ATO Interpretative Decision

ATO ID 2010/209

Income Tax

Legal expenses incurred in pursuit of an assessable workers compensation payment for lost earnings
FOI status: may be released
CAUTION: This is an edited and summarised record of a Tax Office decision. This record is not published as a form of advice. It is being made available for your inspection to meet FOI requirements, because it may be used by an officer in making another decision.

This ATOID provides you with the following level of protection:

If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.

Issue

Can the taxpayer claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in pursuing a workers compensation payment for lost earnings?

Decision

Yes. The taxpayer can claim a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in pursuing a workers compensation payment for lost earnings.

Facts

The taxpayer was injured in the workplace and claimed workers compensation.

The taxpayer's claim for workers compensation was rejected and legal assistance was sought with legal expenses incurred.

The taxpayer was successful in their claim and received an assessable compensation payment for lost earnings.

Reasons for Decision

Broadly, 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.

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. 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 which is sought to be gained by incurring the expenses.

If the advantage to be gained is of a revenue nature, then the expenses incurred in gaining the advantage will also be of a revenue nature. In the same way, 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. It follows also that the character of legal expenses is not determined by the success or failure of the legal action.

The question of deductibility of legal expenses under section 8-1 of the ITAA 1997 to enforce a contractual entitlement to a lump sum payment in lieu of notice was considered in Romanin v. Commissioner of Taxation [2008] FCA 1532; 2008 ATC 20-055; (2008) 73 ATR 760.

In that case, McKerracher J held, at FCA paragraph 52, in terms of positive limb nexus:    


In my view, the requisite connection exists between the outgoing claimed (legal expenses) and the incurrence [sic] of assessable income. On this point, I accept Mr Romanin's submission that he pursued proceedings in the Commission to obtain income that was contractually owed to him and that the costs incurred in doing so are deductible under s8-1(1) of the ITAA.

In terms of the negative limbs, McKerracher J held, at FCA paragraph 56, that:    


It is true that payment was for a lump sum in lieu of 12 months income (less other income received) but the amount was described in the orders pursuant to the Commission's judgment as remuneration, was computed by reference to his entitlement to income, was set off against other income actually earned and is a financial reward for exertion that would have been carried out had his employment not been (invalidly) terminated. Income is of course received by people and entities in a variety of ways. The payment in a lump sum of the sum which would otherwise be income by way of regular payments, does not of itself, in my view change the character of the payment . [Emphasis added.]

That is, the character of the advantage sought was held to be on revenue rather than capital account.

Therefore, in the circumstances here, the same conclusion follows. That is, the taxpayer's legal expenses in order to obtain the workers compensation payments are outgoings with nexus to assessable income, where the character of the advantage sought is on revenue account. The legal expenses are therefore deductible under section 8-1 of the ITAA 1997.

Date of decision:  9 November 2010

Year of income:  Year ended 30 June 2011

Legislative References:
Income Tax Assessment Act 1997
   section 8-1

Case References:
Hallstroms Pty Ltd v Federal Commissioner of Taxation
   (1946) 72 CLR 634
   (1946) 3 AITR 436
   (1946) 8 ATD 190

Romanin v Commissioner of Taxation
   [2008] FCA 1532
   2008 ATC 20-055
   (2008) 73 ATR 760

Related ATO Interpretative Decisions
ATO ID 2002/505

Keywords
Deductions & expenses
Compensation income
Legal action
Legal expenses

Business Line:  Small Business/Individual Taxpayers

Date of publication:  19 November 2010

ISSN: 1445-2782