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Edited version of your written advice
Authorisation Number: 1051219368938
Date of Advice: 4 May 2017
Ruling
Subject: Deductibility of legal expenses
Question 1
Are the legal expenses regarding serious misconduct charges incurred prior to your dismissal deductible?
Answer
Yes
Question 2
Are the legal expenses regarding unfair dismissal incurred after to your dismissal deductible?
Answer
No
This ruling applies for the following periods:
Year ended 30 June 2015
Year ended 30 June 2016
The scheme commences on:
1 July 2014
Relevant facts and circumstances
You were employed at Entity X.
You were held to both a Code of Ethics and a Code of Conduct by Entity X.
Failure to act in accordance with the codes can be cause for investigation under the misconduct provisions of the Entity X Workplace Agreements.
During 2014 disciplinary action was commenced regarding alleged misappropriation of funds and serious misconduct.
An investigation was conducted into the matter, as a result you were suspended and the area you worked in was closed.
During 2015 you were dismissed from your position for alleged serious misconduct.
You commenced a claim against Entity X for unfair dismissal with the Fair Work Commission.
You sought legal advice and incurred legal expenses in relation to the investigation into the alleged serious misconduct.
You sought further legal advices and incurred legal expenses in relation to the action for unfair dismissal.
You ceased the action for unfair dismissal against Entity X due to the serious impact the proceedings were having on your physical and mental health.
Relevant legislative provisions
Income Tax Assessment Act section 8-1.
Reasons for decision
Question 1
Summary
You are entitled to a deduction for the legal expenses incurred in defending your employment, prior to your dismissal.
Detailed reasoning
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.
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) 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 (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).
Similarly, in FC of T v. Day [2008] HCA 53 and FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the courts accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. No significance was placed by the court on the taxpayer's status as an employee.
The High Court found in FC of T v. Day [2008] HCA 53 that the legal expenses incurred by a taxpayer in relation to disciplinary action taken by their employer are not outgoings of a private or domestic nature. In your case, the terms of your employment exposed you as an employee to the employer action of the investigation and you therefore needed to incur legal expenses in defending the claims of misappropriation of funds and serious misconduct. That is the proceedings were internal to your employment relationship.
Therefore the legal expenses incurred prior to your dismissal in defending the internal action and the investigations instigated by your employer are deductible under section 8-1 of the ITAA 1997.
Question 2
Summary
You are not entitled to a deduction for the legal expenses incurred in relation to the unfair dismissal action against your former employer.
Detailed reasoning
Paragraph 5 of Taxation Determination TD 93/29 Income tax: if an employee incurs legal expenses recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997? explains that 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 where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible.
In your case, you instigated an unfair dismissal action against your former employer with the Fair Work Commission in order to regain your employment and have your former position reinstated. As stated above, these expenses are considered to be capital in nature and as such, are not deductible. This is because the advantage sought in incurring the expenses is of a capital nature rather than of an income nature. The purpose of the expenditure is to re-establish an income stream or for gaining an enduring benefit, that is, the reinstatement of the employment position. Therefore, no deduction is allowable under section 8-1 of the ITAA 1997.