ATO ID 2002/664: Deductions & Expenses: Legal fees incurred in defending a claim of harassment and victimisation
Date of decision: 17 December 2001
Year of income: Year ended 30 June 2001
Business line: Small Business/Individual Taxpayers

Issue
Are legal fees incurred by the taxpayer in defending a sexual harassment and victimisation charge deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
No. The legal fees incurred by the taxpayer in defending a sexual harassment and victimisation charge are not deductible under section 8-1 of the ITAA 1997 as they were not incurred in gaining or producing assessable income.

Facts
The taxpayer is an employee. The duties of the taxpayer do not include advising other employees on their work performance. Another employee lodged a complaint of sexual harassment and victimisation against the taxpayer with the relevant Government Authority. The taxpayer denied the allegations and in defending the charge engaged a solicitor for which they paid certain costs. The matter proceeded to the relevant Government Authority where it was resolved through a conciliation agreement.

Reasons for decision
Summary: Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent that they are incurred in gaining or producing assessable income except where the outgoings of a capital, private or domestic nature, or relate to the earning of exempt income. For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income, ( Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; [1949] HCA 15; (1949) 4 AITR 236; (1949) 8 ATD 431). Also, 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] HCA 34; (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 activities of the taxpayer's business. ( Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; [1932] HCA 56; (1932) 39 ALR 46; (1932) 2 ATD 169) 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 (1980) 49 FLR 183; [1980] FCA 150; (1980) 11 ATR 276; 80 ATC 4542). Similarly, in FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. No significance was placed by the court on the taxpayer's status as an employee. In Case U102 87 ATC 621; AAT Case 72 (1987) 18 ATR 3515 the taxpayer took defamation action against comments made with regard to the management of a trust fund of which he was a trustee. It was found that the expenses were not incidental to the proper execution of the office of trustee but rather were to maintain the taxpayer's personal reputation. In Case W94 89 ATC 792; AAT Case 5376 (1989) 20 ATR 4001 the taxpayer, a public servant incurred legal fees in defending and then appealing against disciplinary charges of improper conduct resulting from his compulsive gambling. It was found that the expenses incurred where not incidental or relevant to the gaining of the taxpayer's assessable income. It was the conduct of the taxpayer through his compulsive gambling which led to the charges which, in turn, led to him incurring legal costs. The expenses incurred were not incidental or relevant to the gaining of the taxpayer's assessable income. The legal expenses incurred by the taxpayer in defending the sexual harassment and victimisation claim made by another employee arose from the personal conduct of the taxpayer. They did not arise from the performance of the taxpayer's duties from which they derived assessable income. Therefore, the legal fees incurred by the taxpayer are not an allowable deduction under section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: AAT Case 72 (1987) 18 ATR 3515
Related ATO interpretative decisions: ATO ID 2002/663
Subject references: Deductions & expenses Legal expenses