Edited version of private advice

Authorisation Number: 1051938541662

Date of advice: 24 January 2022

Ruling

Subject: Deduction - legal expenses

Question 1

Will all the legal expenses you incurred in relation to your actions in the Fair Work Commission (FWC), the Circuit Court (FCC) and the Deed of Settlement and Release (the deed) be deductible?

Answer

No.

Question 2

Will some of the legal expenses you incurred in relation to your actions in the FWC, the FCC and the deed be deductible?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

In late 20XX, you commenced employment in your chosen industry.

Your employment was subject to an employment contract.

On or around May 20XX, the director at company X provided you with a termination letter which summarily dismissed you because of alleged wrongdoing. Your employment was terminated on the same day without notice.

You engaged the services of a legal professional and have incurred legal costs in the 20XX and 20XX financial years.

You lodged a general protections application involving dismissal in May 20XX in the Fair Work Commission (FWC) against the company and director (the FWC proceedings).

The remedy you were seeking by lodging the application was:

•         for the company to cease and desist in advising professional bodies about the alleged wrongdoing until the dispute was resolved via a deed of release or otherwise

•         compensation for time lost working in your role, an additional amount for training purposes and an amount for non-economic loss for hurt and humiliation

•         payment of unpaid entitlements due to breaches of Part 2-2 of the Fair Work Act 2009, totalling $XX,XXX. The total amount is made up of unpaid hours for public holidays, unpaid hours for approved personal/carer's leave, unpaid wages, unpaid notice period and accrued annual leave.

You also lodged a small claim under the Fair Work Act 2009 (Cth) in the Federal Circuit Court in November 20XX against the company and director (the FCC proceedings).

Prior to the FWC and FCC hearings, the company offered you a lump sum ex-gratia payment.

You incurred further legal expenses with a firm that specialises in workplace legal services.

In late 20XX, you entered into a Deed of Settlement and Release (the deed) with the company and director.

You, the company, and the director agreed, without admission of liability by the company and/or the director, to resolve all claims, complaints, matters, rights and/ or entitlements whether relating to and/or arising directly or indirectly from the employment, the employment contract, and termination, the FWC proceedings and/or the FCC proceedings now or in the future (together, the employment matters) on the terms set out in the deed.

Under the deed, you agreed to discontinue the FWC and CCC proceedings by filing the required forms or discontinuances in the FWC and FCC. And to serve copies of those filed forms or discontinuances on the company and director within an agreed timeframe.

There was no provision within the deed for legal costs. Under the deed, all parties agreed to bear their own costs in relation to the FWC and FCC proceedings and the deed's negotiation, preparation and execution.

The settlement payment you received was paid as an eligible termination payment.

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 the earning of exempt income.

In determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses, that is, whether the legal expenses are incurred for a capital or a revenue purpose.

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

Taxation Determination TD 93/29 Income tax: if an employee incurs legal expense recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997? articulates the Commissioners view on legal expenses and how they are viewed. The rulings states that if an employee incurs legal expense 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 expenses 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 amounts 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. F C of T (1949) 78 CLR 47 at 59).

Paragraph 7 of TD 93/29 discusses the apportionment of legal expenses:

7. Where the solicitor's 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 solicitor's account is not itemised, a possible basis for apportionment would be either 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 incurred expenses in taking legal action against your former employer for compensation for damages, as well as the recovery of unpaid wages, leave and contractual entitlements. This action has gone beyond a revenue claim.

The deductibility of your 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.

The payment you were seeking for contractually entitled salary in lieu of notice, public holidays and unused annual leave, and the recovery of unpaid wages and sick leave are outgoings with nexus to assessable income and are revenue in nature and deductible.

However, compensation for loss of employment such as wrongful dismissal or loss of office, is a capital receipt. Legal costs incurred in seeking such compensation are not deductible because the nature of the advantage sought is capital. It should also be noted that you were seeking an amount for retraining purposes which is considered private in nature. Both capital and private expenses and not deductible under section 8-1 of the ITAA 1997.

As the legal expenses you have incurred are both revenue and capital in nature, you will need to apportion the legal expenses in a reasonable manner. You should apply the above principles in paragraph 7 of TD 93/29 in undertaking the apportionment.

Accordingly, you are entitled to a partial deduction under section 8-1 of the ITAA 1997 for your legal expenses in the year of income in which the invoices were raised.