Edited version of private advice

Authorisation Number: 1051889352051

Date of advice: 23 August 2021

Ruling

Subject: Deductibility of legal expenses

Question

Are the legal expenses you incurred in relation to the HR dispute deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You have been employed by XYZ under a contract of employment and the Staff Agreement (the Contract).

Your employer advertised a vacancy for a position which you applied for but was not selected for the position.

You filed a grievance complaining about the decision on not appointing you to the position. You made certain allegations as to the reasons why you were not selected for the position.

Your employer denied the allegations.

You and your employer exchanged written correspondences, met to discuss a dispute resolution process to resolve the allegations and took part in mediation to resolve the dispute.

You and your employer, without admitting liability, have reached agreement to resolve the dispute on the terms set out in the Deed of Release (the Deed).

The Deed provides you will access paid sick leave, and/or other paid leave entitlements and will not attend, or be required to attend, any of your employer's office without the written agreement of the parties.

The Deed also provides that if your employment is terminated, your employer will pay you for any outstanding leave entitlements that are payable on separation under the Contract.

Under the Deed, there's a bar to all claims by the relevant parties including confidentiality and non-disclosure agreement between the parties on the content of the Deed and all information leading up to the execution of the Deed.

You will be resigning at the expiration of your paid leave entitlements which will be in February 20XX.

Currently, you're receiving half pay from your employer by using up your annual leave and long service leave.

There is no ongoing legal action between you and your employer.

You incurred legal expenses in relation to the dispute.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the 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.

For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691 (Rowe's case), the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties, in order to defend the threat of dismissal, were allowable. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income.

However, your case is distinguished from the Rowe's case. In your case, you were not suspended from your normal duties as an employee. The dispute arose because you complained that you missed out on a position you applied for. You incurred legal expenses in relation to that dispute. The principal reason for incurring the legal expenses was appealing an unfavourable decision made on your job application, it was not prompted or caused as a consequence of the performance of your current duties.

Also, 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 to be gained is of a capital or private in nature, then the expenses incurred in gaining the advantage will also be of a capital or private in nature.

In Federal Commissioner of Taxation v. Day (2008) 250 ALR 388; (2008) 236 CLR 163; 2008 ATC 20-064; (2008) 70 ATR 14 (Day's case), although the court accepted that legal expenses incurred by the taxpayer were allowable, Kirby J held that the taxpayer had not incurred the legal expenses in gaining or producing his assessable income. The matters giving rise to the expenditure lacked the requisite temporal or other connection with gaining or producing his assessable income. Alternatively, the expenditure was a loss or outgoing of a private nature and therefore excluded from deductibility.

In your case (unlike the Day's case), you're not exposed to a legal action by reason of your employment with the consequences of the action affecting your employment. The dispute arose because you complained that you missed out on a position you applied for. You incurred the legal expenses in the process of resolving that dispute.

Conclusion

It is considered that the legal expenses were not sufficiently connected with your income earning activities and were essentially private or capital in nature and character. Therefore, the legal expenses are not deductible under section 8-1 of the ITAA 1997.