Edited version of private advice

Authorisation Number: 1052318936302

Date of advice: 16 October 2024

Ruling

Subject: Deductions - legal expenses

Question

Can you claim a deduction for the legal expenses you incurred?

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

On XX XXXX 20XX, you commenced employment with Employer A.

On XX XXXX 20XX, Employer A sent correspondence to you advising that you were stood down from duty effective immediately, pending the outcome of an investigation in relation to allegations that your behaviour was consistent with harassment towards a colleague. You were required to attend a meeting with HR on XX XXXX 20XX.

On XX XXXX 20XX, you engaged a Lawyer A as a support person for the meeting and to respond to all correspondence from your workplace.

On XX XXXX 20XX, you attended the meeting via telephone with HR and upper management with Lawyer A also connected on the call. You were stood down for over X months with threat of termination for inappropriate conduct while the investigation was in progress.

On XX XXXX 20XX, you were notified of the finding from your employer. Employer A requested any information that you considered relevant to its consideration of appropriate disciplinary action.

On XX XXXX 20XX, Lawyer A sent correspondence to Employer A demanding immediate reinstatement of your position without disciplinary action.

On XX XXXX 20XX, Employer A advised you to engage a barrister for an injunction action and further advice on your case.

On XX XXXX 20XX, Employer A provided you with the findings of the investigation and advised you that Employer A considered that your conduct may warrant disciplinary steps being taken against you. Before determining whether disciplinary action was warranted in this matter, they provided you with an opportunity to respond to why your employment should not be terminated.

On XX XXXX 20XX, you attended a meeting with Employer A.

Before you received the notification of the disciplinary outcome, you incurred $XX in legal expenses.

On XX XXXX 20XX, Employer A provided you with the notification of the disciplinary outcome. You were notified that your employment was terminated effective from XX XXXX 20XX.

After the notification of the disciplinary outcome, you incurred $XX in legal expenses.

On XX XXXX 20XX, you engaged a barrister to submit an unfair dismissal claim.

On XX XXXX 20XX, you lodged your unfair dismissal application.

In your unfair dismissal application, you sought reinstatement or alternatively, compensation in lieu of reinstatement.

On XX XXXX 20XX, you had a conference call with a barrister and Employer A regarding your unfair dismissal claim.

On XX XXXX 20XX, you attended a conciliation.

There were further negotiations between Lawyer A and Employer A.

On XX XXXX 20XX, Employer A signed the deed of release.

On XX XXXX 20XX, Lawyer A informed you that you can discontinue your fair work proceedings as the statement of service and reference agreed to in the deed of release had been provided.

The following documents provided with respect to the private ruling application form part of, and are to be read with, the description of the facts and circumstances:

•                     Letter from Employer A dated XX XXXX 20XX.

•                     Letter you sent to Employer A dated XX XXXX 20XX.

•                     The notification of disciplinary outcome from Employer A dated XX XXXX 20XX.

•                     The unfair dismissal claim application.

•                     The deed of release dated XX XXXX 20XX

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.

The High Court majority in Commissioner of Taxation v Payne [2001] HCA 3 said it is well established that these words are to be understood as meaning incurred 'in the course of' gaining or producing assessable income, and do not convey the meaning of outgoings incurred 'in connection with' or 'for the purpose' of deriving assessable income.

The majority further stated that the meaning of 'in the course of' gaining or producing income was amplified in Ronpibon Tin NL v Commissioner of Taxation (Cth) [1949] HCA 15 where it was held that:

... to come within the initial part of [section 8-1] it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income, or if none be produced, would be expected to produce assessable income...

Also, 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; (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 or private in nature, then the expenses incurred in gaining the advantage will also be of a capital or private in nature.

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 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?

•                     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 (FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691); and

•                     defending the manner in which employment duties are performed: (Inglis and FCT 87 STC 2037)

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; [1932] HCA 56; (1932) 39 ALR 46; (1932) 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; [1980] FCA 150; (1980) 11 ATR 276; 80 ATC 4542).

Similarly, in FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court 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. In this case, 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.

In Case W94 89 ATC 792; AAT Case 5376 (1989) 20 ATR 4001 the taxpayer, a public servant incurred legal fees in defending and then appealing against disciplinary charges of improper conduct resulting from his compulsive gambling. It was found that the expenses incurred where not incidental or relevant to the gaining of the taxpayer's assessable income. It was the conduct of the taxpayer through his compulsive gambling which led to the charges which, in turn, led to him incurring legal costs. The expenses incurred were not incidental or relevant to the gaining of the taxpayer's assessable income.

The ATO's view on the deductibility of legal expenses in defending a claim of sexual harassment is contained in ATO Interpretative Decision ATO ID 2002/664 Income Tax: Deductions & Expenses: Legal fees incurred in defending a claim of harassment and victimisation. It states that these legal expenses are not deductible as they arose from the taxpayer's personal conduct rather than in the performance of their employment duties.

In relation to the issue of determining whether expenditure is of a revenue or capital nature, paragraph 12 of Taxation Ruling TR 2000/5 Income tax and fringe benefits tax: costs incurred in preparing and administering employee agreements, 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 Tax 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?, legal expense relating to an action for damages for wrongful dismissal are not deductible as the claim is of a capital nature. Paragraphs 5 to 7 of TD 93/29 state:

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 amounts 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).

6A. A deduction for legal expenses by an employee depends on the particular facts of any case. To be deductible the occasion of the expenditure must be found in what is productive in the gaining of assessable income by the employee. If expenses are incurred to dispute the receipt of income contractually owed under an employment contract, then the expenses are on revenue account and allowable as a deduction.

7. Where the solicitor's account is itemised, one reasonable basis for apportionment would be the time spent involving the revenue claim, relative to the time spent on the capital claim. If the solicitor's account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim.

Application to your circumstances

The legal expenses you incurred in the period from XX XXXX 20XX to XX XXXX 20XX in defending the harassment claim made by another employee of Employer A arose from your personal conduct. They did not arise from the performance of your day to day work duties from which you derived assessable income. Therefore, the legal fees incurred by you are not an allowable deduction under section 8-1 of the ITAA 1997.

After you received the notification of the disciplinary outcome regarding your investigation from Employer A on XX XXXX 20XX, you incurred further legal expenses making a claim for unfair dismissal. You sought reinstatement or alternatively, compensation in lieu of reinstatement. These advantages sought were capital in nature and therefore, the related legal expenses are not deductible under section 8-1 of the ITAA 1997.