Edited version of private advice

Authorisation Number: 1052370561927

Date of advice: 27 March 2025

Ruling

Subject: Legal expenses - disputing termination of employment

Question 1

Can you claim a deduction for all of the legal expenses you incurred under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Can you claim a deduction for the legal expenses you incurred under section 8-1 of the ITAA 1997before you ceased employment with the Employer?

Answer

Yes.

Question 3

Can you claim a deduction for the legal expenses you incurred under section 8-1 of the ITAA 1997 after you ceased employment with the Employer?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You have worked in your occupation for many years.

Several years ago, you were informed of an investigation into your conduct.

Disciplinary charges were commenced against you later that year.

The following year, the results of an independent investigation into the investigation against you were handed down.

You were issued with a Loss of Confidence (LOC) from the relevant entity.

The following month, you commenced employment in another occupation.

You submitted an application for secondary employment which was granted.

The following month, you were issued with a letter advising that the relevant entity had regained confidence in you.

Once the loss of confidence letter was rescinded, you were expected to recommence working. However, you were unable to do so due to your health issues.

You have been on sick leave since then.

Several months after your application for secondary employment had been granted, your authorisation for secondary employment was revoked on the grounds that you had applied to have your leave changed from annual to work-related sick leave.

You were assessed by a medical professional. The medical professional advised that you initially presented with a particular condition which has evolved into another condition.

During a subsequent consultation with the medical professional, they advised that you had no capacity for work (total incapacity). They also advised that you would not be fit to participate in any internal processes including internal investigations or hearings at that time.

During a consultation with a vocational rehabilitation consultant, they recommended that you be progressed to medical retirement on the basis of your work-related condition.

The disciplinary examination was held in your absence.

At the disciplinary hearing, the penalty imposed was dismissal.

You remained employed following the disciplinary hearing.

Several months after the disciplinary hearing, you were sent a without prejudice offer of settlement from your employer's legal team.

You declined the settlement offer.

Your legal team sent a counteroffer to your employer.

Your employer did not accept the terms of your counteroffer.

You faced a disciplinary hearing.

The disciplinary hearing was in relation to the breaches of the relevant act you had been charged with on several occasions.

The result of the hearing was that you should be dismissed.

You were dismissed from your employment.

Some months later you faced the Appeals Board. The finding from that hearing was that misconduct had occurred on your part and dismissal was the only reasonable outcome.

You were seeking the following relief at your Appeal hearing:

•                     That the finding that the relevant charges are proven be set aside and quashed

•                     That the decision to dismiss be set aside and quashed

•                     That the relevant entity be directed to proceed with medical retirement as previously commenced

You have provided a list of the legal fees you incurred in relation to advice on your appeal following your disciplinary examination finding and medical discharge.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Question 1

Summary

You cannot claim a deduction for all of the legal expenses you incurred under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

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

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.

To be deductible under section 8-1, the legal expenses must have a sufficient connection with the carrying on of a business for the purpose of gaining or producing assessable income. Whether there is the necessary nexus between your legal expenses and your income producing activities is a question of fact to be determined by reference to all relevant facts and circumstances.

As outlined in Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47 at 56 (Ronpibon Tin), for legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of your assessable income or business operations.

Legal expenses take their character from the cause or purpose of incurring the expenditure. In determining whether a deduction for legal expenses is allowable under section 8-1, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation(1946) 72 CLR 634.)

The primary considerations in determining whether a legal expense is on revenue or capital account as outlined in Sun Newspapers Ltd v. Federal Commissioner of Taxation (1939) 61 CLR 337 are as follows:

•                     whether the legal expenses relate to the profit-yielding subject and the process (which is indicative of a capital nature) or profit-yielding structure (which is indicative of an income nature), and

•                     whether the nature of the asset or advantage sought to be gained is of an enduring benefit, which is indicative of a capital nature.

Application to your circumstances

You incurred some of your legal expenses prior to the cessation of your employment and some of the expenses after the cessation of your employment.

The advantages you were seeking following the cessation of your employment all relate to items that are capital in nature. As no deduction is allowed for expenses that relate to items of a capital nature, you cannot claim a deduction for all of the legal expenses you incurred.

Question 2

Summary

You can claim a deduction for the legal expenses you incurred before you ceased employment with the Employer.

