Edited version of private advice

Authorisation Number: 1052292012258

Date of advice: 19 August 2024

Ruling

Subject: Deduction - legal expenses

Question

Are you entitled to a deduction for legal expenses in relation to a bullying and damage to reputation?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2023

Year ended 30 June 2024

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You were employed as a XXX at a privately operated XXX campus during the relevant period.

The campus you worked at is one of several XXX campuses in your area which operate under the governance of an independent XXXX institution (the Institution).

You lodged an internal harassment claim with the Institution as you felt that you were being harassed by other members of the XXX staff.

The outcome of the internal harassment claim was not in your favour.

You subsequently withdrew your application for a contract renewal, a decision that directly affected your employability.

Following the withdrawal, you received a letter from the Institution stating that they had revoked your XXX XXX, meaning that that you were no longer eligible to work in any of their campuses, even as a casual employee.

You incurred $XXX obtaining legal advice and representation to bring an action against your former employer seeking reinstatement of your position to allow you to continue working at a XXX campus operated by the Institution and fix the damage to your professional reputation.

You were not seeking any financial gain by pursuing legal representation.

You discontinued the claim against your former employer prior to having the matter adjudicated in court.

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, 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 this advantage will also be of a capital nature.

The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day-to-day income producing activities of the taxpayer (The Herald and Weekly Times Ltd v. FC of T (1932) 48 CLR 113). The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business or income earning activities. The expense may arise out of litigation concerning the taxpayer's professional conduct (Magna Alloys and Research Pty Ltd v. FC of T (1980) 11 ATR 276; 80 ATC 4542; Putnin v. FC of T (1991) 21 ATR 1245; 91 ATC 4097).

Taxation Ruling TR 2000/5 Income tax and fringe benefits tax: costs incurred in preparing and administering employment agreements, states that costs associated with attempting to settle a dispute arising out of an existing employment agreement including the cost of representation are deductible.

When legal action is undertaken to obtain a payment, then the deductibility of the legal expenses depends on whether the payment sought is revenue in nature, such as unpaid wages, or whether the payment sought is capital in nature, such as a redundancy type payment or compensation for unfair dismissal.

This principle is confirmed in Taxation Determination TD 93/29 which states that if an employee incurs legal expenses in recovering wages, the legal expenses are an allowable deduction providing that the legal action relates solely to the recovery of wages. The ruling continues:

5. However, 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.

6. There will often be occasions where the legal expenses are incurred in relation to proceedings that relate both to accounts that are revenue in nature as well as amounts which are capital in nature. For example, many proceedings in relation to wrongful dismissal will also involve the recovery of unpaid salary or wages. In these circumstances '... there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income' (Ronpibon Tin N.L. v. FC of T (1949) 78 CLR 47 at 59).

Generally, legal expenses incurred in an unfair dismissal action (seeking reinstatement and/or damages) are of a capital nature and therefore, not deductible.

Application to your circumstances

You engaged a lawyer to bring an action for workplace harassment against the Institution, seeking to be reinstated in your previous employment role and to fix actions taken which damaged your professional reputation.

As stated previously, the nature of legal expenses follows the nature of the advantage sought in incurring the legal expenses. Therefore, if you are seeking a capital payment then the advantage you are seeking is capital in nature and consequently the legal expenses incurred in trying to obtain that capital payment are not deductible.

The legal expenses you incurred in order to defend your dismissal from the Institution are capital and therefore not deductable under Section 8-1 of the ITAA 1997.