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Authorisation Number: 1051302105672

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Date of advice: 30 October 2017

Ruling

Subject: Legal expenses

Question 1

Is the settlement sum paid by you of $50,000 deductible?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2017

The scheme commences on

1 July 2016

Relevant facts and circumstances

You were employed as the legal counsel of a group of companies named Group X, which consisted of a number of private companies.

You and your parent (who was the CEO of Group X), became involved in a legal dispute with Group X.

While the claims were largely against your parent, the main basis for the action against you related to alleged unauthorised bonus and salary payments you received in a previous financial year.

Your employment with Group X ended.

The legal action was settled by a confidential out of court settlement

You and the other defendants were required to pay an undissected lump sum to the plaintiff.

This settlement payment was made on a ‘without admission’ basis.

You entered an arrangement with the other defendants on how much you would pay towards the settlement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Question 1

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 (Hallstroms Pty Ltd v. FC 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.

A deduction for legal costs by an employee depends on the particular facts of any case. To be deductible the occasion of the expenditure must be found in what is productive in the gaining of assessable income by the employee. However where the expenditure is incurred for the purpose of securing an enduring benefit, rather than a revenue purpose the expenditure is capital in nature, and is not deductible (Sun Newspapers Ltd v. FC of T (1938) 61CLR 337; 5 ATD 87; (1938) 1 AITR 403). In Federal Commissioner of Taxation v Rowe (1995) 60 FCR 99 (Rowe), the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable.

Generally, the treatment of a settlement sum or damages payment will follow the treatment of the other legal costs incurred in relation to a particular matter.

Application to your circumstances

The payment was given to extinguish all the potential legal claims against you. It cannot be concluded that the settlement sum related to you earning your assessable income. In fact it was paid to receive an enduring benefit of not having the claims against you litigated by your previous employer. The settlement agreement itself does not list categorically what the amount was specifically in relation to. It specifically does not mention that it includes an amount to be paid that could constitute a repayment of unauthorised income.

In Rowe, the expenses were specific legal expenses incurred in defending the employee’s performance of their duties. Your circumstance can be distinguished on the basis that this case specifically concerns a settlement payment, as opposed to general legal expenses. While generally settlement payments with follow the treatment of other legal expenses in the matter, the settlement payment was not paid in the course of defending your income producing activities. The primary objective was to extinguish future claims against you.

Therefore the expense you paid would be a capital expense and cannot be deducted.

Other relevant comments

It was considered that section 59-30 of the ITAA 1997 could be relevant in your circumstances. That section provides that:

An amount you receive is not assessable income and is not exempt income for an income year if:

a) You must repay it; and

b) You repay it in a later income year; and

c) You cannot deduct the repayment for any income year.

This section could be relevant as the amount paid represented a capital outgoing, and was not deductible, therefore satisfying s 59-30(1)(c). It was argued that the amount paid was in relation to a repayment of bonuses and salary you were awarded in a previous financial year allegedly without authorisation. However the Settlement Deed contained no reference to an obligation to repay the amount in question. It merely referenced the claims made in the various Statements of Claim. We therefore cannot conclude that there was an obligation to repay the amounts. This section therefore cannot be used to reduce your previous assessable income to reflect the payment you have made.