Private ruling: Deduction of Legal Expenses
Published: November 2011
Ruling period: 1 July 2008 - 30 June 2009 | 1 July 2009 - 30 June 2010 | 1 July 2010 - 30 June 2011 | 1 July 2011 - 30 June 2012

Ruling: Question and Answer | Are you entitled to a deduction for legal expenses incurred while seeking payment for an unpaid performance-based bonus? | Yes.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. You were an employee of a financial advisory firm from xx xx. As a Senior Adviser your salary consisted of 'base remuneration' (Salary), paid monthly and 'bonus payments' (commission). Both the base remuneration and performance-based bonus payments formed part of your assessable income between financial years ended xx xx xx and xx xx xx. On your payslip, payment date 30 June 2008, the performance-based bonus is shown as wages. It was a term and condition of the Agreement, between you and your employer, that you would be paid a performance-based bonus every three months. On xx xx xx you resigned from your position. At the time of your resignation you were contractually entitled to a quarterly bonus payment for the quarter ended xx xx xx. Bonus payments are typically paid between one to three months after the end of each quarter. You received correspondence from your employer stating your would be paid the outstanding bonus statement by xx xx xx. You contacted your employer when you did not receive the bonus payment by Xx xx xx. On xx xx xx you had a meeting with your former employer. As no agreement could be reached you commenced legal action. In xx xx your legal team negotiated a settlement with your former employer.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 6-10(2) | Income Tax Assessment Act 1997 Section 8-1 Reason for Decision | Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that ordinary income is income according to ordinary concepts | Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. | Other characteristics of ordinary income that have evolved from case law include receipts that; | · Are earned | · Are expected | · Are relied upon, and | Have an element of periodicity, recurrence or regularity. | Subsection 6-10(2) of the ITAA 1997 provides that an amount is statutory income if it is not ordinary income but is included in assessable income by another provision. | 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. | Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income. | In Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190, the Court established that in determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. Dixon J stated at CLR 647 that: | ...legal expenses...take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or purposes of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them. | This is also the viewed contained in Taxation Determination TD 93/29, where legal action is undertaken, in whole or in part, for the purpose of gaining assessable income, a deduction may still be allowable for some or all of the legal expenses incurred. | 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. | 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 the assessable income of the taxpayer. | You incurred legal expenses in seeking payment for an unpaid performance-based bonus for the period between x xx xx and xx xx xx. The performance-based bonus forms part of your assessable income and is included on your payslip as wages. | You are entitled to a deduction for legal expenses in relation to the unpaid performance-based bonus under section 8-1 of the ITAA 1997.

Reasons for decision: Summary: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that ordinary income is income according to ordinary concepts Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Other characteristics of ordinary income that have evolved from case law include receipts that; · Are earned · Are expected · Are relied upon, and Have an element of periodicity, recurrence or regularity. Subsection 6-10(2) of the ITAA 1997 provides that an amount is statutory income if it is not ordinary income but is included in assessable income by another provision. 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. Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income. In Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190, the Court established that in determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. Dixon J stated at CLR 647 that: ...legal expenses...take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or purposes of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them. This is also the viewed contained in Taxation Determination TD 93/29, where legal action is undertaken, in whole or in part, for the purpose of gaining assessable income, a deduction may still be allowable for some or all of the legal expenses incurred. 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. 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 the assessable income of the taxpayer. You incurred legal expenses in seeking payment for an unpaid performance-based bonus for the period between x xx xx and xx xx xx. The performance-based bonus forms part of your assessable income and is included on your payslip as wages. You are entitled to a deduction for legal expenses in relation to the unpaid performance-based bonus under section 8-1 of the ITAA 1997.

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