Edited version of private advice

Authorisation Number: 1052328639285

Date of advice: 12 November 2024

Ruling

Subject: Deductions - legal expenses

Question 1

Can you deduct the $X,XXX in legal expenses you incurred in accordance with section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No.

Question 2

Is the settlement payment you repaid to your former employer an allowable deduction under section 8-1 of the ITAA 1997?

Answer 2

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

On XX XX 20XX, you commenced your employment with the employer (the Employer).

You were employed on a full-time basis.

In XX XX 20XX, you ceased work with the Employer.

Your year-to-date gross wages were reported to the Australian Taxation Office (ATO).

The Employer withheld and submitted Pay As You Go Withholding (PAYGW) tax to the ATO.

On XX XX 20XX, the Employer commenced legal proceedings against you.

The Employer filed a Statement of claim and alleged that during the period XX XX 20XX to XX XX 20XX (Employment Period) you were unjustly enriched by way of mistaken payments.

You denied this and alleged that you were owed other monies including monies due to you pursuant to the National Employment Standards. You believe you were also entitled to unpaid commission.

The Employer denied your claim.

You engaged a lawyer for correspondence and negotiations with the Employer.

You reach a settlement agreement by which you were required to repay $XX,XXX.XX to the Employer.

You paid an initial deposit of $XX to your lawyer.

In total, you paid the lawyer $X,XXX in legal fees.

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

•                     Employment contract

•                     Payslips

•                     Settlement Agreement

•                     Tax invoice from your lawyers.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 59-30

Reasons for decision

Question 1

Can you deduct the $X,XXX in legal expenses you incurred in accordance with section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

You received an overpayment of wages which you were required to repay to the Employer. The overpayment is therefore non-assessable, non-exempt income. You cannot deduct the legal expenses you incurred to defend the overpayment in accordance with section 8-1 of the ITAA 1997 if the loss you incurred is in relation to gaining or producing your non-assessable, non-exempt income.

Detailed reasoning

Section 8-1 of the ITAA 1997 explains that you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing assessable income. Subsection 8-1(2) of the ITAA 1997 provides that you cannot deduct a loss or outgoing under this section to the extent that:

(a)           It is a loss or outgoing of a capital, or of a capital nature; or

(b)           It is a loss or outgoing of a private or domestic nature; or

(c)           It is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

(d)           A provision of this Act prevents you from deducting it.

In determining whether a deduction for legal expenses is allowed, the nature of the expenditure must be considered (Hallstrom 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 capital in 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 expenses arises has to have more than a peripheral connection to the taxpayer's business or income earning activities.

Taxation Ruling TR 2000/5 Income tax and fringe benefits tax: costs incurred in preparing and administering employee agreements recognises that both the employer and employee may incur expenses in setting the conditions for administering the employee agreement. These costs may include costs associated with the settlement of disputes and representation. Where an employee incurs costs associated with settlement of disputes arising out of an existing employment agreement that is an allowable deduction.

The facts in your case, are that you received an overpayment of wages which you were required to repay. The overpayment is non-assessable, non-exempt income and therefore you cannot deduct the legal expenses you incurred to defend the overpayment. You are not entitled to deductions under section 8-1 of the ITAA 1997 if the loss you incurred relates to the earning of exempt income.

Question 2

Is the settlement payment you repaid to your former employer an allowable deduction under section 8-1 of the ITAA 1997?

Summary

Section 59-30 of the ITAA 1997 operates to exclude an amount from your assessable income for an income year if you have repaid it in a later income year and you cannot deduct the repayment in any income year.

Detailed reasoning

Under section 6-5 of the ITAA 1997, assessable income includes income according to ordinary concepts.

Paragraph 42 of Taxation Ruling (TR) 98/1 Income tax: determination of income: receipts vs earnings states that income from employment would normally be assessable on a receipts basis even though they relate to a past or future period. As such, you would be required to report employment income you receive in an income year in that year's tax return.

Repayment of prior year employment income

Section 59-30 of the ITAA 1997 operates to exclude an amount from your assessable income for an income year if you have repaid it in a later income year and you cannot deduct the repayment in any income year.

Subsection 59-30(2) of the ITAA 1997 provides that it does not matter if you received the amount as part of a larger amount; or the obligation to repay existed when you received the amount, or it came into existence later.

Application to circumstances

You have incurred legal expenses following the serving of a claim on you for repayment of overpaid wages. The costs have been incurred in connection with the earning of non-assessable, non-exempt income and are not deductible under section 8-1 of the ITAA 1997.

You can amend your income tax return within 2 years of a Notice of Assessment being issued to report the change in the amount of assessable income you received. If you are not able to amend your income tax return within the 2-year timeframe; you can lodge an objection. The Commissioner can amend assessments if an amendment request is submitted by you prior to the date the period of review ends for each assessment.