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Edited version of your written advice
Authorisation Number: 1012875761807
Date of advice: 9 September 2015
Ruling
Subject: Legal expenses
Question 1
Are you entitled to claim a deduction for legal expenses incurred to obtain an employment termination payment?
Answer
No
Question 2
Are you entitled to claim a deduction for legal expenses incurred to obtain unused annual leave and long service leave?
Answer
Yes
This ruling applies for the following periods:
Year ended 30 June 2015
The scheme commences on:
1 July 2014
Relevant facts and circumstances
You suffered a workplace injury. The injury did not have a great impact on your ability to perform your work.
Your employer subsequently deemed you were no longer capable of carrying out your duties. You negotiated with your employer to resign due to ill health in exchange for an early termination payment and your unused annual leave and long service leave.
You incurred legal expenses to obtain these payments.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Question 1
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 assessable income except where the outgoings are of a capital, private or domestic nature.
In determining whether a deduction for legal expenses is allowed, 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.
It follows also that the character of legal expenses is not determined by the success or failure of the legal action.
Payments made in consequence of termination of employment are treated as ETP's and subject to special tax treatment that may result in some or the entire amount being included in the taxpayer's assessable income. However the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.
In your case, you incurred the legal expenses seeking to obtain the ETP. Although the ETP may be included in the assessable income, the ETP retains its character as a capital receipt.
As the legal expenses were incurred in gaining a capital sum, they will also be of a capital nature and are therefore not deductible.
Question 2
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.
Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the year. Salary and wages, including annual leave payments, is considered ordinary income as it is paid directly as a result of the personal services an employee renders for their employer.
However, unused annual leave and unused long service leave (although acquired through personal services and thus characterised as ordinary income) are considered to be forms of statutory income under section 6-10 of the ITAA 1997.
The legal expenses incurred in order to obtain the unused annual leave and unused long service leave resulted in you gaining assessable income. There is a clear connection between the assessable income and the expense. However in contrast to the ETP as detailed above, the expenses were not incurred in respect of income that was capital, private or domestic in nature.
Accordingly, the legal expenses incurred in gaining your unused annual leave and long service leave are deductible under section 8-1 of the ITAA 1997.
Summary
You will need to apportion the legal expenses incurred between those incurred to obtain the ETP and those incurred to obtain the unused annual and long service leave.