Edited version of private advice

Authorisation Number: 1052200544156

Date of advice: 6 December 2023

Ruling

Subject: Deductions - legal expenses

Question 1

Are you entitled to claim a deduction for the legal expenses incurred to dispute your employer's compliance with the relevant enterprise agreement under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Yes, as the legal expenses were incurred to dispute your employer's compliance with an existing employment contract, the cost incurred are considered deductible.

Question 2

Are you entitled to claim a deduction for legal expenses incurred to obtain compensation or damages under section 8-1 of the ITAA 1997?

Answer

No.

As the legal expenses incurred sought an advantage of a capital nature, they are not deductible.

This ruling applies for the following periods:

Year ended XX XXXX 20YY

Year ended XX XXXX 20YY

The scheme commenced on:

XX XXXX 20YY

Relevant facts and circumstances

You commenced employment with your employer on XX XXXX 19YY.

Your substantive role on XX XXXX 20YY was an engineer.

You have taken sick leave since XX XXXX 20YY due to several medical conditions.

On XX XXXX 20YY, your personal leave entitlements were exhausted, and you have since taken approved leave without pay.

On XX XXXX 20YY, your employer provided a letter explaining your potential eligibility for Total and Permanent Disability (TPD). Your employer interpreted a medical practitioners report as meaning that you were an eligible candidate for TPD. The letter referred you to make an application for TPD with your super fund, or other relevant insurance provider. The letter also details that access to personal leave will cease if you were not to make a TPD claim.

You did not make a TPD claim with your super fund or other relevant insurance provider and your access to personal leave ceased. This changed your status from being on leave without pay to your absence being unauthorised.

On XX XXXX 20YY, you paid an initial consultation fee to a legal representative and incurred ongoing expenses for their legal services.

On XX XXXX 20YY, your employer sent a letter requesting you to provide reasons why your employment should continue due to your extended absence.

On XX XXXX 20YY, your legal representative sent a letter to your employers disputing the TPD conclusion and proposed a return to work subject to conditions. Your legal representative also lodged a complaint to the States human rights commission.

On XX XXXX 20YY, your employer responds to the previous letter and invited you to complete an assessment to assess your suitability against other suitable roles.

On XX XXXX 20YY, you received a letter from your employer confirming the undertaking of an independent assessment set for XX XXXX 20YY.

On XX XXXX 20YY, your legal representative sent your employer a letter expressing concerns with the validity of the vocational assessment process.

In XXXX 20YY, your legal representative made an application for a hearing the States human rights commission.

On XX XXXX 20YY, your legal representative requested a referral to the States industrial relations commission.

The referral made to the commission by your legal representative sought settlement of the dispute through an apology from your employer, compensation for economic loss, damages for hurt humiliation, interests and costs.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

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.

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; (1949) 4 AITR 236; (1949) 8 ATD 431).

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) 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. The character of legal expenses is not determined by the success or failure of the legal action.

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. No significance was placed by the court on the taxpayer's status as an employee.

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 relation to the issue of determining whether expenditure is of a revenue or capital nature, the decision of the Taxation Ruling TR 2000/5 Income tax and fringe benefits tax: costs incurred in preparing and administering employee agreements, at paragraph 12 provides both the employer and employee may incur expenses in setting the conditions for and administering the employee agreement. These costs may include costs associated with settlement of disputes.

Where an employee incurs costs associated with settlement of disputes arising out of an existing employment agreement (includes the costs of legal representation), this as an allowable deduction. Similarly, where the employer incurs costs in the settling of disputes arising out of existing employment agreements, this is an allowable deduction (paragraphs 2 and 4 of TR 2000/5).

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. As outlined at paragraph 5 of TD 93/29, legal expense relating to an action for damages for wrongful dismissal are not deductible as the claim is of a capital nature.

Application to your circumstances

Legal expenses incurred disputing your enterprise agreement

You incurred legal expenses to dispute your employer's compliance with a contractual entitlement contained within the enterprise agreement. It is considered that your expenses were incurred to preserve your employment and were incidental and relevant to the production of your assessable income. Therefore, we consider that TR 2000/5 is applicable in your case and the relevant costs incurred to dispute your employer's compliance with the agreement are deductible.

Legal expenses incurred seeking compensation or damages

Your complaint with the Industrial Commission requested an apology from your employer, compensation for past and future economic loss as a result of your employer, damages for humiliation and hurt, interest and associated costs. As the advantages sought from these claims are of a capital nature or do not relate to assessable income, they are not deductible under section 8-1 of the ITAA 1997.

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.