Edited version of private advice

Authorisation Number: 1051918929704

Date of advice: 4 November 2021

Ruling

Subject: Legal expenses deduction

Question

Can you deduct legal expenses incurred in relation to breach of employment obligations?

Answer

Yes.

This ruling applies for the following period:

Period ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were employed for a period of approximately X year by your previous employer and you entered into an employment agreement at the beginning of your employment.

At the time you ceased employment, you still had possession of client information that you had in order to perform your employment duties while you were required to work from home during the course of your employment.

Some time after your employment ended, your previous employer engaged legal representation. Their legal representative sent you a letter that alleged you had breached the employment agreement you entered into at the beginning of your employment.

The letter stated you had breached your employment agreement by taking home and retaining possession of the client information and instructed you to destroy/or delete the client information and sign a statutory declaration.

You engaged legal representation to respond to this claim and was involved in the issues related to the conduct of your day-to-day employment activities.

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 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.

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).

Legal expenses are generally deductible if they arise out of the day-to-day activities of the taxpayer's business. (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; [1932] HCA 56; (1932) 39 ALR 46; (1932) 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; [1980] FCA 150; (1980) 11 ATR 276; 80 ATC 4542).

The courts accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable (FC of T v. Day [2008] HCA 53 and FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691). No significance was placed by the court on the taxpayer's status as an employee.

In your case, some time after your employment was terminated, your previous employer brought an action for breach of confidentiality against you caused by actions undertaken in your day-to-day activities of your employment.

You engaged a legal representative to respond to this claim and incurred the cost defending the actions undertaken in the course of your employment.

While the action occurred after you ceased employment, the action related to the way you carried out your duties while employed and the legal expenses are therefore deductible.