Edited version of private advice

Authorisation Number: 1051597926174

Date of advice: 4 November 2019

Ruling

Subject: Legal expenses - deductibility

Question 1

Are you entitled to a deduction for all your legal expenses?

Answer

No

Question 2

Are you entitled to a deduction for the legal expenses incurred in respect of pursuing your annual leave, long service leave, penalties and loading, outstanding wages and pay in lieu of notice entitlements?

Answer

Yes

Question 3

Are you entitled to a deduction for your legal expenses incurred in seeking reinstatement, compensation for unfair dismissal or redundancy pay?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2019

Year ending 30 June 2020

The scheme commences on:

01 July 2018

Relevant facts and circumstances

You received a letter from your employer advising you of allegations against you.

You were stood down until further notice.

Preliminary legal advice was sought to address the allegations.

You engaged an employment lawyer who provided advice on how to recover entitlements and unpaid wages.

You received notice of termination of employment.

You lodged an unfair dismissal case with the Fair Work Commission seeking reinstatement and back-pay, or compensation and redundancy pay.

You legal representation is ongoing with provision of advice in regards to the progression of your Fair Work Commission Matter.

Outcome of the unfair dismissal case has currently not been received

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Summary

You are allowed a deduction for legal expenses to the extent to which they are incurred in relation to claims of a revenue rather than a capital nature. In your case the payment of your entitlements and outstanding pay up to your termination are items of a revenue nature. Conversely the advantage sought in your representation to the Fair Work Commission for unfair dismissal seeking reinstatement or alternatively, compensation for unfair dismissal and redundancy pay is seen as capital in nature and therefore the related legal expenses are not deductible.

Detailed reasoning

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, or relate to the earning of exempt income.

In determining whether a deduction for legal expenses is allowable, the nature or character of the expenditure must be considered, that is, whether the legal expenses are incurred for a capital or a revenue purpose (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. For example, if the advantage to be gained is of a capital nature, then the legal expenses incurred in gaining the advantage will also be of a capital nature and are not deductible.

It also follows that the character of legal expenses is not determined by the success or failure of the legal action.

Items of a revenue nature

Your claims for outstanding entitlements to annual leave, long service leave, penalties and loading, wages and pay in lieu of notice are claims for items of a revenue nature. Therefore the associated legal expenses are deductible under section 8-1 of the ITAA 1997.

Reinstatement

The deductibility of legal expenses incurred in seeking reinstatement where the former employee claimed they were unfairly dismissed was considered in Case L26 79 ATC 126; 23 CTBR (NS) Case 32 (Case L26). In that case, the taxpayer was employed as a music teacher by the Commonwealth Teaching Service. She was dismissed from her employment as a school teacher on the ground that she could not control classes. She was unsuccessful in her appeal to the Disciplinary Appeal Board against her dismissal.

The taxpayer claimed a deduction for her legal expenses in relation to the appeal. It was held that although the expenditure was a necessary step prior to regaining income from the employment from which the taxpayer had been dismissed; it was not expenditure incurred in the course of gaining or producing such income. Thus, the expenditure was not deductible.

Also, expenditure incurred in seeking reinstatement is considered to be incurred in order to obtain an enduring advantage, being the regaining of the employment position, and therefore is an advantage of a capital nature.

As in Case L26 your legal expenses related to seeking reinstatement are not deductible.

Compensation for unfair dismissal

Taxation Determination TD 93/29 states at paragraph 5 'legal expense relating to an action for damages for wrongful dismissal are not deductible' as the claim is of a capital nature. Consequently, it is clear that your legal expenses that relate to your claim for compensation for unfair dismissal are not deductible.

Redundancy payment

The nature of a redundancy payment was considered in Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184. In that case, it was held that a redundancy payment, being compensation for the loss of the expectation of continuity of service, is a payment that is capital in nature. The payment is made to compensate for the loss of employment position, that is, as compensation for the sterilisation of a capital asset, and thus is capital in nature.

Redundancy payments are treated as eligible termination payments and subject to special tax treatment that may result in some or the entire amount being included in the taxpayer's 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 the assessable income of the taxpayer.

A redundancy payment received by a taxpayer is capital in nature and consequently the legal expenses incurred in obtaining the redundancy payment are also capital in nature.

The legal expenses you incurred in seeking a redundancy payment are not deductible as they are expenses of a capital nature.

Apportionment

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

Where legal expenses are incurred in relation to proceedings that relate both to claims that are revenue in nature as well as those of a capital nature, there must be some fair and reasonable assessment of the extent of the relation of the outlay to the revenue claim.

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 payment of your entitlements and outstanding pay and those that relate to the part of your claim that is capital in nature, that is the Fair Work Commission case for reinstatement, compensation for unfair dismissal and redundancy pay.

You are entitled to claim a deduction under section 8-1 of the ITAA 1997 for the portion of your legal expenses that relate to your revenue claim, being the payment of entitlements and outstanding pay.