Edited version of private advice

Authorisation Number: 1052227908750

Date of advice: 4 March 2024

Ruling

Subject: Legal expenses

Question

Are the legal expenses you incurred in lodging an unfair dismissal claim 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 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You were dismissed from your role with Employer Z on the grounds of serious misconduct.

You were paid out your unused annual leave and wages up to a specific date.

You sought legal help, as you believed you were entitled to other amounts of income from Employer Z.

The relevant industry body and Fair Work Commission stated that you were only entitled to the unpaid amounts if it is found that the grounds of serious misconduct are not valid.

Your solicitor then advised you to file an unfair dismissal claim against your former employer on the grounds of serious misconduct as a means for you to retrieve the remaining amounts to which you believed you were entitled.

The case was settled outside of court with Employer Z agreeing to pay you an amount for unfair dismissal and another amount representing unpaid commission.

The settlement amount was paid as an ETP.

The legal fees were paid over several invoices.

The invoices include work for both the underpayment claim and unfair dismissal claim.

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 a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

In determining whether a deduction for legal expenses is allowed, the nature of the expenditure must be considered. 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 nature or character of expenses follows the advantage that is sought to be gained by incurring the expenses (Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634; (1946) 8 ATD 190). 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.

In your case, you instigated action against your employer claiming unfair dismissal. As stated above, expenses relating to damages for wrongful dismissal are capital in nature.

As the legal expenses were incurred in seeking to gain a capital sum, they will also be of a capital nature and are therefore not deductible.