Private ruling: Legal expenses
Date of advice: 7 August 2017
Published: November 2017
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you entitled to a deduction for the portion of your legal expenses incurred that relate to you seeking your weekly compensation payments and interest? | A1: Yes. | Q2: Are you entitled to a deduction for the portion of your legal expenses incurred that relate to you seeking compensation for medical and treatment costs? | A2: No. | Q3: Are you entitled to a deduction for the portion of your legal expenses incurred that relate to the settlement agreement and the receipt of the undissected capital payment? | A3: No. | Q4: Are you entitled to a deduction for the portion of your legal expenses incurred that relate to your long term incapacity, loss of earning capacity, permanent impairment, or rehabilitation? | A4: No.


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

Reasons for decision: Summary: Legal expenses Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature. For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of assessable income or business operations. 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) 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. Weekly compensation and interest In Tax Determination TD 93/29 Income tax: if an employee incurs legal expenses recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997? The Commissioner states that legal expenses incurred by an employee in recovering unpaid wages are deductible under section 8-1 of the ITAA 1997, as the expenses are directly incurred in the process of deriving assessable income. Similarly you incurred legal expenses in relation to compensation for loss of income. The compensation for weekly payments represents a replacement of your salary and wages and are considered to be revenue in nature and assessable. Also any interest income is also assessable income. The associated legal expenses in relation to you seeking weekly compensation and interest payment relates sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997. Medical costs Medical expenses are generally regarded as private expenses. Additionally it is a long standing principle that a taxpayer does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some casual connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred in gaining or producing your assessable income ( Lunney v Commissioner of Taxation (1958) 100 CLR 478). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3. The deductibility of the expenses can also depend on whether the claims would have resulted in assessable income. Reimbursement of medical expenses is not generally regarded as assessable income. In your case, the legal expenses incurred in relation to seeking compensation for your medical and treatment costs do not have the required nexus with the derivation of assessable income and are of a private nature. Therefore, the associated legal expenses are not an allowable deduction under section 8-1 of the ITAA 1997. Settlement agreement You also incurred the legal expenses in relation to your settlement agreement. The lump sum payment received under the settlement agreement is an undissected capital payment. The associated legal expenses in relation to this capital payment are also capital in nature. Therefore no deduction is allowed for the associated legal expenses under section 8-1 of the ITAA 1997. The settlement agreement refers to claim for loss of earning capacity. As outlined in Taxation Ruling IT 2193 Income tax: compensation for loss of earning capacity compensation for loss of earning capacity is a capital receipt. A compensation for loss of earning capacity will not lose its character as a capital receipt simply because the amount of compensation may be calculated by reference to the amount of income the taxpayer would have earned. Similarly, any payment for incapacity, permanent impairment or rehabilitation is also regarded as capital in nature. The legal expenses associated with these capital claims are also capital in nature and therefore not an allowable deduction. Although the legal costs incurred in relation to your medical expenses and settlement are not an allowable deduction, they are included in the cost base for capital gains tax purposes. Apportionment of expenses As your legal expenses are not fully deductible, you will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances. As your legal expenses are not broken up into the relevant parts by your solicitor, you will need to calculate the deductible portion. One way to apportion your expenses is according to the dollar value of the assessable amount as compared to the total amount being sought. The relevant percentage that relates to your assessable income can then be applied to the legal expenses incurred.

Relevant facts: You were employed by entity A. | Entity B accepted liability for the claim. | A dispute arose between you and your employer in respect of the claim (first dispute). | You made the first application in respect of the first dispute. | You allege you sustained another injury and submitted another claim. | You allege you sustained further injury and submitted claim three. | Entity B disputed liability for the second claim (second dispute). | You made the second application in respect of the second dispute. | The second application was consolidated with the first application. | Entity B disputed liability for the third claim (third dispute). | You made the third application in respect of the third dispute. | The third application was consolidated with the first application. | You made the fourth application. | You provided a copy of the Statement of Claim between you and your former employer. | You have agreed to resolve the three claims, the applications and the fourth application in accordance with the relevant legislation . | Your legal matters were finalised in 2017. An agreement for payment of a lump sum was made. | The lump sum was an undissected capital payment. | You have incurred legal costs. You have not claimed a deduction for your legal expenses. | You were receiving taxable income for loss of wages from your employer and/or through entity B. | You received amounts of Worker’s Compensation.