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Edited version of your written advice
Authorisation Number: 1051416310689
Date of advice: 28 August 2018
Ruling
Subject: Legal costs for breach of employment contract as a capital deduction
Question
Are the legal fees you incurred defending a breach of your employment contract a deductible expense over five years under section 40-880 of the Income Tax Assessment Act (ITAA 1997)?
Answer
No.
This ruling applies for the following period
Financial year ended 30 June 2018
The scheme commenced on:
1 July 2017
Relevant facts and circumstances
You are an Australian resident for taxation purposes.
You entered into an employment contract with a business that sponsored you to work in Australia pursuant to a 457 visa.
You commenced employment and resigned from employment before the agreed timeframe of employment in your contract.
The terms of the employment contract included that you would not work within a certain radius of the business upon termination of the employment contract (the restraint area).
You then commenced working at another business, which is located within the restraint area.
The first mentioned business filed a claim against you in court for damages and loss of income for breach of contract, specifically the restrictive covenants of exclusive service and operation within the restraint area of the contract.
You attended mediation and agreed to settle all outstanding issues without admission of liability.
You incurred legal fees in defending the claim.
Relevant legislative provisions
Income Tax assessment Act 1997 Section 40-880
Reasons for decision
Summary
Section 40-880 of the Income Tax Assessment Act 1997 makes certain business capital expenditure that is not otherwise taken into account deductible over five years. The expenditure must be capital expenditure which is business related. This excludes revenue expenditure and non-business expenditure such as expenditure relating to occupation as an employee. In your case, the legal fees you incurred were not in relation to any business that is, was or is proposed to be carried on; rather, they relate specifically to contractual obligations in your employment contract. As such, the legal fees are not deductible under section 40-880 of the ITAA 1997.
Detailed reasoning
Subject to the limitations and exceptions contained in subsections 40-880(3) to (9) of the ITAA 1997, paragraphs 40-880(2)(a), (b) and (c) allow a deduction for capital expenditure you incur in relation to your business, or in relation to a business that used to be carried on or a business that is proposed to be carried on.
Subsection 40-880(1) of the ITAA 1997 describes the object of section 40-880 of the ITAA 1997 is to make certain business capital expenditure deductible over five years. The expression ‘business capital expenditure’ connotes capital expenditure that has the essential character of business expenditure. This is confirmed by paragraph 2.25 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 (‘EM to the Bill’) which notes: ‘The provision is concerned with expenditure that has the character of a business expense because it is relevantly related to the business’.
Taxation Ruling TR 2011/6 Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues outlines the key concepts in relation to section 40-880 and states that:
The expenditure must be capital expenditure which is business related. This excludes revenue expenditure and non-business expenditure such as expenditure relating to occupation as an employee or to passive investment.
The expenditure you incurred for legal fees does not have the character of an expense that satisfies an objective or requirement of a business. Rather, the payment was made to satisfy your personal obligations under your employment contract.
As the legal fees cannot be characterised as expenditure that serves a need or object of a business they were not incurred in relation to a business, and as such, they are not deductible under section 40-880 of the ITAA 1997.