Edited version of your written advice

Authorisation Number: 1051458058517

Date of advice: 22 November 2018

Ruling

Subject: Deduction – legal expenses

Question 1

Are you entitled to claim a full deduction for your legal expenses under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are you entitled to claim a partial deduction for legal expenses incurred in relation to the part of your claim that is revenue in nature, such as the incorrect payment of wages?

Answer

Yes

Question 3

Are you entitled to claim a partial deduction for legal expenses incurred in relation to the part of your claim that is capital in nature?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

Year ending 30 June 2021

The scheme commences on:

1 July 2016

Relevant facts and circumstances

You were employed.

You accepted an appointment to a temporary position with your employer.

You remained in that temporary position until you resigned.

You have lodged a statement of claim in the Federal Circuit Court of Australia against your previous employer. The heads of claim are:

● Failure to pay wages

● Misleading and deceptive conduct

● Entitlement to benefit of redundancy provisions of Enterprise Agreement

● Misrepresentations under the Fair Work Act 2009 (Cth)

● Adverse Action

The matter has not yet been resolved.

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) allows a deduction for losses and outgoings to the extent that they 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.

Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income.

In Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190, the Court established that in determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. Dixon J stated at CLR 647 that:

...legal expenses...take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or purposes of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.

If the advantage to be gained is of a capital nature then the expenses incurred in gaining the advantage will also be of a capital nature.

In your case, you have incurred legal expenses for duel purposes. Firstly, pursuing a claim for incorrectly paid wages and, secondly, pursuing a claim of misleading and deceptive conduct, entitlement to the benefit of redundancy provisions, misrepresentations under the Fair Work Act 2009 (Cth) and adverse action. While the advantage sought in pursuing the incorrectly paid wages is revenue in nature, the remaining claims are capital in nature.

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 ? discusses the deductibility of legal expenses incurred in recovering an amount for wages and states that if 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.

As the nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses, a portion of the expenses you have incurred are considered to be of a capital nature and are not deductible. Therefore, any deduction will need to be apportioned to reflect the dual purpose of the expenses incurred.

Apportionment of expenses

TD 93/29 also discusses the apportionment of legal expenses.

Where legal expenses are incurred in relation to proceedings that relate both to amounts that are revenue in nature as well as amounts which are capital in nature, there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income.

Where the solicitors account is itemised, one reasonable basis for apportionment would be the time spent involving the revenue claim, relative to the time spent on the capital claim.

If the solicitors account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim.

You should apply the above principles in determining the portion of your legal expenses that relate to the part of your claim that is revenue in nature, that is the incorrect payment of wages and those that relate to your remaining heads of claim, that are capital in nature.

You are entitled to claim a deduction for the portion of your legal expenses that relate to your revenue claim, the incorrect payment of wages, under section 8-1 of the ITAA 1997.