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Ruling

Subject: Legal expenses

Question

Are you entitled to claim a deduction for legal expenses incurred in pursuit of a wrongful dismissal case against your employer?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts and circumstances

You incurred legal fees in the 2010-11 financial year and in the 2011-12 financial year, in pursuit of a wrongful dismissal case against your employer.

You sought compensation for alleged hurt, humiliation and distress arising from your termination.

You received a settlement amount from your employer.

A Deed of Settlement and Release between yourself and your employer, provides that you release them from any further complaints, claims, damages, proceedings and demands in relation to the matter on acceptance of the settlement sum, dissected as follows;

§ a component in respect of your alleged hurt, humiliation, distress, pain and suffering arising from termination.

§ a component in respect of the legal fees you incurred in the proceeding.

In addition, your employer admits no liability in relation to the matter.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

A compensation amount for alleged hurt, humiliation and distress arising from wrongful dismissal is a capital payment. Consequently, the legal expenses you incurred in seeking the compensation amount are also capital in nature. As your legal expenses are capital in nature, you are not entitled to a deduction.

Detailed reasoning

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.

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

An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 AITR 443; (1952) 10 ATD 82). Lump sum damages awarded for a personal injury, wrong or illness suffered, which is not direct compensation for loss of income, will usually be capital in nature.

In your case, the payment you sought was compensation for the personal pain and suffering you felt on termination of your employment. No part of the payment you sought related to the loss of income or payment of outstanding salary or wages owed to you. Therefore, the payment you sought and received is capital in nature.

As the compensation payment is capital in nature, the legal expenses incurred in seeking the payment will, consequently, be capital in nature as they follow the advantage that is sought to be gained by incurring the expenses.

Accordingly, the legal expenses you incurred in taking legal action for wrongful dismissal are not deductible under section 8-1 of the ITAA 1997, as they were outgoings of a capital nature.