Private ruling: Deductions - Legal Expenses
Date of advice: 2 June 2016
Published: July 2016
Ruling period: Year ending 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you entitled to claim a deduction for legal expenses incurred to obtain an employment termination payment (ETP)? | A1: No. | Q2: Are you entitled to claim a deduction for legal expenses incurred to obtain unused long service leave? | A2: No. | Q3: Can you claim all of these legal expenses in the 2014-15 income year? | A3: No.

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 employed as a director and had been unfairly dismissed. Following this you commenced legal action against the employer filing a Statement of Claim. You incurred a large amount in legal fees. As a result of the legal action you received an ETP and a payout of long service leave.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 section 8-1

Reasons for decision: Detailed Reasoning - Expense related to the ETP: Section 8-1 of the Income Tax Assessment Act 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. In determining whether a deduction for legal expenses is allowed, 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. Payments made in consequence of termination of employment are treated as ETP's and subject to special tax treatment that may result in some or the entire amount being included in the taxpayer's 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 the assessable income of the taxpayer. Taxation Ruling TR 2012/8 Income tax and fringe benefits tax: assessability of amounts received to reimburse legal costs incurred in disputes concerning termination of employment provides examples of this type of arrangement and how legal expenses are treated. Example 4 reads: Colin commences legal action claiming that the termination of his employment was unlawful. On execution of a Deed of settlement, Colin received an undissected amount including an unspecified amount to cover Colin's legal costs, within 12 months of that termination. There is a clear connection between the termination of Colin's employment and the undissected payment made under the deed. The lump sum was paid 'in consequence' of termination of employment, within 12 months of that termination and is not covered by the payments mentioned in section 82-135; it is therefore an ETP. The legal costs incurred by Colin are not deductible because the advantage sought by the legal action (compensation for loss of employment) is of a capital nature. In your case, you incurred a portion of the legal expenses seeking to obtain the ETP. Although the ETP may be included in your assessable income, the ETP retains its character as a capital receipt. As that portion of the legal expenses was incurred in gaining a capital sum, they will also be of a capital nature and are therefore not deductible. | Detailed Reasoning - Expenses related to long service leave: 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. Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of a resident taxpayer includes ordinary income derived directly or indirectly from all sources during the year. Salary and wages, including annual leave payments, is considered ordinary income as it is paid directly as a result of the personal services an employee renders for their employer. However, unused long service leave (although acquired through personal services and thus characterised as ordinary income) are considered to be forms of statutory income under section 6-10 of the ITAA 1997. The legal expenses incurred in order to obtain the unused long service leave resulted in you gaining assessable income. There is a clear connection between the assessable income and the expense. However in contrast to the ETP as detailed above, the expenses were not incurred in respect of income that was capital, private or domestic in nature. Accordingly, the legal expenses incurred in gaining your long service leave payout are deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Note:: You will need to apportion the legal expenses incurred between those incurred to obtain the ETP and those incurred to obtain the unused annual and long service leave. | Detailed Reasoning - When you can claim expenses: Expenses are claimable in the income period in which they are incurred as outlined in Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions.