal expenses in seeking compensation for illegal termination of your employment.

Although the settlement is not finalised, you expect to receive compensation as an ETP for illegal termination of your employment. The payment is comprised of the following amounts:

· unpaid annual leave

· several days normal pay for time in lieu, and

· payment for loss of future salary and wages.

After termination of your employment you received an ETP consisting of your entitlements under your employment contract.

You have stated that the additional payment you are seeking will be made as an ETP.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1,

Income Tax Assessment Act 1997 Section 82-135, and

Income Tax Assessment Act 1997 Section 83-10.

Reasons for decision

Summary

Annual leave and normal pay for time in lieu

Amounts of annual leave and normal pay for time in lieu, are revenue in nature as they are considered to fall within the meaning of ordinary income.

As such, the legal and associated costs you incurred in pursuing your claims for annual leave and normal pay for time in lieu are an allowable deduction.

ETP for loss of future earnings

As the ETP you will receive as a result of your legal action is capital in nature, the expenses incurred in pursuing your claim and obtaining the ETP are also capital in nature. Consequently, no deduction is allowable for the legal costs you incurred in pursuing this payment.

Detailed reasoning

Section 8-1 of 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.

In determining whether a deduction for legal expenses is allowed 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). The nature or character of the legal expenses follows the advantage which 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.

Annual leave and payment for time in lieu

Amounts of annual leave and normal pay for time in lieu are revenue in nature, as they are considered to fall within the meaning of ordinary income. They are expressly excluded from the definition of an ETP at section 82-135 of the ITAA 1997 and although they may be taxed at concessional rates of tax as set out in section 83-10 of the ITAA 1997, their character remains revenue in nature.

Therefore, there is a clear connection between the legal expenses you incurred and the advantage sought in the form of the assessable income you expect to derive by virtue of the expenditure. Accordingly you are entitled to a deduction for the portion of the legal costs you incurred in pursuing your claims for annual leave and normal pay for time in lieu under section 8-1 of the ITAA 1997.

ETP for loss of future earnings

An ETP is a capital amount paid as compensation for the loss of the means of producing income. ETP's are included in assessable income under specific provisions of the ITAA 1997. However, the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

Through your legal action you will obtain an ETP which is a capital payment. Therefore the legal expenses you incurred are also capital in nature. As such, the portion of the legal and associated costs incurred in gaining a capital sum is not deductible under section 8-1 of the ITAA 1997.

Apportionment

Taxation Determination TD 93/29 recognises that on occasions the legal expenses are incurred in relation to proceedings that relate both to amounts that are revenue in nature as well as amounts which are capital in nature. In these circumstances, the legal costs are required to be apportioned on a fair and reasonable basis to reflect the deductible component.

Paragraph 7 of TD 93/29 states that the apportionment can be calculated where a legal representative's account is itemised and a reasonable basis for apportionment can be calculated based on the time spent involving the revenue claim, relative to the time spent on the capital claim.

If the amount is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken in relation to the revenue claim, or an apportionment on the basis of the monetary value of the revenue claim relation to the capital claim.

Further, the Commissioner has indicated in Taxation Ruling TR 95/33 that in situations where expenses are incurred in earning assessable income and for another reason, a fair and reasonable basis of apportionment of expenditure taking into account all the factors would be acceptable.