ATO Interpretative Decision

ATO ID 2002/656

Income Tax

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Issue

Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in seeking entitlements under an employment contract on termination of employment?

Decision

No. The taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in seeking entitlements under an employment contract on termination of employment.

Facts

The taxpayer was employed under an employment contract that provided for a lump sum payment in lieu of notice on termination of their employment.

The taxpayer terminated their employment and their employer refused to make the lump sum payment provided for under the employment contract.

The taxpayer took legal action to recover the lump sum payment in lieu of notice of termination plus interest and costs. The case was dismissed.

The taxpayer incurred legal expenses in relation to this matter.

Reasons for Decision

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 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.

It follows also that the character of legal expenses is not determined by the success or failure of the legal action.

A lump sum payment in lieu of notice is considered to be a capital amount paid as compensation for the loss of the means of producing income (Scott v. Commissioner of Taxation (1935) 35 SR (NSW) 215; (1935) 3 ATD 142). Such an amount is also considered to be an eligible termination payment (ETP) as it is a payment made in consequence of the termination of employment.

As an ETP, a lump sum payment in lieu of notice is included in assessable income under specific provisions of the Income Tax Assessment Act 1936. However, the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

As the taxpayer incurred legal expenses attempting to obtain a capital payment, the legal expenses are also capital in nature and are therefore not deductible under section 8-1 of the ITAA 1997.

Year of income:  Year ended 30 June 2001

Legislative References:
Income Tax Assessment Act 1936
   1

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

Related ATO Interpretative Decisions
ATO ID 2001/667
ATO ID 2002/657

Keywords
Deductions & expenses
Eligible termination payments
Legal action
Legal expenses
Employment contracts

Business Line:  Small Business/Individual Taxpayers

Date of publication:  25 June 2002

ISSN: 1445-2782