Edited version of your private ruling

Authorisation Number: 1012530225486

Ruling

Subject: legal expenses

Question

Are you entitled to a deduction for legal and other expenses incurred in relation to your unfair dismissal?

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 and

§ additional information.

You were a full-time employee.

Your employment contract was valid until 30 June 20XX.

Under your employment agreement, your employer may end employment by giving two weeks notice.

You were warned about unsatisfactory performance and conduct at a meeting in 20YY. You were subsequently dismissed and paid two weeks notice in lieu. The dismissal and eviction from your family accommodation took effect in 20YY.

Your employer advised that they were not liable for any other compensation or payment except for payment of any accrued leave entitlements due. Your employer advised that your entitlements will be deposited into your bank account as soon as possible.

You immediately contacted Fair Work Australia and submitted a claim for unfair dismissal.

Conciliation between you, the employer and Fair Work Australia failed to achieve re-instatement or any acceptable outcome.

Consequently a three day arbitration hearing was convened for 20XX.

You sought legal assistance, however, two law firms advised you that their costs would be substantial. Self representation was the only option.

You were seeking payment for loss of income/wages.

The observations in the Fair Work Australia decision stated that you technically performed your job well, however the method of communication with other staff and with the public was the essence of the conduct and performance which led to your termination.

The Fair Work Australia decision stated that taking into account all factors and the absence of a valid reason for termination, the termination was harsh, unjust and unfair. It was found that an order for compensation was appropriate. Compensation of X weeks pay was ordered. You received a payment. This payment did not include any amount for personal or associated costs incurred.

You incurred legal expenses in attending court as well as airfares, accommodation, transport, internet and phone costs.

As your family were evicted from the employer subsidised housing you incurred costs for temporary accommodation whilst attending to your Fair Work Australia submission.

You did not obtain any reimbursement of your legal or other costs.

Your dismissal disadvantaged you and your family financially and personally.

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 taxpayer's 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 and other expenses in relation to the termination of your employment. The payment you received following the Fair Work Australia decision was compensation for loss of your employment, and is capital in nature. Although the payment you received is assessable and calculated as X weeks pay, this does not change the character of the payment.

Legal and other expenses incurred in relation to an unfair dismissal do not sufficiently relate to your day to day employment duties. 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 expenses.