Edited version of private advice

Authorisation Number: 1052371278269

Date of advice: 12 March 2025

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for the legal expenses incurred in defending charges which resulted from the duties of your employment under section 8-1 of the Income Tax Assessment Act 1997?

Answer 1

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You are employed with an Australian organisation.

In early 20XX, you faced allegations which resulted from the duties of your employment.

Consequently, you were charged, which eventually resulted in a Court hearing a couple of years later.

In mid-20XX, the Court acquitted you of all charges, with a detailed reasons for judgment provided a couple of months later.

During the legal proceedings, you were suspended from your employment duties on full pay.

As you were not a member of the relevant union, you were not eligible for union-funded legal assistance. Consequently, you incurred significant legal costs to fund your own legal defence.

However, after mid-20XX (in the next financial year), you were awarded a X% cost recovery (but not including GST), which left you with an unrecovered balance of $X, which is your total out of pocket legal costs.

You wish to claim this amount of $X as a legal expense deduction in the 20XX-XX income year, as you incurred this expense in full during the 20XX-XX income year (prior to the cost recovery amount which was awarded to and received by you in mid-20XX, which was in the next financial year).

Your employer did not provide you with any reimbursement or financial assistance for the legal proceedings.

You hold comprehensive records, including invoices and receipts, to substantiate the legal expenses you have incurred, including the proper apportionment relating to the unrecovered legal costs.

You also hold payslips which confirm the period you were suspended on full pay during the legal proceedings.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Question

Are you entitled to a deduction for the legal expenses incurred in defending charges which resulted from the duties of your employment under section 8-1 of the Income Tax Assessment Act 1997?

Summary

The principal reason for incurring your legal expenses was defending the allegations against you, in which directly related to you carrying out your employment duties. Therefore, these expenses are characterised as being of a revenue nature and you are entitled to a deduction under 8-1 of the ITAA 1997.

Detailed reasoning

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.

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).

Also, in determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. FC 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.

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).

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).

Similarly, in FC of T v. Day [2008] HCA 53 and FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the courts 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.

Application to your circumstances

In early 20XX, you faced allegations which resulted from the duties of your employment.

During the legal proceedings, you were suspended from your employment duties on full pay.

The purpose of the legal representation was to resolve the allegations against you, along with being able to return to your employment role. It was not to seek compensation or cease your employment when the legal action commenced. The allegations 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 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.