Edited version of private advice

Authorisation Number: 1052198504655

Date of advice: 15 December 2023

Ruling

Subject: Deduction - legal expenses

Question

Are you entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 in respect of your legal expenses incurred in respect of making your claim on your Total and Permanent Disability insurance?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

XX XXXX 20XX

Relevant facts and circumstances

You have a work-related injury.

You engaged a law firm to represent you in making a claim on your Total and Permanent Disability (TPD) insurance through your superannuation fund.

The claim was successful resulting in a payout from your TPD insurance.

You provided a copy of the PAYG payment summary - superannuation lump sum document.

You have stated that the claim on your TPD insurance was related to an ongoing Worker's compensation claim.

You incurred legal expenses from your engagement of the law firm.

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 under section 8-1 of the ITAA 1997, the nature of the expenses must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses, that is, whether the legal expenses are incurred for a capital or revenue purpose. The outcome of the legal action does not affect the deductibility of the legal expense, rather the nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses.

ATO Interpretative Decision ATO ID 2001/667 Income Tax Legal Expenses - to recoup full entitlement to a superannuation lump sum payment explains that if the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. Whether a capital payment is specifically brought to account as assessable income does not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

Here, it was decided that the lump sum superannuation benefit, being a payment for the loss of the taxpayer's earning capacity, was a capital receipt. The taxpayer incurred the legal expenses in order to obtain the superannuation benefit. Although the taxable component of the superannuation benefit was included in the taxpayer's assessable income, the superannuation benefit retained its character as a capital receipt. The ATO ID concluded that as the legal expenses were incurred in gaining a capital sum, they were also of a capital nature and therefore not deductible under section 8-1 of the ITAA 1997 even though the taxable component of the superannuation benefit was included in the taxpayer's assessable income.

Application to your situation

In your case, you incurred legal expenses in order to obtain a Total and Permanent Disability (TPD) payment from your superannuation fund. While there is an ongoing Worker's Compensation claim, the legal expenses relate to the TPD claim, and as explained above such superannuation payments are considered a capital receipt. As in ATO ID 2001/667, the fact that a portion of the lump sum payment you received may be assessable does not change the nature of the payment you sought from being capital in nature.

As you sought a capital payment, the legal expenses you incurred in doing so are also capital in nature. As the disability benefit received is capital in nature, the expenses incurred in relation to your claim are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses you incurred in relation to your disability benefit as expenditure of a capital nature is expressly excluded under section 8-1 of the ITAA 1997.