Edited version of private advice

Authorisation Number: 1052319508060

Date of advice: 31 January 2025

Ruling

Subject: Legal expenses

Question 1

Are the legal expenses you incurred pursuing legal proceedings, prior to the termination of your employment, deductible under section 8-1 of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Answer 1

Yes.

Question 2

Are the legal expenses you incurred pursuing legal proceedings, after the termination of your employment, deductible under section 8-1 of the ITAA 1997?

Answer 2

No.

This private ruling applies for the following period:

Year ending XX June 20XX

The scheme commenced on:

XX July 20XX

Relevant facts and circumstances

On XX/XX20XX, you commenced permanent full-time employment with the Company in the position.

The position was pursuant to an employment contract dated XX/XX20XX.

From the commencement in the position to XX/XX20XX, you reported to senior management.

During your employment with the Company, you were requested to work outside of regular working hours, being 9am to 5pm, and during weekends and public holidays.

On XX/XX20XX, you reported to senior management that your health was being impacted by the extended working hours. You made several complaints of a similar nature after this date.

On XX/XX20XX, you contacted the Fair Work Commission regarding senior managements behaviour towards you.

Between XX/XX20XX and XX/XX20XX, you attended sessions with the Company's Employee Assistance Program ('EAP').

In addition to the EAP sessions, you attended medical appointments in regard to ongoing issues you were experiencing at the Company.

On XX/XX/20XX, an external investigation into the issues was conducted.

On XX/XX20XX, you lodged an application for a 'stop-bullying' order with the Fair Work Commission.

A 'stop-bullying' hearing was subsequently set down for some time in 20XX.

On XX/XX/20XX you were placed on leave by the company while a conference could take place with an external agency.

On XX/XX20XX, your employment was terminated by the Company.

As you were no longer employed with the Company, the 'stop-bullying' hearing was cancelled.

You have commenced a 'General Protections Adverse Action' legal claim ('the application').

On the specified date, you received a costs agreement letter from a professional firm regarding the application for the total specified amount

On the specified date, you received a further estimate from professional firm regarding the application. This total includes the projected costs of the hearing scheduled in the relevant financial year.

As at the end of the 20XX financial year, you incurred legal costs totalling $X.

You have never had professional indemnity insurance.

On the specified date, the external agency provided a letter concluding that after attending the conciliation conference, they are satisfied that all reasonable attempts to resolve the dispute have been unsuccessful.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 83-295

Reasons for decision

Question 1

Summary

The legal expenses you incurred during your employment period with the Company have sufficient nexus to gaining or producing assessable income and you are entitled to a deduction under section 8-1 of the ITAA 1997.

Detailed reasoning

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, or relate to the earning of exempt income.

A deduction for legal expenses by an employee depends on the particular facts of a case. 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] HCA 15; (1949) 4 AITR 236; (1949) 8 ATD 431).

When the principal reason for incurring the legal expenses is defending the actions of the taxpayer in carrying out their employment duties through which they gain or produce assessable income, such expenses are characterised as being of a revenue nature and are deductible (Inglis v. FC of T 87 ATC 2037; and Case V116 88 ATC 737; AAT Case 4502 (1988) 19 ATR 3703).

Application to your circumstances

You commenced legal action against the Company due to your treatment conducting your daily work duties. You were not seeking compensation or to cease your employment. The claims directly related to your daily work duties in which you derived your assessable income.

Therefore, you have demonstrated the legal expenses directly related to you defending your employment conditions and a matter that was directly related to your daily work duties. Your legal expenses follow the advantage sought and, in this case, will be an allowable deduction under section 8-1 of the ITAA 1997.

Question 2

Summary

Since the termination of your employment, you have incurred legal expenses relating to loss of earnings. The compensation for loss of employment earnings is capital in nature therefore the associated legal expenses will also be capital in nature and, as such, you are not entitled to a deduction under section 8-1 of the ITAA 1997.

Detailed reasoning

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, or relate to the earning of exempt income.

Apart from specific provisions, legal expenses are deductible under section 8-1 of the ITAA 1997 if incurred in gaining or producing assessable income, or if necessarily incurred in carrying on a business for the purposes of gaining or producing assessable 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 the advantage will also be of a capital nature.

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.

TR 2012/8 explains whether or not amounts received to reimburse legal costs incurred in disputes concerning termination of employment are included in assessable income either:

•                     because they form part of an employment termination payment ('ETP') within the meaning of section 82-130 of the ITAA 1997; or

•                     as an assessable recoupment under section 20-20 of the ITAA 1997, where the legal costs are deductible under section 8-1 of the ITAA 1997.

Paragraph 45 of TR 2012/8, states that compensation for loss of employment, such as in an action for wrongful dismissal or loss of office, is a capital receipt (Scott v. Commissioner of Taxation). Legal costs incurred in seeking such compensation are not deductible because the nature of the advantage sought is capital. This is so, even if the amount of compensation awarded is calculated by reference to unpaid salary or lost income or is assessable as statutory income.

Compensation for loss of employment is often included in a taxpayer's assessable income. Pursuant to section 83-295 of the ITAA 1997, employment termination payments ('ETP') made more than 12 months after employment termination is considered assessable income. However, as outlined in paragraph 45 of TR 2012/8, this does not mean the associated legal expenses incurred are deductible. We still consider compensation for loss of employment capital in nature therefore the associated legal expenses are treated the same.

Application to your circumstances

Since the termination of employment, you have incurred legal expenses associated with your application to seek compensation for loss of income. As this in an ongoing matter and payments have not been received within 12 months after termination, if you are awarded compensation this will be treated as assessable income.

Furthermore, the compensation sought will still be considered capital in nature as it relates to a loss of employment, opposed to loss of income. Once you were terminated from the Company, you were no longer contractually entitled to income therefore any compensation sought associated with this loss is considered capital in nature.

As the compensation sought is considered to be capital in nature, the associated legal expenses that you have incurred are also capital in nature and you are not entitled to a deduction under section 8-1 of the ITAA 1997.