Edited version of private advice

Authorisation Number: 1051930447045

Date of advice: 6 December 2021

Ruling

Subject: Nature of legal expenses and deductions

Question

Are the legal expenses incurred in defending your employment conditions deductable?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 2021

The scheme commences on:

1 July 2020

Relevant facts and circumstances

You commenced employment with you responsible for a particular group of clients.

You entered into annual "Commission Agreements" for each financial year up to and including the 2020 year.

Your "Commission Agreement" for the 2021 financial year reduced the commission and you refused to sign the agreement.

In mid-2020 your employer placed you on a Performance Management Plan and revised your responsibilities, thereby reducing your potential commissions.

You believe you were placed on the Performance Management Plan and had your responsibilities revised so the employer could avoid paying you large commissions.

You engaged legal representation for advice and guidance on the Performance Management Plan. They assisted you with your response to the plan, your position being it was unreasonable. You received advice on strategies to preserve your conditions of employment including commission entitlements, clarification of meeting the requirements of the employer, drafting documents, interviews with legal staff and meeting with a Barrister.

Your legal representative also reviewed the employer's grievance process and potential Fairwork Australia escalations.

Your intention when you engaged legal representation was to protect and maintain your employment with the employer.

You incurred $Z in legal expenses.

You did not have any legal representation after a particular date. Negotiations with your employer after that time were undertaken independently by yourself.

The dispute process with the employer was not resolved. Unexpectedly the employer offered you a settlement in exchange for your resignation.

You did not seek a settlement with the employer, nor did you engage legal representation for the purpose of negotiating a more advantageous settlement.

The employer made a settlement offer to you and both parties signed the Deed of Release, taking effect in late 2020 with your resignation.

No legal expenses related to your termination of employment.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Expenditure incurred in earning assessable income is deductable except to the extent it is private or capital in nature.

You were in a dispute with your employer over reduced commission rates and being placed on a Performance Management Plan.

You believe you were placed on the Performance Management Plan and had your responsibilities revised in order for the employer to avoid paying you large commissions.

Your legal expenses all relate to you seeking advice from your Legal representative on how to resolve these issues in order to remain in your employment with your employer so are deductible. This is because you were defending the way in which you undertook your employment duties so that you could continue earning income from your current employment and this advantage that was sought is not capital in nature.

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, 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 this advantage will also be of a capital nature.

The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day income producing activities of the taxpayer (The Herald and Weekly Times Ltd v. FC of T (1932) 48 CLR 113). The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business or income earning activities. The expense may arise out of litigation concerning the taxpayer's professional conduct (Magna Alloys and Research Pty Ltd v. FC of T (1980) 11 ATR 276; 80 ATC 4542; Putnin v. FC of T (1991) 21 ATR 1245; 91 ATC 4097).

When legal action is undertaken to obtain a payment, then the deductibility of the legal expenses depends on whether the payment sought is revenue in nature, such as unpaid wages, or whether the payment sought is capital in nature, such as a redundancy type payment or compensation for unfair dismissal.

This principle is confirmed in Taxation Determination TD 93/29 which states that if an employee incurs legal expenses in recovering wages, the legal expenses are an allowable deduction providing that the legal action relates solely to the recovery of wages. The ruling continues: -

5. However, 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 where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible. For example, legal expense relating to an action for damages for wrongful dismissal, are not deductible.

6. There will often be occasions where the legal expenses are incurred in relation to proceedings that relate both to accounts that are revenue in nature as well as amounts which are capital in nature. For example, many proceedings in relation to wrongful dismissal will also involve the recovery of unpaid salary or wages. In these circumstances '....there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income' (Ronpibon Tin N.L. v. FC of T (1949) 78 CLR 47 at 59).

Generally, legal expenses incurred in an unfair dismissal action (seeking reinstatement and/or damages) are of a capital nature and therefore, not deductible.

When 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 apportionment of the extent of the relation of the outlay to the revenue claim.

TD 93/29 paragraph 7 discusses the apportionment of legal expenses.

7. 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.

Application to your circumstances

In your case, you did not sign-off on your 2021 financial year Commission Agreement as you believed it had a detrimental impact on the amount of income you would earn.

You were involved in a disagreement with your Manager concerning your performance in mid-2020. You then obtained legal representation to resolve these issues so you could continue/maintain your employment.

You received advice and assistance from your legal representative until a particular time.

At the time you were receiving legal representation and until their final engagement, your intention was to protect and retain your position of employment. You received the final account from your legal representative at that time and did not use their services after that time.

The employer offered you a settlement in late 2020, which required your resignation. You did not have legal representation at this time and negotiated the terms of the settlement independently.

You did not incur any legal expense for the purpose of obtaining or negotiating a settlement with the employer.

You were seeking to defend the manner in which you undertook your employment duties in order to continue your employment. The advantage sought at this stage was not capital in nature and therefore this portion of your legal expenses is deductible.

When the dispute process over your performance appeared unable to be resolved, the deductibility of your subsequent legal expenses is determined by the nature of those payments you were seeking. As stated previously, the nature of legal expenses follows the nature of the advantage sought in incurring the legal expenses. Your intention was to maintain your employment and the settlement was offered by the employer when the dispute process could not progress. You did not expect the employer to offer the settlement.

All of the legal expenses were incurred to resolve the dispute about the performance plan and the way you carried out your duties, none were incurred in relation to the termination or the associated package.

All the legal expenses are deductible.