Edited version of your private ruling

Authorisation Number: 1012516898469

Ruling

Subject: Legal expenses

Question 1

Are you entitled to the portion of your legal expenses incurred in relation to your claim for the unpaid bonus?

Answer

Yes

Question 2

Are you entitled to the portion of your legal expenses incurred in relation to your claim for other damages relating to alleged breaches of your contract?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2014

The scheme commenced on:

1 July 2013

Relevant facts and circumstances

Your employer offered to pay you a performance bonus in recognition of your performance and as an incentive to continue your employment.

You have only ever received a portion of your bonus.

Your employment with your employer ceased.

You obtained alternative employment after a period of time, however your remuneration package is significantly less that the package you had with your previous employer.

You have commenced legal action including a claim for breach of your employment contract and the payment of the balance of your performance bonus.

You have sent various letters of demand and had some discussions; however claims have not yet been negotiated or settled.

You have provided a draft copy of your statement of claim which requests various amounts of relief in relation to your claim.

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 income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

In determining whether a deduction for legal expenses is allowed 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.

A deduction for legal expenses by an employee depends on the particular facts of any case. To be deductible the occasion of the expenditure must be found in what is productive in the gaining of assessable income by the employee. If expenses are incurred to dispute the receipt of income contractually owed under an employment contract, then the expenses are on revenue account and allowable as a deduction.

However, if the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the 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 expenses relating to an action for damages for wrongful dismissal are not deductible (Taxation Determination TD 93/29).

Unpaid bonus

As discussed above, 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 unpaid bonuses are generally allowable as they directly relate to gaining or producing assessable income.

In your case you incurred legal expenses in relation to a claim for an unpaid bonus entitlement. It is considered that the associated legal expenses in relation to your unpaid bonus and leave payments related sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

Other damages for breach of contract

In your case a large part of your claim relates to damages, in particular lost opportunity damages regarding ongoing and future employment. In accordance with TD 93/29, the damages you are seeking are considered to be capital amounts.

Damages for past and future economic loss

Your claim includes an amount for economic loss of your salary and benefits for the period you were unable to find alternative employment. Additionally, you are claiming an amount for future economic loss, being for the reduction in salary and benefits you are receiving from alternative employment compared to what you would have received if you had remained employed by your previous employer until your retirement.

These claims do not represent amounts owed to you under your employment contract with your previous employer as they relate to periods of time after your employment contract ceased. Rather, the claims relate to a reduction in your earning capacity, which is a capital asset.

As proceeds or damages received for the loss or reduction of earning capacity are a capital receipt, it follows that legal expenses incurred in relation to a claim for such proceeds would not be deductible under section 8-1 of the ITAA 1997 as they are capital in nature.

General damages for hurt, distress and loss of reputation

Compensation or damages for wrong or injury suffered by a person, or damages for wrong or injury suffered by a person to his or her profession or vocation are of a capital or private nature. Taxation Ruling IT 2424 states that payments to compensate for personal injury, injury to feelings, humiliation, embarrassment, depression or anxiety are considered to be capital in nature.

Case U102 87 ATC 621; AAT Case 72 (1987) 18 ATR 3515 found that legal expenses incurred in protecting a taxpayer's personal good name and reputation were capital or private in nature.

Your claim for general damages for hurt, distress and loss of reputation falls into this category. Therefore, the legal expenses incurred in attempting to obtain this compensation are also of a capital nature and not deductible under section 8-1 of the ITAA 1997.

Further information: apportionment of expenses

As your legal expenses are not fully deductible, 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. A possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim.