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Subject: Legal expenses

Questions:

Are you entitled to a deduction for all the legal expenses incurred?

Answer: No.

Are you entitled to a deduction for the portion of your legal expenses that were incurred in relation to the payment in lieu of notice?

Answer: Yes.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

In 2006, the company you had worked for, for around eight years, ceased trading.

The company did not pay the employee's redundancy payments or payments in lieu of notice.

The director of the company refused to pay the amounts owed to the employees, claiming the company had no money, and he refused to put the company into administration.

If the company was not in administration, the employees could not pursue a claim under the General Employee Entitlements and Redundancy Scheme (GEERS).

You decided to take your own legal action to force the company into administration and incurred legal fees.

As a result of your actions, the company was placed in administration and you have since received an assessment under GEERS for a payment in lieu of notice and a redundancy payment.

Under your industry national award, you were entitled to fours weeks notice where you have completed service of five years or more.

You were only given four days notice of the closure of the business by your former 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 your case, you incurred legal expenses to place your former employer into administration for the sole purpose of pursuing a claim under the GEERS for unpaid entitlements. It is accepted that the expenses were incurred in gaining assessable income in the form of a payment in lieu of notice and a redundancy.

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.  

Where an expense relates to multiple purposes, the expense must be apportioned between the purposes on a fair and reasonable basis: Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 78 CLR 47. 

Payment in lieu of notice

In Romanin v FC of T 2008 ATC 20-055; [2008] FCA 1532 (Romanin) the court considered the deductibility of legal expense incurred by the taxpayer for proceedings at the Industrial Relations Commission. In the proceedings, the taxpayer argued that an employment contract existed where they were entitled to 12 months notice, or a payment in lieu of this notice. The employer had denied such a contract existed and had given seven days notice.  

The proceedings found in favour of the taxpayer and the employer was ordered to pay them the total value of the employment package for the period of 12 months less any salary and other earnings that they had earned in alternative employment during the 12 months following the termination of his employment. 

The legal expenses were found not to be capital in nature because the character of the advantage which the taxpayer sought in bringing the proceedings was on revenue account, namely receipt of his contractual entitlement to salary he would have received had he been given 12 months notice. 

Legal expenses incurred to recover income payments such as were at issue in Romanin - that is, salary that would have been derived during the notice of termination period, had it been given - will be deductible, even if the receipt was paid as a lump sum and subject to assessment as an eligible termination payment. 

This case can be distinguished from cases in which legal expenses are incurred in seeking compensation for loss of employment, such as in an action for wrongful dismissal or loss of office where the advantage sought is of a capital nature. In such cases, the legal expenses are of a capital nature, even if the amount awarded is calculated by reference to unpaid salary or lost income, or is assessable as statutory income.

In your case, you were entitled to four weeks notice under your industry award as you had worked for the employer for more than five years. Your employer only provided you with four days. GEERS assessed that you were entitled to a payment in lieu of notice. Had you been given the opportunity to work the notice period, the income received would have been assessable as ordinary income. Therefore, the portion of the legal expenses incurred to recover this amount is deductible under section 8-1 of the ITAA 1997.

Redundancy payment

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 

Redundancy payments can be subject to special tax treatment, resulting in some or all of the amount being included as 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 your assessable income.

In your case, GEERS assessed that you were entitled to a redundancy payment. This payment is capital in nature; therefore, the portion of the legal expenses incurred to recover this amount is not deductible under section 8-1 of the ITAA 1997.