Edited version of your private ruling

Authorisation Number: 1012512288830

Ruling

Subject: legal expenses

Question 1

Are you entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in pursuit of your claim of sexual harassment in the workplace?

Answer

No.

Question 2

Are you entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses you incurred in pursuing your employer for unpaid wages?

Answer

Yes.

Question 3

Are you entitled to a deduction under section 8-1 of the ITAA 1997 for a portion of legal expenses you incurred in pursuing your claim for breach of contract?

Answer

Yes.

This ruling applies for the following periods:

¢ 2011-12 financial year, and

¢ 2012-13 financial year.

The scheme commenced on:

1 July 2011.

Relevant facts and circumstances

You were initially engaged as a sub-contractor by your employer.

Your position as a sub-contractor was changed to that of a permanent part-time employee. You also had an agreement with your employer that you would provide some services for a share of profits.

You commenced pursuing your employer for amounts owing including unpaid wages and your employment was subsequently terminated.

You then lodged an unfair dismissal claim to the relevant regulatory body to assist you with recovering unpaid amounts owing.

You also submitted a complaint to the relevant legal body for sexual harassment in the workplace.

You engaged the services of Legal Aid to act for you in relation to your complaint of sexual harassment in the workplace at no cost to you. You have since ceased pursuing the matter.

You were referred to another legal body to pursue the matter of unpaid amounts owing.

You engaged legal representation to act on your behalf in legal proceedings relating to your claims for unpaid wages, superannuation, and your share of profits.

You previously traded in partnership with your ex-business partner. During this time, the partners developed and acquired joint ownership of intellectual property and rights in and to products developed for the purpose of providing training in the industry. The partnership also supplied industry training, courses and other related services.

By agreement, the parties dissolved their partnership.

Terms of the dissolution of partnership agreement included profit sharing provisions in the event of any subsequent profits arising from the utilisation of the intellectual property, knowledge and /or skill acquired, developed and/or as a consequence of the partnership by either partner.

You have stated that since the dissolution of the partnership, your ex-business partner:

- used and/or profited from the intellectual property, and

- provided related training and/or courses that utilised knowledge and skill acquired and/or developed during the course of and/or as a consequence of the partnership

in breach of the profit sharing provisions of the partnership dissolution agreement.

You engaged legal representation to act on your behalf in legal proceedings in pursuit of damages for breach of contract, your share of partnership profits, interest and costs. These matters were subsequently settled resulting in a payment of a sum to you.

You were issued invoices for legal services provided.

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.

Therefore, in determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expense must be considered.

The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). If the advantage to be gained is of a revenue nature, then the expenses incurred in gaining the advantage will also be of a revenue nature.

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, (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

Further, legal expenses are generally deductible if the expenses 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), 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 (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).

It follows also that the character of legal expenses is not determined by the success or failure of the legal action.

Consequently, it is necessary to consider the reason why your legal expenses were incurred. The nature of advantages sought from your legal proceedings is considered below.

Taxation Determination TD 93/29 provides the following examples of legal expenses that may be claimed:

- solicitor's fees in pursuing the debt in court

- court costs, and

- costs associated with serving a legal process.

Legal expenses - sexual harassment

In the pursuit of your claim for sexual harassment in the workplace, you did not incur a loss or outgoing as you engaged Legal Aid services at no cost to you.

Accordingly, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in pursuing a claim for sexual harassment.

Legal expenses - unpaid wages

TD 93/29 states that legal expenses relating to an action for recovery of wages are deductible. TD 93/29 explains that legal expenses incurred in pursuing an amount of income (revenue) owing, those legal expenses are directly incurred in the process of deriving assessable income. Consequently, they are deductible under section 8-1 of the ITAA 1997.

You began an action with the relevant legal body seeking recovery of unpaid wages, sub-contractor fees, and your share of profits. You engaged legal representation to act on your behalf in these legal proceedings.

Wages, sub-contractor fees and profit shares are income (revenue) amounts and thus legal expenses incurred in claiming these amounts are incurred in earning assessable income. Accordingly, you are entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in pursuit of unpaid wages, sub-contractor fees and your share of profits.

Legal expenses - breach of contract

In making your claim to the relevant legal body, you were seeking damages for breach of contract, your share of profits as provided for in the contract, interest and costs.

Regarding the pursuit of partnership profits owing, you were seeking to enforce contractual entitlements which relate to a right to income and thus the advantage you sought was to receive payments that are income (revenue) amounts. Therefore, the portion of legal expenses incurred in claiming these amounts are incurred in earning assessable income and are deductible.

However, damages for breach of contract may be of a capital or revenue nature.

Paragraph 5 of Taxation Determination TD 93/29 cautions that:

…if the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of 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 costs relating to an action for damages for wrongful dismissal are not deductible.

You engaged legal representation to act on your behalf in legal proceedings relating to your claim of breach of contract. As discussed above, the portion of their fees that relate to the claim for revenue items are deductible. However, any portion of fees that relate to a claim for capital items are not deductible. Therefore, a reasonable apportionment may be required to determine the portion of the fees that are deductible.

Apportionment

TD 93/29 states that where a solicitor's account is itemised, one reasonable basis for apportionment would be the time spent involving the deductible claim, relative to the time spent on the non-deductible claim.

If the solicitor's account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the deductible claim, or, where this is not possible, an apportionment on the basis of the monetary value of the deductible claim relative to the non-deductible claim.

You should apply the above principles in determining the portion of the legal fees that can be claimed as a deduction.