Edited version of your private ruling

Authorisation Number: 1012512092198

Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for legal expenses incurred in relation to your employment termination?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You suffered from a work place accident.

After the accident you were on restricted duties.

You lodged a notification of industrial dispute while you were still employed.

Your employment was terminated after many years of service.

You received an employment termination payment from your employer.

You then lodged an application for unfair dismissal against your employer.

You subsequently attended a compulsory conference.

Your employer made you an offer which you rejected on legal advice.

You lodged a further claim for reinstatement which resulted in another compulsory conference.

The final outcome was an employment termination payment.

You incurred legal expenses in relation to your termination and unfair dismissal.

You did not seek nor obtain any reimbursement of your legal costs from your previous 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 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. 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).

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 or seeking to regain employment following dismissal are of a capital nature and not deductible 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.

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.

The nature of a redundancy payment was considered in Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184. In that case, it was held that 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 for the loss of employment position, that is, as compensation for the sterilisation of a capital asset, and thus is an affair of capital.

In your case you incurred legal expenses in relation to the termination of your employment. The payment you received constitutes an employment termination payment. Your employment termination payment was paid to you as compensation for loss of your employment, and is capital in nature. Although the payment you received is subject to special tax treatment that results in the amount being included in assessable income, this does not change the character of the payment.

Legal expenses incurred in relation to an unfair dismissal and requesting reinstatement do not sufficiently relate to your day to day employment duties. The expenses have been incurred too early to be regarded as having been incurred in gaining or producing the taxpayers' income from any future 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. Such expenses are not deductible as they are capital in nature. Therefore no deduction is allowable under section 8-1 of the ITAA 1997 for the associated legal expenses.