Edited version of your written advice

Authorisation Number: 1012754812385

Ruling

Subject: WRE -legal expenses

Question

Are you entitled to a deduction for legal expenses incurred in seeking reinstatement following a dismissal?

Answer

No

This ruling applies for the following period

Income year ended 30 June 2013

Income year ended 30 June 2014

Income year ended 30 June 2015

The scheme commences on:

January 2013

Relevant facts and circumstances

On x your employer terminated your employment.

On x you filed a notice of appeal with the relevant court/tribunal seeking reinstatement.

You incurred legal expenses in both that appeal and your employer's subsequent appeals against the initial decision.

The final outcome of the matter was that:

• your appeal was allowed

• your employers decision to dismiss you was set aside

• your employer was ordered to pay you an amount of remuneration equivalent to the amount which you would have received but for the dismissal

• the continuity of your employment was taken to be unbroken.

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.

In your case you incurred legal and other expenses in relation to the termination of your employment. The payment you received following the New South Wales Industrial Relation decisions of outstanding wages was incidental to your reinstatement. Although that amount is assessable it will not change the character of the legal expenses which is determined by the advantage sought which in this instance was reinstatement.

The authorities indicate that to be deductible there must be more than a causal connection between the expenditure and the derivation of income. Legal and other expenses incurred in relation to an unfair dismissal and reinstatement put you in position to earn income, they are not part of earning your income. 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.