Edited version of private advice

Authorisation Number: 1051710772607

Date of advice: 9 July 2020

Ruling

Subject: Legal expenses

Question 1

Can you claim a deduction for the legal expenses incurred in relation to the settlement payment you received from your employer?

Answer

No

Question 2

Can you claim a deduction for the legal expenses incurred in relation to the lump sum payment you received from a superannuation fund?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Sometime between 20XX and 20XX you sustained a workplace injury.

You took extended periods off work during this period and commenced seeing professional medical practitioners.

You received many evaluations and assessments from treating specialists and consequently you were diagnosed with a disorder. You were prescribed medication and continue to take this.

You also commenced legal proceedings against your employer during the period from 20XX to 20XX through your solicitor and the Workers Compensation Commissioner. This took several years to finalise.

In 20XX you were considered permanently unfit for your work duties by a medical professional and are no longer able to work in your profession.

In 20XX the Workers Compensation Commissioner determined that your employer pay you as a lump sum compensation in respect of a permanent impairment resulting from your injury.

In 20XX you reached a settlement agreement with your employer.

In 20XX, you received a payment from your superannuation for total and permanent disablement (TPD). At the same time, you also received a partial amount from your superannuation account. You were below the age of 55 year when you received these lump sum amounts.

You received the funds and a payment summary was provided to you for the year ended 30 June 20XX describing the total tax withheld, the taxed element and the tax-free component.

You incurred legal expenses plus GST for the settlement payment you received from your previous employer.

You incurred legal expenses plus GST for the payment you received from the superannuation fund.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 116-40

Income Tax Assessment Act 1997 section 118-37

Reasons for decision

Detailed reasoning

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 under section 8-1 of the ITAA 1997, the nature of the expenses 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 is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

Settlement payment

In your case, you incurred legal expenses for legal action against your employer seeking compensation for the injury. As a result, you received a lump sum payment to give up your right to seek compensation.

Your right to seek compensation is an intangible capital gains tax (CGT) asset and your ownership of that asset ended when you accepted the lump sum payment. CGT event C2 happens if your ownership of an intangible CGT asset ends in certain ways, including being released or cancelled (subsection 104-25(1) of the ITAA 1997).

As the payment of you received is capital in nature, the expenses (not including GST) incurred in securing that payment are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses you incurred as expenditure of a capital nature is expressly excluded.

Superannuation payment

Similarly, you incurred the legal expenses in order to obtain the release of your superannuation as a lump sum disability benefit. The lump sum superannuation payment is also a capital receipt. The payment remains a capital receipt despite the fact that a portion of the lump sum payment is included in your assessable income.

Therefore, the legal expenses (not including GST) incurred in securing that payment are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses you incurred as expenditure of a capital nature is expressly excluded.