Edited version of your private ruling

Authorisation Number: 1012458131921

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for legal expenses incurred in relation to seeking advice on your employment situation to enable you to do your work more effectively?

Answer

Yes.

Question 2

Are you entitled to a deduction for legal expenses incurred in relation to your accrued annual leave and salary wages owing to you?

Answer

Yes.

Question 3

Are you entitled to a deduction for legal expenses incurred in relation to negotiating a suitable termination package and preparing your Deed of Release?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling,

· Letter from your solicitor, and

· Deed of Release.

You were employed.

You were being bullied in the work place which stopped you from being able to do your work satisfactorily.

You sought legal advice about the inappropriate behaviour that was occurring in your workplace and sought ways for mediation.

You had a conference with your solicitor. Your solicitor provided employment advice to you. The purpose of the conference was to discuss alternative legal remedies to you and to offer a strategy to improve your situation and to resolve the issues. Your solicitor suggested that he/she shall attempt to negotiate a suitable termination package for you. You were invoiced for this advice.

Your solicitor wrote letters to your employer and prepared a Deed of Release. Your solicitor invoiced your employer in relation to the services rendered.

You resigned as a result of an employment dispute between you and your employer.

You received an employment termination payment and payment for any accrued annual leave and salary and wages owing to you.

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 a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478), 

· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, in determining whether a deduction for legal expenses is allowable 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.

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties, in order to defend the threat of dismissal, were allowable. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income.

In your case, you allege that other's actions and inappropriate behaviour hindered the performance of your day to day employment duties. You incurred legal expenses in relation to bullying in your work place and possible ways to remedy the situation.

The associated legal expenses in seeking advice about your current employment situation and possible ways to restore or improve your day to day working conditions were a consequence of defending your rights under your current employment situation. It is considered that your expenditure on legal expenses was a consequence of your day to day activities as an employee from which you derived assessable income. Therefore the associated legal expenses incurred are deductible under section 8-1 of the ITAA 1997.

Annual leave and salary and wages

Legal expenses incurred in recovering salary or wages are considered to be of a revenue nature and therefore deductible under section 8-1 of the ITAA 1997.

Similarly, legal expenses incurred in recovering unused annual leave are generally allowable as they directly relate to gaining or producing assessable income.

In your case some of the legal expenses incurred related to your accrued annual leave and salary and wages owing to you that you would normally derive.

It is considered that the associated legal expenses in relation to your salary and wages and leave payments related sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

Termination package and Deed of Release

Taxation Determination TD 93/29 states: 

If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for a breach of the contract of employment, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible.

The Courts, Boards and Tribunals have consistently held that the legal expenses incurred by taxpayers in defending themselves against dismissal from their employment are of a capital nature unless they are defending the way they carry out their day to day employment duties. This is because:

· the legal expenses can be regarded as having been incurred once and for all, and

· the advantage sought to be gained is the preservation of the taxpayers employment.

In your situation, although you were not dismissed, much of your legal expenses related to negotiating a suitable termination package and preparing the Deed of Release. Legal expenses incurred in negotiating a termination package and preparing your Deed of Release do no sufficiently relate to your day to day employment duties. Furthermore, such expenses are not deductible as they are considered to provide an enduring advantage and are therefore capital in nature (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184). No deduction is allowable under section 8-1 of the ITAA 1997 for the associated legal expenses.

Apportionment of expenses

As outlined above, your legal costs relate partly to deductible legal action and partly to non-deductible legal action. Therefore only the relevant portion of the associated legal expenses is an allowable deduction.

The portion of the legal costs incurred in relation to your employment duties and the payment of your accrued annual leave and salary and wages are considered to be sufficiently connected to your assessable income and deductible. However, the portion that relates to your termination package and Deed of Release are capital in nature and no deduction is allowed for these associated legal expenses.

You will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

Where legal expenses are not broken up into the relevant parts by your solicitor, you will need to calculate the deductible portion. One way to apportion your expenses is according to the dollar value of the assessable leave and salary and wage amount as compared to the total amount agreed to under your termination package. The relevant percentage can then be applied to the legal expenses incurred.