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Edited version of your written advice
Authorisation Number: 1051303520242
Date of advice: 1 November 2017
Ruling
Subject: Legal expenses deduction
Question
Are you entitled to a deduction for the legal expenses incurred in fighting allegations of misconduct, which had resulted in a decision by your employer to terminate your employment?
Answer
Yes
This ruling applies for the following periods:
Year ended 30 June 2016
Year ended 30 June 2017
Year ending 30 June 2018
The scheme commences on:
1 July 2015
Relevant facts and circumstances
You are employed by your employer.
You have been employed in a senior role.
Several breaches of discipline allegations made against you and you were removed from the position.
You engaged lawyers to defend yourself against these allegations.
Your appeal was allowed.
Your employer has commenced making arrangements for you to return to your position and for salary owing to you to be paid as soon as possible.
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 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.
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),
● 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).
For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income. Also, in determining whether a deduction for legal expenses is allowable 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 High Court in Federal Commissioner of Taxation v. Day (2008) 236 CLR 163; 2008 ATC 20-064; (2008) 70 ATR 14 held that for an employee’s legal expenses to be deductible, the occasion for the expenses must be found in their employment. It also held that the scope of a particular taxpayer's employment is not confined to the day-to-day activities performed by the employee. In the circumstances of Day the High Court had regard to the nature of the employment and the fact that the taxpayer was exposed to the action by reason of his employment.
In your case, it is the Commissioner’s view that the occasion for your legal expenses was your employment. It was your employment which exposed you to the allegations of misconduct and you incurred the expenses in order to continue your employment.
Therefore, it is considered that there is sufficient connection between your legal expenses incurred in fighting the allegations of misconduct and your employment; as such, the legal expenses are deductible under section 8-1 of the ITAA 1997.
Additional information for your consideration
Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions sets out the Commissioner's views on the meaning of incurred. Generally, a taxpayer incurs an expense at the time they owe a present money debt that they cannot escape.
The guidelines developed by the courts that help to determine if an expense has been incurred include:
● there must be a presently existing liability to pay a pecuniary sum,
● presently existing liability is determined on the circumstances of the case,
● an expense is incurred when actually paid if there was no presently existing liability.
In your case, you made several payments to your lawyers; the payments were made in different financial years. You have to claim legal expenses deduction in relevant financial years accordingly.