Edited version of your written advice

Authorisation Number: 1012880104130

Date of advice: 17 September 2015

Ruling

Subject: Legal expenses

Question 1

Are you entitled to claim a deduction for legal expenses?

Answer

Yes.

Question 2

If the legal action is successful, will the compensation for loss of remuneration, annual leave accrual and long service leave accrual form part of your assessable income?

Answer

Yes.

Question 3

If you receive a payment from your former employer towards your legal fees, will this amount form part of your assessable income?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2015

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

The scheme commenced on

1 July 2014

Relevant facts and circumstances

Your employer undertook a staff restructure and you commenced a new position.

You received a letter from your employer which stated:

• your last day in the office would be XX, and

• you would receive a payment in lieu of the remaining notice period.

You assert you were wrongfully dismissed and the appropriate notice period is longer period. You are seeking damages for loss of remuneration, annual leave accrual and long service leave accrual which you would have received had you been given the opportunity to serve out the longer notice period.

You have incurred legal expenses in undertaking this action and are seriously considering taking the matter to the courts.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 20-20

Income Tax Assessment Act 1997 Section 83-10

Income Tax Assessment Act 1997 Section 83-80

Reasons for decision

Legal expenses

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, or relate to the earning of exempt income.

Legal costs take their character as an outgoing of capital or revenue nature from the cause or purpose of incurring the expenditure. If the advantage to be gained is of a revenue nature, then the costs incurred in gaining the advantage will also be of a revenue nature.

It also follows that the character of legal expenses is not determined by the success or failure of the legal action.

Where legal costs are incurred to enforce a contractual entitlement which relates to a right to income, even if it is after employment has ceased, the taxpayer will be entitled to a deduction under section 8-1 of the ITAA 1997.

In Romanin v. Commissioner of Taxation [2008] FCA 1532; 2008 ATC 20-055 (Romanin's case), the taxpayer was pursuing his entitlement under his employment contract to receive 12 month's notice or payment in lieu after his employment was terminated on seven days notice. Had the taxpayer received the appropriate notice required under his contract, he would have worked out the 12 months and been assessed on that income.

The Federal Court held that the fact that the taxpayer recovered that income as a lump sum payment, which was then assessed as an eligible termination payment, did not change its character to one of a capital nature. The Tax Office accepts that the taxpayer was entitled to a deduction for the legal expenses because the occasion of the expenditure was the enforcement of his contractual entitlement as an employee to income (in the form of payment in lieu of notice). However, the deductibility of legal expenses incurred in obtaining such a payment will depend upon the particular circumstances of each case.

Your case is similar to that in Romanin's case in that you have taken legal action to obtain amount which would have been paid to you under the longer notice period. As these amounts would have formed part of your assessable income, the legal expenses incurred are considered to be revenue in nature.

You are entitled to claim a deduction for legal expenses associated with action to recover entitlements payable under your employment contract.

Assessability of payment for lost remuneration, accrued annual leave and accrued long service leave

Section 6-5 of the ITAA 1997 provides that your assessable income includes ordinary income derived directly or indirectly from all sources during that financial year.

Section 6-10 of the ITAA 1997 states your assessable income include some amounts that are not ordinary income and are referred to as statutory income. Statutory income includes payments for unused annual leave and unused long service leave (sections 83-10 and 83-80 of the ITAA 1997, respectively).

However, an amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; (1952) 5 ATR 443; 10 ATD 82.

In your case, you are seeking damages for the loss of remuneration, annual leave accrual and long service leave accrual. Had you served out the longer notice period and received these amounts they would have formed part of your assessable income as either ordinary income under section 6-5 of the ITAA 1997 or statutory income under sections 83-10 and 83-65 of the ITAA 1997.

If your legal action was successful, the amount you are paid as compensation for the loss of remuneration, accrued annual leave and accrued long service leave will be assessable as the amounts they are compensating for is also assessable.

Reimbursement of legal expenses

Subsection 20-20(2) of the ITAA 1997 provides that an amount you receive as a recoupment of a loss of outgoing is an assessable recoupment if:

• you receive the amount by way of insurance or indemnity, and

• you can deduct an amount for the loss or outgoing for the year in which the reimbursed legal costs were received, or you have deducted or can deduct an amount for it in an earlier income year, under any provision of this Act.

If an amount is recouped by way of settlement of a claim for legal costs, it will be an assessable recoupment under subsection 20-20(2) of the ITAA 1997 where the purpose of the settlement is to indemnify the recipient for professional legal costs actually incurred in the conduct of the litigation, where the legal costs were deductible.

You instigated legal action seeking damages for lost entitlements you would have received under your employment contract had your employment not been terminated. As discussed above, you are entitled to claim a deduction for the legal expenses associated with this action and the related appeal.

As the legal expenses are deductible, any reimbursement of your legal expenses is considered to be an assessable recoupment and is included in your assessable income in the financial year in which it is received.