Edited version of your written advice

Authorisation Number: 1012679362384

Ruling

Subject: Legal expenses

Question 1

Can you claim a deduction for legal expenses incurred in relation to obtaining compensation?

Answer

Yes

Question 2

Can you claim a deduction for overnight travel and accommodation incurred in obtaining compensation?

Answer

Yes

Question 3

Are you entitled to claim a deduction for the legal expenses incurred in relation to obtaining a termination payment?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commenced on

1 July 2014

Relevant facts and circumstances

You incurred legal expenses and have been reimbursed part of the expense as part of the proceedings. The legal fees are un-dissected so the net expense will be pro-rated between the self-rehabilitation expenses, termination payment and statutory entitlements. You also incurred overnight accommodation costs and travel expenses while attending court.

You were still in the employ of the employer at the time of proceedings.

You were injured at work and were granted workers compensation for the injury. Because of the way your initial request for workers compensation was dealt with you made an official complaint regarding the behaviour of the employer.

This application was denied and you then sort legal advice and applied to have the denial of workers compensation overturned through the Administrative Appeals Tribunal (AAT).

You were still on workers compensation for the initial physical injury and when the workers compensation period ceased you were on leave without pay as you were advised by your medical physicians you were not able to return to work.

A hearing was started in the AAT and part way through the hearing you were offered settlement by the employer. The matter was settled prior to judgment when you accepted the offer made by the employer.

As a condition of the settlement payment you were required to sign a termination notice. The settlement included self-rehabilitation expenses, termination payment in lieu of redundancy and statutory entitlements (long service leave and annual leave).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Compensation

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 or business operations. 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.

In Tax Determination TD 93/29 the Commissioner states that legal expenses incurred by an employee in recovering unpaid wages are deductible under section 8-1 of the ITAA 1997, as the expenses are directly incurred in the process of deriving assessable income.  However, if legal action goes beyond a claim for a revenue item such as wages, the legal costs may not be deductible.

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.

In your case you incurred legal expenses in relation to continuing your weekly worker's compensation payments. As these payments represent a replacement of your salary and wages, they are considered to be revenue in nature and assessable. The associated legal expenses in relation to your unpaid worker's compensation payments relates sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

Statutory entitlements

Legal expenses incurred in order to obtain unused annual leave or long service and sick leave generally results in the taxpayer gaining assessable income. Therefore there is a clear connection between the assessable income and the expenses incurred. Furthermore the expenses are not in respect of income that is capital, private or domestic in nature.

Accordingly, the legal expenses incurred in gaining your assessable accrued annual and long service on your salary are deductible under section 8-1 of the ITAA 1997.

Termination Payment

Section 8-1 of the ITAA 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.

For legal expenses to constitute an allowable deduction it must be shown that they were incidental and relevant to the production of the taxpayer's assessable income (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

The nature of the expenditure must also be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190). The nature or character of the legal expense 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 expense incurred in gaining the advantage will also be of a capital nature.

A termination payment is capital in nature because it is a payment made to compensate for the loss of the employment position (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184).

Case 79 ATC 126 found that the expenditure in question 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. Case Y24 91 ATC 268 explains that a redundancy payment paid to a worker whose job "is shut down'' is compensation for loss of that job. The redundancy payment was not intended to compensate for loss of future income.

Therefore the timing of the legal expense does not change the character of that expense if the advantage to be gained from incurring legal expenses is of a capital nature, then the expense incurred in gaining the advantage will also be of a capital nature.

In your case you incurred legal expenses to secure termination payment from your employer. As the payment was paid to compensate for the loss of your employment position, it is considered to be capital in nature. For this reason, the legal expenses at issue would also be considered to be capital in nature. The legal expenses are not, therefore, deductible under section 8-1 of the ITAA 1997.