Edited version of your written advice

Authorisation Number: 1012935831940

Date of advice: 19 January 2016

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for legal expenses incurred in relation to the dispute regarding your work hours?

Answer

Yes.

Question 2

Are you entitled to a deduction for legal expenses incurred in relation to the dispute regarding your sick leave payments?

Answer

Yes.

Question 3

Are you entitled to a deduction for legal expenses incurred in relation to negotiating your lump sum termination payment?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2015

The scheme commenced on

1 July 2014

Relevant facts

You requested that your employer allow you flexible work hours.

Your request was refused and it was suggested you resign which you declined to do.

The stress of the dispute resulted in you taking sick leave.

Your employer stopped paying you your entitled sick leave.

The dispute was heard before the Fair Work Commission.

You alleged unlawful discrimination, bullying, breach of the enterprise agreement and breach of the Fair Work Act 2009.

The Commission found that your employer should continue to pay you sick leave and that your employer and you should attempt to renegotiate a flexible working arrangement. However, the dispute continued.

You engaged a lawyer in order to represent you in negotiations with your employer over your request for a flexible working arrangement, for the continued payment of your sick leave and to address the direction that you resign.

No agreement could be reached. You signed a deed of release in which you agreed to resign from your employment.

You received a lump sum termination amount along with payments for accrued annual leave, annual leave loading and accrued long service leave.

You incurred legal expenses in relation to discussions with your employer to resolve your right to flexible working hours and continued employment, representation at the Fair Work Commission, your entitlement to continued sick leave and negotiations on an amount upon termination.

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.

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 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).

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties, in order to defend the threat of dismissal, were allowable. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income.

Negotiating work hours and employment agreement

Taxation Ruling TR 2000/5 Income tax and fringe benefits tax: costs incurred in preparing and administering employment agreements outlines the Commissioner's views on the costs incurred in relation to employment agreements. A deduction is allowed for an employee for costs associated with settlement of disputes arising out of an existing employment agreement including the cost of representation. An employment agreement is a reference to an agreement between an employee and an employer regarding employment.

Expenditure incurred by an employee in relation to work hours are generally deductible under section 8-1 of the ITAA 1997 provided it is not capital, private or domestic in nature.

In your situation, your incurred legal expenses in relation to your working hours with your employer. The associated legal expenses were a consequence of defending your rights under your current employment agreement. It is considered that your expenditure on this portion of your legal expenses was a consequence of your day to day activities as an employee from which you derived assessable income and are deductible under section 8-1 of the ITAA 1997.

Sick leave

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.

Similarly, legal expenses incurred in relation to leave payments are generally allowable as they directly relate to gaining or producing assessable income.

In your case there was a dispute between you and your employer over their continued payment of sick leave to you. You incurred legal expenses in order to resolve this dispute. It is considered that these legal expenses related sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

It is noted that you received amounts in respect of unused annual leave, annual leave loading and unused long service leave. There is no indication that there was a dispute over your unused leave entitlements. Rather it appears that you would simply have received those entitlements after you agreed to resign as part of your settlement and therefore no portion of your legal expenses were incurred in relation to those entitlements. However, if you have incurred legal expenses in order to settle a dispute over the amount of unused annual leave, annual leave loading and unused long service leave you would be paid then these legal expenses would be deductible under section 8-1 of the ITAA 1997.

Termination payment

Taxation Determination TD 93/29 states that legal expenses incurred in pursuing a claim for a revenue item such as unpaid wages are deductible but if the claim is for a capital payment then the legal expenses will be capital in nature and therefore not deductible.

In your case, a portion of your legal expenses were incurred in relation to the negotiation of a lump sum termination payment. Such a payment is capital in nature.

Although lump sum termination payments are capital in nature, there are specific legislative provisions that include these payments, or parts of these payments, in assessable income.

The fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. That is, an amount that is capital in nature will remain capital notwithstanding that it is specifically included as assessable income.

Although your lump sum termination payment may be subject to taxation, it retains its character as a capital receipt. The legal expenses that you incurred in relation to the negotiation of your lump sum termination payment are also capital in nature and are therefore not deductible under section 8-1 of the ITAA 1997.

Apportionment of expenses

As your legal expenses are not fully deductible, you will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.