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Ruling
Subject: legal expenses incurred in course of employment - legal costs awarded
Question 1
Are you entitled to a deduction for the legal expenses you incurred?
Answer
Yes.
Question 2
Are the legal costs awarded by the court included in your assessable income?
Answer
Yes.
This ruling applies for the following period
1 July 2010 to 30 June 2011
The scheme commenced on
1 July 2010
Relevant facts
You are an employee.
Allegations were made against you concerning the manner in which you carried out your employment duties.
The allegations were dismissed and you were awarded legal costs by the court.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 6-5
Income Tax Assessment Act 1997 section 6-10
Income Tax Assessment Act 1997 section 8-1
Income Tax Assessment Act 1997 subdivision 20-A
Income Tax Assessment Act 1997 subsection 20-20(1)
Income Tax Assessment Act 1997 subsection 20-20(2)
Reasons for decision
Question 1
Summary
The legal expenses you incurred are sufficiently connected to your income earning activities, and are therefore deductible.
Detailed reasoning
You can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income except where the loss or outgoing is capital or private in nature (section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)).
The courts on a number of occasions have determined legal expenses to be an allowable deduction if they arise out of the day to day activities by which the taxpayer earns their assessable income, or the manner in which the taxpayer performs a particular task in the course of earning such income. That is, legal expenses are deductible if they are incurred in defending the manner in which the taxpayer carries out the day to day duties of their employment and the legal action has more than a peripheral connection to the taxpayer's income producing activities.
In FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. No significance was placed by the court on the taxpayer's status as an employee.
In your case, you incurred legal expenses arising from allegations that arose in the course of carrying out your employment duties. You were defending the manner of the performance of your duties. The legal expenses you incurred are sufficiently connected to your income earning activities, and are therefore deductible under section 8-1 of the ITAA 1997.
Question 2
Summary
The legal costs awarded to you are included in your assessable income.
Detailed reasoning
Your assessable income includes income according to ordinary concepts, which is called ordinary income (section 6-5 of the ITAA 1997).
The amount you received for legal costs does not have the characteristics of income according to ordinary concepts and is therefore not ordinary income.
Your assessable income also includes statutory income amounts which are not ordinary income but are included in assessable income by provisions about assessable income (section 6-10 of the ITAA 1997).
Subdivision 20-A of the ITAA 1997 provides that certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable.
Subsection 20-20(1) of the ITAA 1997 provides that an amount is not an assessable recoupment to the extent that it is ordinary income, or it is statutory income because of a provision outside of Subdivision 20-A of the ITAA 1997.
An amount received by way of insurance or indemnity is an assessable recoupment if it is paid for a deductible expense and the deduction can be claimed in the current year or in an earlier income year (subsection 20-20(2) of the ITAA 1997). [Current year means the income year for which you are working out your assessable income and deductions].
As you are entitled to a deduction for the legal expenses you incurred, and you received legal costs by way of indemnity for this expenditure, the amount you received for legal costs is an assessable recoupment under subsection 20-20(2) of the ITAA 1997. As such, the legal costs are included in your assessable income.