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Ruling
Subject: Legal expenses
Questions and Answers
1. Are you entitled to a deduction for legal expenses incurred in relation to your employment performance?
Yes
2. Are you entitled to a deduction for legal expenses incurred in relation to negotiating your resignation from your employment?
No
This ruling applies for the following periods:
Year ended 30 June 2011
The scheme commences on:
1 July 2010
Relevant facts and circumstances
You received a formal document from your supervisor regarding your underperformance in your position. The document stated that for various reasons you were underperforming in your role and you would undergo a three month performance review. After three months you would be assessed and either your contract would be continued or your employment would be terminated.
You disagreed with the allegations leading to the three month performance review for several reasons:
You engaged a lawyer. Between date A and date B you incurred legal expenses pertaining to your performance.
Your lawyer received a letter from the employer's lawyer on date C arguing against some of the claims made by your lawyer, but making an offer of settlement whereby you would leave the position.
You, your lawyer, and the employer's lawyers negotiated an offer of settlement, including the wording of a deed of settlement, an agreed statement of resignation, and your payment entitlement.
You formally resigned from the employer on date D after signing a Deed of Release.
You incurred legal expenses between date C and date D regarding on offer of settlement and resignation from the employer.
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.
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; (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, domestic or private nature, then the expenses incurred in gaining the advantage will also be of a capital, domestic or private nature.
The courts on a number of occasions have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer's business or employment. In FC of T v Rowe (1995) 31 ATR 392; 95 ATC 4691 (Rowe's case), an employee incurred legal expenses in defending the manner in which he performed his employment duties. The court accepted that such expenses were allowable.
Your case
In your case, you were employed by an employer. You were advised formally by your supervisor of your underperformance.
Between date A and date B you incurred legal expenses regarding your employment underperformance.
Your circumstances are similar to Rowe's case in which the taxpayer was defending the manner in which he performed his duties. In Rowe's case, it was decided that as the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income. In your case also, the legal expenses between date A and date B are allowable as they related to your day to day employment duties,
Between date C and date D you incurred legal expenses relating to your resignation. These expenses are not allowable as they did not relate to the day to day aspects of your employment.
Conclusion
The legal expenses relating to your performance at the employer are allowable as a deduction. The legal expenses relating to your resignation are not allowable. You will need to apportion your legal expenses accordingly.