Edited version of private advice

Authorisation Number: 4120085531536

Date of advice: 24 February 2021

Ruling

Subject: General deductions - capital vs revenue expenditure

Question

Are you entitled to claim a deduction for legal expenses incurred under section 8-1 of the ITAA 1997?

Answer

Partly

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were employed for a one-year contract.

Colleagues submitted a series of complaints about your work performance.

This matter resulted in a workplace investigation where you were required to defend the manner in which you preformed your duties.

You incurred expenses through engaging several solicitors to provide you with advice and information to defend these complaints.

The legal expenses were incurred in gaining and producing accessible income to defending the manner in which you had performed my employment duties while you were still receiving wages.

The legal advice you sought was in relation to your employment position and reapplication for a training program.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Question 1

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act (ITAA 1997) allows a deduction for all losses and outgoing to the extent that they are incurred in gaining or producing assessible income. You can deduct these losses or outgoings except where they are of a capital, private or domestic nature, or relate to the earing of exempt income.

Legal expenses will be characterised as an outgoing of capital or revenue nature depending on the cause or purpose of incurring the expenditure. The nature or the legal expenses follows the advantage that is sought to be gained by incurring the expenses. Legal expenses are deductible provided the legal action;

•         Arose out of, or concerns the day to day income producing activities of the taxpayer (The Herald and Weekly Times Ltd v. FC of T (1932) 48 CLR 113)

•         Is not undertaken to protect the taxpayer's profit-yielding subject

•         Has more than a peripheral connection to the taxpayer's business (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 ATC4097)

•         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)

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 assessable income, such expenses are characterised as being of a revenue nature and are deductible (Inglis v. FC or T 87 ATC 2037; and Case V116 88 ATC 737; AAT Case 4502 (1988) 19 ATR 3703).

A number of significant court decisions have determined that for an expense to be an allowable deduction:

•         It must have the essential character of an outgoing incurred in gaining assessible income or, in other words, of an income-producing expense (Lunney v FC of T; (1958) 100 CLR 478,

•         There must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessible income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47) and,

•         It is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessible income (Charles Moore Co (WA) Pty Ltd v. FC of T (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184)

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessible income. Also, in determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITE 436; (1946) 8 ATD 190)

As an employee you incurred legal expenses to defend the manner in which you performed your employment duties through which you gained your assessable income.

In considering whether you are also entitled to a deduction for the legal costs incurred in reapplying for a position on a Training Program it is necessary to consider whether the expenses were incurred in the course of gaining or producing your assessable income.

From the time your employment contract ceased there is no longer a connection to gaining or producing assessible income from this employer. The high-level professional skills you seeking to acquire from the Training Program are well beyond the skills that were required from your previous employment and was not part of your employment conditions.

Expenses incurred by an employee in obtaining employment are not deductible because the expenses come at a point in time too soon to be regarded as being incurred in gaining assessable income. The expenditure is incurred in getting, not in doing, work as an employee (Federal Commissioner of Taxation v. Maddalena 71 ATC 4161; (1971) 2 ATR 541 (Maddalena's case)). Similarly, expenditure that is a prerequisite to obtaining particular employment is not deductible.

The legal expenses in relation to you reapplying for the Training program that were incurred after your employment contract ceased are considered capital in nature and not deductable under Section 8-1 of the ITAA 1997.

In your case, you incurred legal expenses in both defending the manner in which you performed your duties and once your employment contract had ceased in reapplying for a position on a Training Program.TD 93/29 provides advise on apportionment of solicitor's accounts. Where a solicitors 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 their work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible. And apportionment on the basis of the monetary value of the revenue claim relative the capital claim.