Edited version of private advice

Authorisation Number: 1051595657981

Date of advice: 16 October 2019

Ruling

Subject: Deductions for legal expenses

Question

Are the legal fees you incurred deductible?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You were employed with an organisation and you resigned in the 20XX income year.

You commenced employment with another employer in the 20XX income year.

Your first employer took action against you for breach of contract.

In order to maintain your employment income, you sought legal advice and counsel to defend yourself against the claim.

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) provides that a loss or an outgoing is an allowable deduction if it is incurred in producing assessable income or in carrying on a business for the production of assessable income unless that loss or outgoing is capital or of a private or domestic nature. The costs associated with employment arrangements, and in particular legal expenses associated with settling disputes of the arrangements, may be deductible.

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 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.

Legal expenses are generally deductible if they arise out of the day to day income earning activities (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).

If the advantage to be gained does not have an immediate connection to the derivation of income and is more of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Breach of contract

Taxation Determination TD 93/29 examines the deductibility of legal expenses in certain situations and states: If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for a breach of the contract of employment, the legal costs would not be deductible because they are capital in nature.

Taxation Ruling TR 2012/8, at paragraph 40 further states;

40. Where the legal costs are incurred to enforce a contractual entitlement which relates to a right to income, even if they were incurred after employment has ceased, the taxpayer will be entitled to a deduction under section 8-1.

Restraint of Trade

Defending a right to practice a profession or employment is capital in nature, as the right to practice is considered a structural asset and the associated expenses are incurred to protect this right (Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859 and Case X84 90 ATC 609; AAT Case 6258 (1990) 21 ATR 3721). As the nature of the expense follows the nature of the advantage sought, the expense is also capital in nature.

Application to your circumstances

In your situation, you were defending an action taken by your previous employer in trying to enforce a restraint of trade clause in your employment contract. The action by your previous employer was to prevent any possible future action on your part and does not relate to any current or previous actions taken by you while in their employ. The action was not prompted or caused as a consequence of the performance of your then current duties.

It is considered that your legal expenses in relation to this matter were incurred to enable you to continue working for future employers or yourself. They are not related to the duties of your previous employment. Therefore you are not entitled to a deduction for legal expenses incurred to defend an action brought against you for restraint of trade as it is capital in nature.

You mentioned the cases of Inglis & Anor v. Federal Commissioner of Taxation Administrative Appeals Tribunal of Australia, (1987) and X42, Administrative Appeals Tribunal of Australia, (12 April 1990). These cases can be distinguished from your situation as they did not deal with the issue of breach of contract and restraint of trade. In the quoted cases the main issue was the day to day situation of the employment out of which the actions arose.

Your circumstances related to a former employer and not your current employment situation.

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