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Edited version of private advice
Authorisation Number: 1051572177742
Date of advice: 27 August 2019
Ruling
Subject: Legal expenses
Question
Are the legal expenses incurred in disputing an early termination payment tax deductible?
Answer
No. An ETP is capital in nature and legal expenses incurred in reaching a settlement for an increased ETP are also capital in nature.
This ruling applies for the following period:
Year ending 30 June 20XX
The scheme commences on:
1 July 20XX
Relevant facts and circumstances
Your employment was terminated for reasons of redundancy.
You took legal action against your former employer for unfair dismissal.
You have entered into a settlement agreement with your former employer.
You incurred legal expenses.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-10
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 82-130
Reasons for decision
Employment termination payment
Statutory income includes ETPs which are governed by the provisions in Division 82 of the ITAA 1997.
An ETP does not have the characteristics of ordinary income (earned, expected and recurring) and is considered to be capital in nature.
Legal expenses
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. 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.
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.
ETP's are subject to special tax treatment that may result in some or all of the amounts being included in assessable 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 assessable income.
Application to your circumstances
In your case, you incurred expenses in taking legal action against your employer for unfair dismissal. You entered into a settlement with your employer where $X less applicable income tax would be paid to you as an ETP.
Conclusion
As your legal expenses related to an item which is capital in nature, the legal expenses are also capital in nature. Therefore the legal expenses are not deductible under section 8-1 of the ITAA 1997.