ATO ID 2002/674: Legal Expenses - personal injury damages award
Date of decision: 22 January 2002
Year of income: Year ended 30 June 2001
Business line: Small Business/Individual Taxpayers

Issue
Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in obtaining a personal injury damages award?

Decision
No. The taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in obtaining a personal injury damages award.

Facts
The taxpayer took their employer to court to recover damages for an injury suffered by the taxpayer that occurred at work. The taxpayer wanted recognition from their employer that the injury was work related and also sought monetary compensation for injury suffered. The taxpayer obtained a personal injury damages award. The taxpayer incurred legal expenses in relation to this matter.

Reasons for decision
Summary: Section 8-1 of the 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 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. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. An amount paid to compensate for loss generally acquires the character of that for which it is substituted (Federal Commissioner of Taxation v. Dixon (1952) 86 CLR 540; [1952] HCA 65; (1952) 5 AITR 443; (1952) 10 ATD 82). Lump sum damages awarded at common law for a personal injury claim generally do not form part of a taxpayer's assessable income (ATO ID 2004/943). The personal injury damage award received by the taxpayer is capital in nature and does not form part of the taxpayer's assessable income. The legal expenses incurred in obtaining the payment will consequently be capital in nature as they follow the advantage that is sought to be gained by incurring the expenses. Accordingly, no deduction is allowable under section 8-1 of the ITAA 1997 to the taxpayer for the legal expenses incurred in obtaining the personal injury damages award.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634 [1946] HCA 34 (1946) 3 AITR 436 (1946) 8 ATD 190
Related ATO interpretative decisions: ATO ID 2004/943
Subject references: Deductions & expenses Legal action Legal expenses Personal injury awards