Edited version of your written advice

Authorisation Number: 1012939684767

Date of advice: 20 January 2016

Ruling

Subject: Deduction - Legal expenses

Question

Are you entitled to a deduction for legal fees associated with taking legal action against your employer for unfair dismissal?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You took legal action against your former employer for unfair dismissal.

You engaged legal practitioners to assist you in taking the matter to the Fair Work Commission.

You have entered into a settlement agreement with your former employer under which they will pay you an agreed sum

You incurred legal fees to your legal practitioners for representing you in your case.

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 or 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 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.  For example, 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. Therefore, to determine the deductibility of the legal expenses, it is necessary to consider the reason for which expenses were incurred.

Taxation Determination TD 93/29 which considers the deductibility of legal expenses states at paragraph 5:

...if the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the contract of employment, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible. 

A compensation payment made by an employer to a former employee in settlement of an unfair dismissal action qualifies as an ETP, as it is considered to be made 'in consequence of the termination of any employment of the taxpayer' (Taxation Ruling IT 2424, paragraph 24).  For this reason an ETP, whether it is made in one lump sum or through several amounts, is capital in nature.

ETP's are subject to special tax treatment that may result in some or all of the amounts being included in 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 assessable income.

In your case, you incurred expenses in taking legal action against your employer for unfair dismissal. This action has gone beyond a claim for revenue. You entered into a settlement with your employer the majority of which is considered to be an ETP. ETP's are capital in nature.

As your legal expenses related to items which were capital in nature, the legal expenses are also considered to be capital in nature. Therefore the legal expenses are not deductible under section 8-1 of the ITAA 1997.