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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 2012

The scheme commenced on:

1 July 2011

Relevant facts:

You were employed from 2005 until you were terminated in early 2012.

You took legal action against your employer on the grounds of unfair dismissal and also sought a better redundancy payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 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.

Unfair dismissal

Taxation Determination TD 93/29 provides the Commissioners view on the deductibility of legal expenses incurred in relation to a wrongful dismissal action.  Paragraph 5 of TD 93/29 states that the expenses:

will be deductible to the extent to which they relate to a claim for items of a revenue nature such as unpaid salary or wages; but will not be deductible to the extent to which they relate to a claim for items of a capital nature such as damages for breach of contract of employment or for damages for wrongful dismissal.

The Courts, Boards and Tribunals have consistently held that legal expenses incurred by taxpayers in seeking to regain their employment following dismissal are not deductible. The expenses have been incurred too early to be regarded as having been incurred in gaining or producing the taxpayers' income from that employment. The purpose of the expenditure is to re-establish an income stream or for gaining an enduring benefit, that is, the reinstatement of the employment position.

The deductibility of legal expenses incurred in relation to an action for unfair dismissal was considered in Case L26 79 ATC 126; 23 CTBR (NS) Case 32. In that case, the taxpayer was employed as a music teacher by the Commonwealth Teaching Service. She was dismissed from her employment as a school teacher on the ground that she could not control classes. She unsuccessfully appealed to the Disciplinary Appeal Board against her dismissal. The taxpayer claimed a deduction for her legal expenses in relation to the appeal. It was held that the expenditure was a necessary step prior to regaining income from the employment from which the taxpayer had been dismissed but it was not expenditure incurred in the course of gaining or producing such income. Thus, the expenditure was not deductible.

Better redundancy

Redundancy payments are treated as employment termination payments (ETP's) and subject to special tax treatment that may result in some or the entire 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, you incurred the legal expenses in order to seek a better redundancy. Although the ETP may be included in the assessable income, the ETP retains its character as a capital receipt.

As the legal expenses were incurred to gain a capital sum, they will also be of a capital nature and are therefore not deductible.