Edited version of private advice

Authorisation Number: 1012678604081

Ruling

Subject: Legal expenses

Question

Are you entitled to claim a deduction for the expenses incurred in defending yourself against employer allegations of an internal breach of code of conduct?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2014

The scheme commences on:

1 July 2013

Relevant facts and circumstances

You were involved in an incident in your workplace and you were subsequently suspended following an allegation that you breached an internal code of conduct of your employer.

You have been suspended for a considerable time whilst an ongoing investigation is taking place and your pay has been reduced.

Your union is assisting in defending your case, however you have incurred additional expenses to defend yourself in order to support your case and seek re-instatement.

You have engaged the professional services of three experts in their fields, in defence of your case, at considerable cost.

You incurred a number of expenses relating to travelling to and meeting with your union representative.

Relevant legislative provisions

Income Tax Assessment Act 1997 (ITAA 1997) section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable 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. FC 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.  

The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day income producing activities of the taxpayer (The Herald and Weekly Times Ltd v. FC of T (1932) 48 CLR 113).

Taxation Ruling TR 2000/5 states that expenses incurred by an employee to settle a dispute with their current employer over their employment conditions are incurred in earning assessable income and are therefore generally deductible.

In a High Court decision in Commissioner of Taxation v. Day [2008] HCA 53, (Day's case), Mr Day was charged with breaching the standards of conduct and failing to fulfil his duty as an officer. He was suspended without pay. It was found that the requisite connection with his assessable income was present and that he was exposed to the charges by reason of his office.

Decision Impact Statement DIS S315/2008 provides the Commissioner's view on the impact of Day's case and the deductibility of legal expenses.

As highlighted in Day's case, to establish the necessary connection to the employment or service which is productive of income, much will depend upon what is entailed in the employment and duties of the employee. Whether expenses are incurred in gaining or producing assessable income looks to the scope of the operations or activities and the relevance to any legal expenses incurred. The scope of a taxpayer's employment is a question of fact and degree.

The majority approach in Day's case was that an expense will satisfy the test outlined in paragraph 8-1(1)(a) of the ITAA 1997 if the occasion of the expense is found in whatever is productive of actual or expected income. It was indicated that a broad approach should be taken in determining what activities produced the actual or expected assessable income, and that it is not only the day to day tasks performed by the employee that gain or produce this income.

The significant factors affecting the decision in this case included the fact that the legal expenses were incurred in responding to action internal to the employment relationship and existed for no other purpose. The taxpayer in Day's case was exposed to the action by reason of his employment and the consequences of the action only affected his employment.

In your case, you incurred significant legal expenses. These expenses were incurred in defending yourself against allegations made by your employer for an issue involving an internal breach of conduct in your workplace. This issue affected your employment and your capacity to serve in your current role.

In accordance with Day's case, your expenses are not considered to be private in nature as they were related to an issue that arose while carrying out your employment position. Therefore, you are entitled to claim a deduction for these expenses under section 8-1 of the ITAA 1997.