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Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for legal expenses?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Your position with your employer was made redundant in the 2009-10 income year.

It was suggested that you apply for a different role that was at a substantially lower salary.

You believe the redundancy of your position was a targeted attack at you following a continued pattern of bullying and harassment that you had been subjected to.

In the 2010-11 income year you sent a letter of complaint to your employer. The letter of complaint addressed the bullying and harassment you state you were subject to and the redundancy of your position. You stated in the letter, that you had been advised that your employers conduct was unlawful; however you wished to leave your employer on the best possible terms. Your letter offered to settle the matter by payment of an additional number of months salary in lieu of notice (over and above the existing redundancy arrangements).

After further negotiations with your employer, you reached a financial settlement in the 2010-11 income year. This included, amounts labelled as a severance payment, ex-gratia termination payment and payments in lieu of accrued annual and long service leave.

Your employer made no admissions in connection with your complaint.

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 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 nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

A deduction for legal expenses by an employee depends on the particular facts of any case. To be deductible the occasion of the expenditure must be found in what is productive in the gaining of assessable income by the employee. If expenses are incurred to dispute the receipt of income contractually owed under an employment contract, then the expenses are on revenue account and allowable as a deduction.

However, if the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the contract of employment where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible (Taxation Determination TD 93/29).

A redundancy payment, being compensation for the loss of the expectation of continuity of service, is a payment that is capital in nature. The payment is made to compensate the taxpayer for the loss of their employment position. (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184).

Redundancy payments are treated as eligible termination payments and subject to special tax treatment that may result in some or all of the amount being included in the taxpayer's assessable income. 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.

In your case, your position with your employer was made redundant. You sought legal advice and entered into negotiations with your employer. You sent a letter of complaint to your employer requesting a number of months salary in lieu of notice. Although you referred to bullying and harassment in your complaint, it is considered that the advantage you sought was the receipt of a better redundancy or termination payment.

As legal expenses follow the nature of the advantage sought, your legal expenses are capital in nature. Accordingly, you are not entitled to a deduction for legal expenses under section 8-1 of the ITAA 1997.