Edited version of your written advice

Authorisation Number: 1051460499566

Date of advice: 27 November 2018

Ruling

Subject: WRE – legal expenses – work dispute

Question

Are you entitled to a deduction for legal expenses associated with seeking legal advice regarding an Employment Termination Payment (ETP) after dismissal from an employment position under s8-1 Income Tax Assessment Act 1997 (ITAA 97)?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

You are a former employee of company A

Your employment was terminated.

You were a white collar employee whose employment was terminated because you refused to undertake duties that were not consistent with your areas of expertise and experience.

You commenced fulltime employment with company A in the position of clerk.

Company A is the successor of various corporate entities who have operated the same business in which you were employed.

You were employed in a number of what was referred to during the proceedings as “white collar positions.”

You were promoted and a new contract of employment relating to that position was entered into.

Later, a further contract of employment was made between yourself and company’s A’s immediate corporate predecessor in the business.

You were underutilised in your role and you agreed with your employer that you would take on other duties.

Eventually company A terminated your employment. As a consequence of your refusal to accept the additional duties you were dismissed from your employment.

You lodged a general protections application with the Fair Work Commission.

After failing to reach agreement in the Fair Work Commission the matter was lodged with the Federal Circuit Court of Australia

You were unsuccessful in some of your claims but you were successful on a contractual claim that you were entitled to a retrenchment payment within your contract of employment.

Judgement was delivered that company A pay you within 30 days a redundancy payment less any tax required by law

Company A appealed the decision and the appeal was dismissed

You incurred legal expenses in relation to the various actions as part of the settlement of the Federal Court proceedings against you.

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 a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature, or relate to the earning of exempt income.

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 assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478 (Lunney’s case)),

there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable 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 assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

In determining whether a deduction for legal expenses is allowable, the nature or character of the expenditure must be considered, that is, whether the legal expenses are incurred for a capital or a revenue purpose (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. For example, if the advantage to be gained is of a capital nature, then the legal expenses incurred in gaining the advantage will also be of a capital nature and are not deductible.

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

Employment Termination Payments (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.

As ETP’s are capital in nature, any legal expenses associated with obtaining the ETP are also capital in nature and not deductible.

The Commissioner acknowledges that in your private ruling application you refer to Romanin v Commissioner of Taxation [2008] stating that this case supported your claim for the deductibility of your legal expenses. McKerracher J held that:

1. The payment for legal expenses was deductible under section 8-1 of the ITAA 1997 because

● The proceedings were undertaken to enforce an entitlement to income (not to compensation or damages) that was contractually owed to the taxpayer (paragraphs 41 and 52)

● The character of the payment received by the taxpayer was of an income and not of a capital nature. The amount received was described in the orders pursuant to the IRC’s judgement as remuneration, was computed by reference to his entitlement to income, was set off against other income actually earned, and was financial reward for exertion that would have been carried out had his employment not been (invalidly) terminated (paragraph 56)

As mentioned previously, the success or failure of a legal action does not determine the character of legal expenses; rather it is the character of the advantage sought.

In your case, you incurred the legal expenses seeking to obtain the ETP. Although the ETP may be included in the assessable income, the ETP retains its character as a capital receipt.

As the legal expenses were incurred in gaining a capital sum, they will also be of a capital nature and are therefore not deductible.

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