Edited version of your written advice

Authorisation Number: 1051476306576

Date of advice: 14 February 2019

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for the portion of your legal expenses incurred that relate to you seeking compensation for your weekly incapacity payments?

Answer

Yes

Question 2

Are you entitled to a deduction for the portion of your legal expenses incurred that relate to you seeking compensation for your medical expenses?

Answer

No

This ruling applies for the following period:

Year ended 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

You suffered an injury at your workplace.

Your employer paid you incapacity payments while you were unable to work.

You were unable to continue working for your employer due to your medical condition and found work in another industry.

You were paid the incapacity payments for approximately three years until employer’s insurer denied further responsibility and the payment of incapacity payments and medical expenses ceased.

You requested a reconsideration of the determination; however insurer affirmed their original determination to deny the incapacity payments and medical expenses.

You sought legal advice and engaged legal firm to prepare an appeal against determination.

On the Administrative Appeals Tribunal varied determination the decision states: For the reasons given orally at the conclusion of the hearing of this matter the Tribunal varies the decision so that the Respondent is liable to pay compensation for incapacity payments. In relation to the respondent’s liability to pay compensation for medical expenses the decision remains the same.

You received the back payment as a lump sum. The amount is included on your Payment summary.

Some of your legal costs were paid but you incurred out of pocket legal expenses from the legal firm.

You don’t hold professional indemnity insurance to make a claim for legal expenses.

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 a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of assessable income or business operations. 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 nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. 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 Tax 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? the Commissioner states that legal expenses incurred by an employee in recovering unpaid wages are deductible under section 8-1 of the ITAA 1997, as the expenses are directly incurred in the process of deriving assessable income.

Similarly you incurred legal expenses in relation to compensation for loss of income. The compensation for weekly payments represents a replacement of your salary and wages and are considered to be revenue in nature and assessable. The associated legal expenses in relation to you seeking incapacity payments relates sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

Medical Expenses

Medical expenses are generally regarded as private expenses. Additionally it is a long standing principle that a taxpayer does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some casual connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred in gaining or producing your assessable income (Lunney v Commissioner of Taxation (1958) 100 CLR 478). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3.

The deductibility of the expenses can also depend on whether the claims would have resulted in assessable income. Reimbursement of medical expenses is not generally regarded as assessable income.

In your case, the legal expenses incurred in relation to seeking compensation for your medical and treatment costs do not have the required nexus with the derivation of assessable income and are of a private nature. Therefore, the associated legal expenses are not an allowable deduction under section 8-1 of the ITAA 1997.

Apportionment of expenses

As your legal expenses are not fully deductible, you will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

If your legal expenses are not broken up into the relevant parts by your solicitor, you will need to calculate the deductible portion. One way to apportion your expenses is according to the dollar value of the assessable amount as compared to the total amount being sought. The relevant percentage that relates to your assessable income can then be applied to the legal expenses incurred.