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Edited version of your written advice
Authorisation Number: 1012939081559
Date of advice: 19 January 2016
Ruling
Subject: Deductions - Legal Expenses
Question 1
Are you entitled to a deduction for the legal expenses incurred?
Answer
Yes
This ruling applies for the following period:
Year ended 30 June 2015
The scheme commences on:
1 July 20YY
Relevant facts and circumstances
You were previously employed by an employer in the 20XX financial year.
In 20YY, your previous employer commenced legal recovery action against you.
The Claim seeks payment of money (including damages) from you for:
• Work paid to finish incomplete work
• Refund of monies paid for job not completed
• Goods purchased for prototypes and production
• Wages paid for assembly
• Lost sales and orders
The company claimed that you were a third party contractor with an agreement to complete certain tasks.
You claimed that you were an employed as a casual employee who was being paid a wage complete with PAYG and superannuation.
The result of these legal proceedings against you was ruled in your favour and the liquidators of your former employer withdrew their application.
You also incurred legal fees defending yourself in this matter.
As your former employer is in liquidation, you were unable to counter sue for legal expenses incurred.
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) provides that a loss or an outgoing is an allowable deduction if it is incurred in producing assessable income or in carrying on a business for the production of assessable income unless that loss or outgoing is capital or of a private or domestic nature.
In determining whether a deduction for legal expenses is allowed 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.
In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, an employee incurred legal expenses in defending the manner in which he performed his employment duties. The court accepted that such expenses were allowable and no significance was placed on the taxpayer's status as an employee.
Accordingly, for legal expenses to be deductible, you have to be able to show that it was the very act of performing the prescribed or authorised activities of your employment that exposed you to the legal expenses. If it is something other than employment duties that exposed you to the legal expenses, the necessary nexus with the earning of assessable income cannot be established and the expenses are not allowable.
In the High Court decision in Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064 (Day's case), the taxpayer was charged with breaching the standards of conduct and failing to fulfil his duty as a Customs Officer. It was found that the requisite connection with his assessable income was present and that he was exposed to the charges by reason of his office, including the obligation to observe standards of conduct, breach of which might entail disciplinary charges.
It held that the legal expenses were allowable deductions and could not be viewed as private or domestic in nature.
Similar to Day's case, the legal expenses you incurred arose because of your employment and were directly related to income derived, or expected to be derived, from your employment position.
You incurred legal expenses in defending yourself against a claim made against you in regards to the performance of your employment duties. The legal expenses are directly related to the performance of your duties from which you earned your assessable income. Therefore the legal fees are deductible under section 8-1 of the ITAA 1997.