Edited version of private advice

Authorisation Number: 1052270364684

Date of advice: 5 July 2024

Ruling

Subject: Tax deduction for legal expenses

Question 1

Are you entitled to a full tax deduction for the legal expenses you incurred?

Answer

Yes.

Question 2

Are you entitled to a partial tax deduction for the legal expenses you incurred?

Answer

Not Applicable.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July XXXX

Relevant facts and circumstances

You were employed as a XXXX by the XXXX for over XX years.

Your employer made allegations against you in relation to your performance in your employment role with them which resulted in you addressing this dispute with them and seeking legal advice to assist you with the dispute.

You were suspended from duty effective XXXX.

Your employer invited you, by letter dated XXXX, to respond to the particulars of the allegations within 14 days from receipt of the letter ("show cause process"). You advised the matter is sufficiently serious to warrant termination of employment.

You obtained legal advice to assist you to respond to the allegations and your lawyers responded to your employers 'show cause' by letter dated XXXX. You did not obtain legal advice relating to resignation.

To date no reply or decision has been made by your employer as to what disciplinary action will be taken against you.

As you were suspended from employment you resigned from that employment effective XXXX. You commenced employment as a public servant with another XXXX on XXXX.

You advised though you resigned from the XXXX, the 'show cause' process has not ceased so the same disciplinary action can be taken while in your current employment.

You are not seeking a redundancy payment, eligible termination payment or another lump sum payment. You incurred expenses to require your previous employer cease all action in relation to the matter. The associated legal expenses are consequences of defending your actions in carrying out your employment duties.

You provided the following invoices for the legal expenses you incurred relating to the employment allegations made against you-

•         Invoice XXXX for $ XXXX

•         Invoice XXXX for $ XXXX

•         Invoice XXXX for $ XXXX

•         Invoice XXXX for $ XXXX.

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. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining this advantage will also be of a capital nature.

The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day income producing activities of the taxpayer (The Herald and Weekly Times Ltd v. FC of T (1932) 48 CLR 113). The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business or income earning activities. The expense may arise out of litigation concerning the taxpayer's professional conduct (Magna Alloys and Research Pty Ltd v. FC of T (1980) 11 ATR 276; 80 ATC 4542; Putnin v. FC of T (1991) 21 ATR 1245; 91 ATC 4097).

When legal action is undertaken to obtain a payment, then the deductibility of the legal expenses depends on whether the payment sought is revenue in nature, such as unpaid wages, or whether the payment sought is capital in nature, such as a redundancy type payment or compensation for unfair dismissal.

This principle is confirmed in Taxation Determination TD 93/29 which states that if an employee incurs legal expenses in recovering wages, the legal expenses are an allowable deduction providing that the legal action relates solely to the recovery of wages. The ruling continues: -

5. However, 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 where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible. For example, legal expense relating to an action for damages for wrongful dismissal, are not deductible.

6. There will often be occasions where the legal expenses are incurred in relation to proceedings that relate both to accounts that are revenue in nature as well as amounts which are capital in nature. For example, many proceedings in relation to wrongful dismissal will also involve the recovery of unpaid salary or wages. In these circumstances '....there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income' (Ronpibon Tin N.L. v. FC of T (1949) 78 CLR 47 at 59).

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

When legal expenses are incurred in relation to proceedings that relate both to claims that are revenue in nature as well as those of a capital nature, there must be some fair and reasonable apportionment of the extent of the relation of the outlay to the revenue claim.

TD 93/29 paragraph 7 discusses the apportionment of legal expenses.

7. Where the solicitors account is itemised, one reasonable basis for apportionment would be the time spent involving the revenue claim, relative to the time spent on the capital claim. If the solicitors account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim.

Application to your circumstances

In your case, alleged complaints were made against you relating to your performance in your workplace. You engaged the services of a lawyer in defending yourself against these allegations.

You obtained legal representation to resolve these issues so you could protect and retain your position of employment.

You did not incur any legal expense for the purpose of gaining an advantage or obtaining a settlement with the employer.

You were seeking to defend the way you undertook your employment duties to continue your employment. The advantage sought at this stage was not capital in nature and therefore your legal expenses is deductible.

It is considered that your legal expenses were a consequence of your day to day activities as an employee from which you derived assessable income.

The benefit being sought in relation to the legal expenses you incurred is related to the earning of your assessable income and is not capital in nature.

Therefore, the associated legal expenses incurred are deductible under section 8-1 of the ITAA 1997. The associated legal expenses are consequences of defending your actions in carrying out your employment duties.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).