Edited version of private advice

Authorisation Number: 1052227834871

Date of advice: 7 March 2024

Ruling

Subject: Legal expenses

Question

Are the legal expenses you incurred pursuing legal proceedings for unfair termination against your former employer deductible under section 8-1 of the Income Tax Assessment Act 1997?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You were employed in a professional capacity by Employer Z.

You were employed by Employer Z for several years.

Your employment with Employer Z was terminated for reasons with which you disagreed.

You initiated legal proceedings against Employer Z.

The remedies you sought to obtain through the proceedings included reinstatement; compensation and damages; an admission of wrongdoing by Employer Z; and penalties.

You reached an agreement with Employer Z to settle the proceedings and all claims relating to your employment and its termination.

You signed a deed of settlement with Employer Z.

A settlement payout was reached, with the amount paid as an employment termination payment (ETP).

It was acknowledged in the settlement deed that the payment amount is the full amount that Employer Z owes you for all of the heads of claim brought against them in the proceedings.

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.

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.

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 the advantage will also be of a capital nature.

The Commissioner of Taxation considers that expenses incurred in relation to an action for breach of a taxpayer's contract of employment, for example, an action for damages for wrongful dismissal, are capital in nature and not deductible (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?).

Additionally, employment termination payments (ETPs), which are capital payments, are subject to special tax treatment that may result in some or the entire amount being included in the taxpayer's assessable income. The taxation ruling TR 2012/8 Income tax and fringe benefits tax: assessability of amounts received to reimburse legal costs incurred in disputes concerning termination of employment confirms the Commissioner's position that legal fees are not deductible against amounts received as an ETP.

As ETP's are capital in nature, any legal expenses associated with obtaining the ETP are also capital in nature and not deductible.

Therefore, your legal expenses are not deductible under Section 8-1 of the ITAA 1997.