Private ruling: Legal expenses
Published: May 2014
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for legal fees? | A1: No

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: • the application for private ruling and • the documents provided in response to the requests for further information. You had worked for your employer for many years. You became ill and took sick leave. You ceased work due to your illness. Your doctor issued you a medical certificate as a workers compensation claim for your illness. The claim was denied. You sought legal advice from a law firm for your workers compensation claim for your illness (Claim 1). You lost this claim and did not incur any legal costs. You sought legal advice from Law Firm 2. You made a claim against your employer that your first injury sustained is the substantive reason you are sick (Claim 2). This claim was awarded to you but was noted you recovered at a later point in time. You were reimbursed your original sick leave as workers compensation. You made a claim your employer contributed to your ongoing illness from when you ceased working due to allegations you were not ill (Claim 3). Later it was found that you had not recovered from your illness and Claim 2 was reconsidered. Your employer offered a reconciliation meeting, stating they would provide you with a return to work. This did not eventuate due to your employer stating they did not have any suitable duties in line with their psychiatrist's recommendations. You had not returned to work and decided to proceed with all three claims at the Administration Appeals Tribunal (AAT). The AAT found Claim 2 in your favour, accepting that you sustained an injury and continued to suffer for the period up to the AAT decision. Further it was found that while you continued to require medical treatment, on a certain date it was accepted that your injury ceased to result in incapacity to work. Therefore you received workers compensation from the time you ceased working up until the AAT decision as reimbursed sick leave. It was the responsibility of your employer to return you to work. Your employer offered you a settlement rather than a return to work. You agreed to the settlement and resigned from your employer, with an employment termination payment (ETP).

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1

Reasons for decision: Summary: 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. For legal expenses to constitute an allowable deduction it must be shown that they were incidental and 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) 4 AITR 236; (1949) 8 ATD 431). The nature of the expenditure must also be considered ( Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190). The nature or character of the legal expense 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 expense incurred in gaining the advantage will also be of a capital nature. An ETP is defined as a payment made in respect of a taxpayer in consequence of the termination of any employment of the taxpayer, and includes bona fide redundancy payments and payments made under commercial separation agreements. An ETP is capital in nature because it is a payment made to compensate for the loss of the employment position ( Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184). ETPs 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 stated above, if the advantage to be gained from incurring legal expenses is of a capital nature, then the expense incurred in gaining the advantage will also be of a capital nature. In your case you incurred legal expenses in relation to a settlement where you received an employment termination payment. As the ETP and was paid to compensate for the loss of your employment position, it is considered to be capital in nature. For this reason, the legal expenses at issue would also be considered to be capital in nature. The legal expenses are not, therefore, deductible under section 8-1 of the ITAA 1997.