Edited version of your written advice

Authorisation Number: 1012978387301

Date of advice: 1 March 2016

Ruling

Subject: Deductibility of your legal expenses

Question 1

Are you entitled to a deduction for all your legal expenses?

Answer

No.

Question 2

Are you entitled to a deduction for the legal expenses incurred in respect of pursuing your WorkCover claim for weekly benefits?

Answer

Yes.

Question 3

Are you entitled to a deduction for a portion of your remaining legal expenses?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

You were suspended from your employment due to allegations of bullying behaviour against a subordinate. During the investigation you were unable to perform your duties due to ill health and consequently lodged a WorkCover claim which was later rejected.

Your employment was terminated.

You commenced further proceedings with respect to your WorkCover claim.

You also commenced other proceedings against your former employer alleging contraventions of the Fair Work Act 2009 and breaches of your employment contract. You made income and capital claims as part of these proceedings. You also incurred other legal expenses for another legal action relating to these proceedings.

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, or relate to the earning of exempt income.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

• it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478 (Lunney's case)), 

• there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

• it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

In determining whether a deduction for legal expenses is allowable, the nature or character of the expenditure must be considered, that is, whether the legal expenses are incurred for a capital or a revenue purpose (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 legal expenses incurred in gaining the advantage will also be of a capital nature and are not deductible.

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

Compensation for loss of income is considered to be in the nature of income and liable to income tax in the year of receipt.

A payment to compensate the employee for damages suffered as a result of the cessation of employment for example, loss of enjoyment of employment, hurt and humiliation and damage to reputation is not considered to be income; rather the payment is of a capital nature.

WorkCover claim

In your case, your original claim for WorkCover payments was denied and you took further legal action to obtain these payments. As your legal expenses attributable to this claim were incurred in order to obtain income payments, they are of a revenue nature and are deductible in the year you incurred them.

Remaining legal expenses

In your legal action alleging that your former employer contravened the Fair Work Act 2009 and breached your employment contract, you made claims of both an income and capital nature.

Therefore your legal expenses incurred in relation to these proceedings must be apportioned. You are only entitled to the portion of the legal expenses with an income purpose. Your legal expenses with respect to the other related proceedings must be apportioned on the same basis.

Apportionment

Taxation Determination TD 93/29 discusses the deductibility of legal expenses and states that in situations where legal expenses are incurred for proceedings that relate both to amounts that are revenue in nature as well as amounts which are capital in nature, there must be some fair and reasonable apportionment of the extent of the outlay to assessable income.

In relation to the apportionment of legal expenses, TD 93/29 states:

Where the solicitor's account is itemised, one reasonable basis for apportionment would be the time spent involving the revenue claim, relative to the time spent on the capital claim. If the solicitor's account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim.