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Edited version of your written advice
Authorisation Number: 1012885994038
Date of advice: 29 September 2015
Ruling
Subject: Legal expenses
Question 1
Are you entitled to a deduction for the legal expenses incurred to defend your charges?
Answer
No.
Question 2
Are you entitled to a deduction for the legal expenses incurred to obtain compensation?
Answer
No.
This ruling applies for the following periods:
Year ended 30 June 2014
The scheme commences on:
1 July 2013
Relevant facts and circumstances
You are an employee.
After an incident involving a client you were charged with a criminal offence.
You were stood down by your employer.
You settled the case.
Your employment was subsequently terminated.
You incurred legal expenses to defend the charges as well as seeking compensation from your employer.
You sought compensation for unfair dismissal and inappropriate treatment of the situation by your employer.
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 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.
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.
Legal expenses are generally deductible if the expenses arise out of the day to day activities of a taxpayer's employment duties. For example, in FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691 (Rowe's case), the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable.
Conversely, in Case W94 89 ATC 792; AAT Case 5376 (1989) 20 ATR 4001(Case W94) the taxpayer, a public servant, incurred legal fees in defending and then appealing against disciplinary charges of improper conduct resulting from his compulsive gambling. It was found that the expenses incurred were not incidental or relevant to the gaining of the taxpayer's assessable income. It was the conduct of the taxpayer through his compulsive gambling which led to the charges which, in turn, led to him incurring legal costs. The expenses incurred were not incidental or relevant to the gaining of the taxpayer's assessable income.
The Commissioner in his Decision Impact Statement for the case Federal Commissioner of Taxation v. Day (2008) 236 CLR 163; 2008 ATC 20-064; (2008) 70 ATR 14 stated:
…the criminal law applies regardless of any employment obligation, and the duty to obey it and to respond to criminal proceedings is owed by every man or woman to the Crown as a subject of the law, and not as an employee to the employer. Costs incurred in defending criminal proceedings, in the Commissioner's opinion, are private expenses even when an employee is liable to be dismissed from employment on conviction.
In your case, you incurred legal expenses to defend yourself against criminal charges. While it is acknowledged your employment was terminated as a result of the charges and the incident involved a client of your employer, engaging in any form of contact with clients was not part of your employment duties. It is not considered that you were acting in an official or unofficial employment capacity when you undertook the act which led to the charges. The legal expenses you incurred in respect of this action are considered private or domestic in nature and not deductible under section 8-1 of the ITAA 1997.
Additionally, you incurred legal expenses in order to obtain compensation for unfair dismissal and inappropriate treatment of the situation by your employer.
Paragraph 5 of Taxation Determination TD 93/29 provides the Commissioner's view on the deductibility of legal expenses in relation to a wrongful dismissal action. This paragraph states that the expenses:
• will be deductible to the extent to which they relate to a claim for items of a revenue nature such as unpaid salary or wages
• will not be deductible to the extent to which they relate to a claim for items of a capital nature such as damages for wrongful dismissal.
As the compensation payment you were attempting to receive as a result of your legal action is capital in nature, the expenses incurred in pursuing your claim and obtaining the compensation payment are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses you incurred to obtain the compensation payment.