Edited version of private advice

Authorisation Number: 1052159281853

Date of advice: 12 September 2023

Ruling

Subject: Legal expenses

Question 1

Can you claim a deduction for all your legal expenses in accordance with section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Can you claim a deduction for the portion of your legal expenses that relate to your claim for a payment equal to X months' salary and superannuation, and a career transition support payment in accordance with section 8-1 of the ITAA 1997?

Answer

No

Question 3

Can you claim a deduction for the portion of your legal expenses that relate to your claim for payment of your accrued annual leave in accordance with section 8-1 of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

XX XXX 20XX

Relevant facts and circumstances

You commenced work with a Company in XX 20XX, in a senior position.

In XX 20XX a co-worker began to exhibit unprofessional behaviour.

Throughout XX and XX there were multiple incidences of harassment made toward you by the same co-worker.

On XX XXX 20XX you spoke with your employer regarding the co-worker's behaviour, and you agreed that you did not want to make a formal complaint as long as there were consequences for the co-worker and there were no further incidents.

Incidents of unprofessional behaviour from the co-worker continued.

You ultimately resolved to resign from the Company after you determined that your employment position was untenable.

You employed a Law Firm to assist you in this matter.

On XX XXX 20XX you proposed a separation agreement which included the following terms:

•         You will resign effective XX XXX 20XX.

•         You will be paid:

-       X months' worth of salary plus superannuation as payment in lieu of notice

-       Any accrued annual leave

-       A career transition support payment to the value of $00.00 be funded by the Company

•         All incurred legal fees were to be funded by the Company.

On XX XXX 20XX you received a response from your employer.

Your employer did not agree with all the above-mentioned terms. They responded with the following offer:

•         You will confirm your resignation from your employment in writing.

•         You will be paid your accrued and outstanding annual leave.

•         The Company will pay you for the period from XX to XX XXX 20XX.

•         The Company will provide you with a statement of service.

•         The Company will pay you an ex-gratia amount of X months' salary plus superannuation.

You agreed to these terms and received the following:

•         An ex-gratia payment of X months' salary plus superannuation.

•         A payment of your accrued and outstanding leave.

The career transition support payment was not received.

Reimbursement of legal expenses by your now former employer did not occur. You will not be seeking to recover the cost of legal expenses from them in the future.

The legal expenses you incurred are as follows:

•         Initial consultation (Invoiced XX XXX 20XX)

•         Professional Services from XX XXX 20XX to XX XXX 20XX $00.00 (Invoiced XX XXX 20XX):

•         Professional Services from XX XXX 20XX to XX XXX 20XX $00.00 (Invoiced XX XXX 20XX):

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Issue Legal Expenses

Summary

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. Legal costs take their quality as an outgoing of capital or revenue nature from the cause or purpose of incurring the expenditure.

The information provided indicates that the purpose of incurring your legal expenses in this case was to obtain certain payments on your resignation. The deductibility of the legal expenses depends on whether the payments sought were revenue or capital in nature. It is considered that only the payment for accrued annual leave was revenue in nature. The other two payments sought are considered to be capital in nature. Consequently, only the portion of the legal expenses that relate to seeking the payment for accrued leave is deductible. You need to apportion your legal expenses on a reasonable basis.

Detailed reasoning

Section 8-1 of the 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 Taxation Determination TD 93/29 Income tax: if an employee incurs legal expenses 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? the Commissioner states that legal expenses incurred by an employee in recovering unpaid wages are deductible as the expenses are directly incurred in the process of deriving assessable income. This is provided that the legal action relates solely to the recovery of wages.

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.

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 (TD 93/29).

•         Starting proceedings and settling disputes arising out of employment agreements, such as to enforce a contractual entitlement (Romanin v. Commissioner of Taxation [2008] FCA 1532; 2008 ATC 20-055; (2008) 73 ATR 760 (Romanin)).

•         Defending actions undertaken in carrying out employment duties (ATO Interpretative Decision (ID) 2001/549).

Legal expenses incurred in enforcing a contractual entitlement to a payment 'in lieu of notice' are generally deductible (Romanin). However, although you refer to the payment you were seeking of X months' worth of salary and superannuation as a payment in lieu of notice, it is not such a payment. This is because a payment in lieu of notice is a payment that an employer is obliged to make to an employee if they have terminated the employee without giving the required notice set out in the employment contract. In your case, your employer had not terminated you. Rather, you were proposing to resign. Therefore, you did not have a contractual entitlement to a payment in lieu of notice in these circumstances. Rather, the information provided indicates that you sought this payment as compensation for having to give up your employment position because of the way you had been treated. Compensation for loss of employment, such as an action from wrongful dismissal or loss of office, is a capital receipt (Scott v. Commissioner of Taxation (1935) 35 SR (NSW) 215). This is the case even if, like in your case, the employee calculates the amount they seek for compensation for loss of employment, in terms of the salary they would have earned over a period. That is, the fact that you chose to seek an amount equal to X months' worth of salary as compensation for loss of employment rather than a set amount such as $100,000 does not convert the amount from being capital to revenue in nature. As this payment is capital in nature, the portion of your legal expenses that relate to this claim is also capital in nature and consequently not deductible.

The career transition support payment proposed is a one-off lump sum to be made on termination rather than wages, an allowance, or a benefit relating to work undertaken. It is a capital payment and therefore the portion of legal expenses related to that claim is not deductible.

Termination payments may be subject to special tax treatment that could result in all or some of the amounts being included in assessable income. However, the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in assessable income and any expenses incurred in seeking such an amount will also remain capital in nature and consequently not deductible.

The payment you sought for accrued annual leave is revenue in nature and therefore, the portion of your legal expenses that relate to this claim is deductible.

As you incurred legal expenses in seeking payments of both a capital and revenue nature, you will have to apportion your legal expenses to calculate the deduction you are entitled to. The apportionment must be on a reasonable basis. TD 93/29 states that if the solicitor's account is itemised and you can determine from it, how much of the legal expenses relate to the revenue claim then this is a reasonable basis for apportionment. However, if you are not able to determine from the account, how much relates to the revenue claim, then an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim would be reasonable.