Edited version of your written advice

Authorisation Number: 1051201054865

Date of advice: 10 March 2017

Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for legal expenses incurred in defending an unfair dismissal claim against your former employer?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2016

The scheme commences on:

1 July 2015

Relevant facts and circumstances

You commenced legal against your former employer for unfair dismissal.

You engaged legal practitioners to assist you with the matter in the Fair Work Commission.

You incurred legal fees for representation for your case.

You have provided invoices from your representation for your legal fees which are categorized as “Unfair dismissal application”.

You have entered into a settlement agreement with your former employer under which they will pay you an amount.

Your employment was not reinstated.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

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.

In determining whether a deduction for legal expenses is allowed, 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.

Generally, legal expenses incurred in an unfair dismissal action (seeking reinstatement and/or damages) are of a capital nature and therefore, not deductible.

Paragraph five of Taxation Determination TD93/29 states:

If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the contract of employment, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible.

A compensation payment made by an employer to a former employee in settlement of an unfair dismissal action qualifies as an ETP, as it is considered to be made 'in consequence of the termination of any employment of the taxpayer' (Taxation Ruling IT 2424, paragraph 24).  For this reason an ETP, whether it is made in one lump sum or through several amounts, is capital in nature.

ETP's are subject to special tax treatment that may result in some or all of the amounts being included in assessable income. 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 assessable income.

In your case, you incurred expenses in taking legal action against your employer for unfair dismissal. This action has gone beyond a claim for revenue. You entered into a settlement with your employer the majority of which is considered to be an ETP. ETP's are capital in nature.

As your legal costs were all capital in nature and therefore in accordance with Commissioners view expressed in TD 93/29 are not deductible under section 8-1 of the ITAA 1997.

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