Edited version of private advice

Authorisation Number: 1051974604464

Date of advice: 4 May 2022

Ruling

Subject: Deductions - legal expenses

Question 1

Will all the legal expenses incurred in protecting your workplace rights be deductible under section 8-1 of the Income Tax Assessment Act 1997?

Answer

No.

Question 2

Will some of the all the legal expenses you incurred in protecting your workplace rights be deductible under section 8-1 of the Income Tax Assessment Act 1997?

Answer

Yes.To the extent that the nature of the benefit being sought in relation to the legal expenses you incurred during your employment, and after your employment ended, related to the earning of your assessable income and is not capital in nature.

This private ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 January 20XX

Relevant facts and circumstances

You commenced employment with your Employer on XX/XX/20XX.

On XX/XX/20XX, you were appointed to the role A and your employment was subject to an employment Contract.

On or around XX/XX/20XX, you were promoted to role B with the Employer.

Early 20XX, you raised concerns with the Employer.

On XX/XX/20XX, you were advised that your reporting line has changed.

On XX/XX/20XX you were informed you were being formally performance managed and provided with a performance management plan.

The Performance Management plan noted your position as role A, not role B.

On XX/XX/20XX, you submitted a workers compensation claim to the Employer in relation to your Medical Episode and related illness.

On XX/XX/20XX and XX/XX/20XX you made formal complaints to the Employer's Chief Executive Officer.

On XX/XX/20XX, the Employer sent you a letter which alleged you had breached the terms and conditions of your employment. The letter stated the misconduct allegations (Allegations), that your actions could amount to serious misconduct and may result in disciplinary action including termination and that you would be stood down (Suspension).

On XX/XX/20XX, the Employer sent you an email about the investigation of breaching your terms and conditions of employment.

You were fearful of your continued employment with the Employer and sought legal counsel.

On XX/XX/20XX, you, by your Lawyers sent a letter of demand to the Employer, alleging you were subject to adverse action contrary to the Fair Work Act 2009 (Cth) and alleging that you made a whistleblower complaint pursuant to the Corporations Act 2001 (Cth) (Letter of Demand).

The Employer denies any wrongdoing.

The Letter of Demand requires the Employer to cease all action in relation to Allegations and the Performance Management and to formally withdraw the Allegations, the Suspension and the Performance Management.

The Employer and you have mutually agreed that Employment will cease by way of your resignation effective XX/XX/20XX.

Without admission of liability, the Employer and you have agreed to settle all matters on the terms specified in the Deed of Release (Deed).

Under the Deed the Employer with make a payment to you.

The payment you received was paid as an eligible termination payment

You incurred legal costs of $XX,XXX.XX in the income year ending 30 June 20XX.

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.

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, 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? outlines the Commissioners view on legal expenses. The ruling 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.

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) 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) 11 ATR 276; 80 ATC 4542).

Similarly, in FC of T v. Day [2008] HCA 53 and FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the courts accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable

Legal expenses are generally deductible by employees and former employees if they arise out of:

•         recovering unpaid wages, unused annual leave and unused long service leave in accordance with the principles contained in Taxation Determination TD 93/29

•         instituting proceedings and settling disputes arising out of employment agreements, such as to enforce a contractual entitlement (Romanin v FCT (2008) 73 ATR 760)

•         preventing redundancy or dismissal. In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, 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; and

•         defending the manner in which employment duties are performed: (Inglis and FCT 87 STC 2037).

In contrast, legal expenses incurred in seeking compensation for loss of employment, such as in an action for wrongful dismissal, are not deductible. It is irrelevant if any amount awarded to the employee is calculated by reference to unpaid salary or lost income.

Application to your situation

Workplace allegations

The Employer outlined allegations of how your actions breached the terms and conditions of your employment. Out of concern for your continuing employment, you incurred legal expenses in relation to seeking advice on your legal rights about your employment situation. You incurred expenses to require the Employer cease all action in relation to the matter. The associated legal expenses are consequences of defending your actions in carrying out your employment duties.

It is considered that this portion of your legal expenses was a consequence of your day to day activities as an employee from which you derived assessable income. Therefore the associated legal expenses incurred are deductible under section 8-1 of the ITAA 1997.

Deed of Release

You also incurred a portion of the legal expenses for setting and advising on a Deed of Release including settlement negotiations on a suitable termination package (including the ex-gratia payment). Legal expenses incurred in negotiating a termination package do not sufficiently relate to your day to day employment duties even though the payment may be included in your assessable income.

The associated legal expenses are capital in nature as they are considered to provide an enduring advantage and are therefore not deductible under section 8-1 of the ITAA 1997.

Apportionment of expenses

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. That is, the portion that relates to the Deed of Release and termination package are capital in nature and no deduction is allowed for these associated legal expenses.