Detailed reasoning

As discussed in Question one, the deductibility of 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 as outlined in Ronpibon Tin.

In the High Court decision of the Federal Commissioner of Taxation v Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064 (Day's case), Mr Day was charged with breaching the standards of conduct and failing to fulfil his duty as an officer. It was found that the requisite connection with his assessable income was present and that he was exposed to the charges by reason of his office.

The majority approach in this case was that an expense will satisfy the test outlined in paragraph 8-1(1)(a) of the ITAA 1997 if the occasion of the expense is found in whatever is productive of actual or expected income. They indicated that a broad approach should be taken in determining what activities produced the actual or expected assessable income, and that it is not only the day to day tasks performed by the employee that gain or produce this income.

In each case the nature of the alleged misconduct, the scope of a taxpayer's income earning activities and other existing circumstances, will determine whether the legal expenses are a deductible expenses.

The decision in Day's case establishes that where the connection between the legal expenses and the income is identified as being incurred to answer allegations of breaching negative duties imposed under the terms of the employment this may also be sufficient to satisfy paragraph 8-1(1)(a) of the ITAA 1997.

It may be generalised that where employment or service is conducted on terms that standards of conduct be observed in a taxpayer's personal life on pain of dismissal or reduction in salary, legal expenses incurred in resisting civil disciplinary or legal action will be deductible.

Application to your circumstances

You incurred legal expenses to dispute disciplinary proceedings that you were subject to as a result of your employment. As you were required to observe standards of conduct in your personal life or risk being dismissed from your employment, the relevant connection is present between your income earning activities at the time and the legal expenses you incurred while employed.

It is considered that your expenses were incurred to preserve your employment and were incidental and relevant to the production of your assessable income. Therefore, you can deduct all of the legal expenses you incurred while you remained employed.

Question 3

Summary

You can't claim a deduction for the legal expenses you incurred following the cessation of your employment as they don't have the requisite connection to the earning of assessable income.

Detailed reasoning

As outlined in Questions one and two, legal expenses will generally be deductible where they relate directly to the earning of assessable income.

However, if the legal expenses relate to a claim for capital items, these expenses will not be deductible. For example, legal expenses relating to an action for wrongful dismissal would not be deductible.

If the advantage to be gained does not have an immediate connection to the duties undertaken to derive income and has more of an enduring and consequently capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Application to your circumstances

In your situation, the advantage you were seeking when you incurred legal expenses following your dismissal from employment was the reinstatement of your employment followed by medical retirement.

If you had been medically retired, you would have received a lump sum payment under the relevant scheme.

The total amount you would have received under the scheme is based on amounts for permanent impairment, permanent total incapacity, vocational rehabilitation and a top up payment if required that make up the total amount.

Are these amounts ordinary income?

Section 6-5 of the ITAA 1997 provides that your assessable income includes income according to ordinary concepts, which is called ordinary income. There is no legislative definition of ordinary income. Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business.

Other characteristics of income that have evolved from case law include receipts that:

•                     are earned

•                     are expected

•                     are relied upon; and

•                     have an element of periodicity, recurrence or regularity.

If you had been medically retired, you would have received dissectible amounts under the scheme. The scheme provides for compensation which is dissected into several components as outlined above. The first two components relate to personal injury (permanent impairment and permanent total incapacity.)

The third component is called the 'salary' component. This component does not meet the definition of ordinary income. It does not have any of the characteristics of being earned, expected or relied upon. It Is a term used in the Act to describe a component used in the formula to calculate the amount of eligible compensation up to the maximum 'prescribed amount'.

The fourth component is called the Vocational rehabilitation amount. It is described in the application as an amount intended to meet the costs of the MRM obtaining alternative employment as the Member can no longer carry out the functions of their employment. It is a one-off lump sum payment.

The compensation, whilst dissected into four components, is to compensate the Medically Retired Members for personal injury.

The effect on the legal expenses

As explained in paragraph 45 of 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,if an amount received for loss of employmentis not income in nature, it will be capital, even where the amount is calculated with reference to unpaid salary or lost income or is assessable as statutory income.

As none of the amounts you would have received if medically retired are assessable, you are not able to claim a deduction for any of the legal expenses you incurred following the cessation of your employment.