Edited version of your written advice

Authorisation Number: 1051434897501

Date of advice: 8 October 2018

Ruling

Subject: Work related expenses – legal fees

Question

Are you entitled to a deduction for all legal expenses incurred in a claim made against your former employer for unpaid amounts consisting of an ‘Incentive Payment’, a ‘Resignation Payment’ and unpaid long service leave entitlements?

Answer

No

Question

Are you entitled to a partial deduction for the portion of the legal expenses that relate to the claim made against your former employer for the ‘Incentive Payment’ and the unpaid long service leave entitlements?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were employed by Company A and were denied an employee bonus (the ‘Incentive Payment’).

You submitted your resignation in Summer 20XX and your solicitors sent a letter of demand to your former employer. You claimed for alleged unpaid amounts for the ‘Incentive Payment’, a ‘Resignation Payment’ and outstanding long service leave.

A settlement was reached regarding this letter of demand and a payment of $X was made in full settlement of your claims.

You engaged solicitors to mount this claim against your former employer. You seek to claim these legal costs as deductible expenses.

The ‘Resignation Payment’ was an amount payable on termination if certain conditions (including when the resignation took place) were met.

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.

In determining whether a deduction for legal expenses is allowed, 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 nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses.

Generally, legal expenses incurred in an unfair dismissal action (seeking reinstatement and/or damages) are of a capital nature and therefore, not deductible.

Paragraph five of Taxation Determination TD93/29 states:

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, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible.

Part of your legal expenses do not relate to damages for wrongful dismissal, they relate to your ‘Resignation Payment’ and are judged to be not salary or wages.

A ‘Resignation Payment’, being a reward paid on termination in return for completing a specified period of service, is a payment that is capital in nature. Such a payment is made to provide the employee with an incentive to provide service for a specified period and is regarded as a capital payment.

Employment termination payments are subject to special tax treatment that may result in some or the entire amount being included in your income. However the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in your assessable income.

Therefore as a ‘Resignation Payment’ is capital in nature, the legal expenses incurred in obtaining this payment will also be capital in nature.

In Romanin v. FC of T 2008 ATC 20-055; [2008] FCA 1532; 73 ATR 760 (Romanin) the court considered the deductibility of legal expenses incurred by the taxpayer for proceedings at the Industrial Relations Commission. In the proceedings, the taxpayer argued that an employment contract existed where they were entitled to 12 months’ notice, or a payment in lieu of this notice. The employer had denied such a contract existed and had given seven days’ notice.

The proceedings found in favour of the taxpayer and the employer was ordered to pay them the total value of the employment package for the period of 12 months less any salary and other earnings that they had earned in alternative employment during the 12 months following the termination of his employment.

The legal expenses were found not to be capital in nature because the character of the advantage which the taxpayer sought in bringing the proceedings was on revenue account, namely receipt of his contractual entitlement to salary he would have received had he been given 12 months’ notice.

Legal expenses incurred to recover income payments such as were at issue in Romanin - that is, salary that would have been derived during the notice of termination period, had it been given - will be deductible, even if the receipt was paid as a lump sum and subject to assessment as an employment termination payment.

In your case, unlike Romanin, you are not seeking payment in lieu of notice but are seeking a contractual entitlement to a lump sum that is considered to be similar to a golden handshake. The ‘Resignation Payment’ you sought is judged to be capital in nature. Therefore, the legal expenses you incur in pursuing this payment are also capital in nature and consequently not deductible.

Given this you will be obliged to determine an appropriate apportionment of your legal expenses as to which part of these expenses relate to the ‘Resignation Payment’ and to not claim this portion of the expenses as they relate to a capital payment. The remainder of the legal expenses will relate to claims that are revenue in nature and hence deductible.