Edited version of private advice

Authorisation Number: 1052088844222

Date of advice: 17 February 2023

Ruling

Subject: Work related expenses - legal fees

Question 1

Are you entitled to a deduction for the legal fees relating to the recovery of the amount of $XXXXXX wages?

Answer

Yes.

Question 2

Are you entitled to a deduction for the legal fees relating to the recovery of $XXXXX amount invested in the company?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You were one of 3 people who started a new company.

Each of you put equal investment into the company.

You were each Directors with equal share in the company.

When the accountant set up the company, $XXXXX from each Director had been allocated as a loan to the company and $XXX was paid for 'shares' in the company.

You decided to leave the company due to differences with the other Directors.

It was verbally agreed that you would be returned the amount you had invested in the company, along with an amount to cover the time you had invested in the start-up (exact amount to be determined based on an hourly rate).

You sought legal advice and confirmation that you should not resign until you were paid out.

The other Directors were issued with a Letter of Demand requesting payment of agreed upon monies and which prevented them from shutting down or directing monies/business away from the company.

Under the terms of a settlement deed entered into by the parties:

1. You were paid $XXXX in a lump sum as wages from the company

2. The $XXXXX loan was repaid to you

3. Your shares in the company were purchased by the other Directors.

In return, you agreed to resign from the company when the last payment was made.

The total legal cost to recover these funds was $XXXXX

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, 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. Conversely, if the advantage to be gained is of an income nature, then the expenses incurred in gaining this advantage will also be of an income nature.

The sum of $XXXXX which you received as a lump sum represents recovery of wages that are assessable income and the legal fees that relate to this amount are deductible.

The legal fees that relate to the sum of $XXXXX are not deductible as the $49,000 which represents a capital amount being the amount you invested in the company.

As the legal fees relate to both an assessable amount and a capital amount the legal fees will need to be apportioned between both amounts.

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 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.