Edited version of your written advice

Authorisation Number: 1013125148417

Date of advice: 16 December 2016

Ruling

Subject: Legal Expenses

Question 1

Are you entitled to a claim a deduction in your 20ZZ return for legal expenses incurred in the 20ZZ income year?

Answer

Yes

Question 2

Are you entitled to a claim a deduction in your 20ZZ return for legal and union expenses incurred in the 20XX and 20YY income years?

Answer

No. However, you can claim them in the year they were incurred.

This ruling applies for the following period(s)

Year ended 30 June 20ZZ.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

You started working for AAA at BBB in X.

Your serious medical condition was deemed to have become apparent in X.

Your last day of work for AAA at BBB was in X.

You lodged a claim for workers compensation against AAA for your time at BBB.

Legal proceedings followed.

You were paid a lump sum E amount with tax withheld.

Legal costs were incurred over X financial years.

You incurred Union Fees in X financial years.

A portion of the legal fees incurred are yet to be paid.

Assumption(s)

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Question 1

Summary

The legal expenses you incurred in recovering salary or wages are a deductible expense in the year they were incurred.

Detailed reasoning

Legal costs incurred same financial year

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, or relate to the earning of exempt income.  

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. 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.

Paragraph 3 of TD 93/29 discusses the deductibility of legal expenses in recovering wages and whether the legal expenses are deductible under subsection 51(1) of the ITAA 1936 (now section 8-1 of the ITAA 1997). Where legal expenses are incurred in enforcing a right to recover an amount owing, such as salary and wages, which are fully assessable when received, and retain the nature of income according to ordinary concepts, the legal expenses will be allowed as a deduction as those expenses are directly incurred in the process of deriving assessable income.

A loss or outgoing may be incurred for the purposes of section 8-1 of the ITAA 1997, even though no money has actually been paid out, as long as the expense is a present liability. In this respect, it is not sufficient that the liability to pay is pending, threatened or expected. Rather, there must be a presently existing liability to pay a specific sum.

In your case, you received assessable income in the form of a lump sum E payment from Return to Work. You incurred legal expenses in pursuit of this payment of lost earnings in the form of weekly income that you were entitled to you under the relevant workers compensation legislation. There is a direct connection between your legal expenses and the gaining or producing of your assessable income.

You have also incurred legal expenses in the 20ZZ year that were not paid by the end of the 20ZZ financial year. However, as the expenses were a present liability in the 20ZZ income year, the expense is deductible in that year.

Therefore any legal expenses incurred in the 20ZZ income year in the pursuit of payment of lost earnings, are deductible expenses in the 20ZZ income year, even though they had not been paid in full at the end of the 20ZZ income year.

Question 2

Summary

Legal and union fees incurred in previous years are not deductible in the current year. They can only be claimed in the year they were incurred.

Detailed reasoning

Legal and Union costs incurred in previous years

A deduction for an expense can only be claimed in the year it is incurred.

If your deductions in a year of income exceed your assessable income, this will result in a tax loss. A tax loss can only reduce your assessable income to nil. An excess amount of tax loss will be carried forward to be offset against assessable income in the following income year.

If you have a tax loss you are required to lodge a tax return.

In your case, you have incurred expenses for legal costs and union fees in the 20XX and the 20YY income years. These fees relate to assessable income that you received in the 20ZZ income year, and are allowable deductions. However, as these expenses were not incurred in the 20ZZ year, you cannot include them in your 20ZZ tax return.

However, you can lodge a return for the 20XX and the 20YY income years to claim the allowable deductions in those years. Any resulting tax loss from the 20XX and 20YY income years will be carried forward to offset the assessable income received in future income years.

ATO view documents

Taxation Determination TD 93/29

Taxation Determination TD 93/58

Taxation Ruling 97/7

Other references (non ATO view)

Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634; 8 ATD 190

Workers Rehabilitation and Compensation Act (South Australia) 1986 Section 35C