Edited version of private advice

Authorisation Number: 1051986370273

Date of advice: 31 May 2022

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for all of your legal expenses?

Answer

No.

Question 2

Are you entitled to a deduction for a portion of your legal expenses?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You commenced employment several years ago, with your previous employer on a full-time basis.

Your duties meant that you were involved in and were privy to material aspects of the business during the relevant period.

A couple of years ago you terminated your employment.

You then commenced employment with a different employment.

The previous employer then alleged that during and after your employment with them you retained and copied sensitive company information.

The previous employer says that they did not authorise you to do this.

The previous employer alleges that the above accusations are in breach of your employment contract.

You deny all of the above allegations.

Along with seeking legal assistance to defend the allegations you were also seeking your final pay and entitlements from the prior employer which was meant to be paid to you 7 days after your employment ceased.

The issue of your unpaid final pay and entitlements was resolved between you and your former employer.

You supplied a PDF of documents with your ruling application which includes:

•         The letter from your solicitor to the previous employer.

•         An invoice, with the itemised invoice.

•         The confirmation from the plaintiff that they had arranged your final payment in full.

Relevant legislative provisions

Income Tax Assessment Act 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.

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). 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).

In each case the nature of the alleged misconduct, the scope of a taxpayer's income earning activities and other existing circumstances, will determine whether the legal expenses are a deductible expense. Only legal expenses relating to the defence of actions performed in the natural course of a taxpayer's business activities are allowable deductions.

In Case W94 89 ATC 792; AAT Case 5376 (1989) 20 ATR 4001, the Administrative Appeals Tribunal held that expenditure incurred on legal fees in circumstances where the conduct of the taxpayer was not related to their income earning activities, was not 'incidental and relevant' to the gaining or production of the taxpayer's assessable income.

In your situation, the majority of the legal expenses you incurred arose from your alleged personal conduct. They did not arise from the performance of your duties from which you derived assessable income.

It was alleged that you breached your employment contract by downloading client information and photocopying client information. The allegations relate to activities that were purported to occur both before and after you terminated your employment.

These allegations were in relation to personal conduct and not out of any work related performance.

Additionally, the legal expenses you incurred were not related to maintaining your income-earning activities with your former employer. You voluntarily terminated your employment prior to incurring the legal expenses.

A percentage of the expenses are private in nature, therefore you are not entitled to a deduction for all of the legal expenses under section 8-1 of the ITAA 1997.

However, part of the initial response sent by your legal representative related to unpaid salary and entitlements. The balance of the response related to matters to which you are not entitled to a deduction under section 8-1 of the ITAA 1997.

Using the invoice provided to the Commissioner an amount of the legal expenses relating to the preparation of that letter are an allowable deduction.

Therefore, you are entitled to a deduction for that portion of the legal expenses.