Private ruling: Legal expenses
Date of advice: 3 November 2020
Published: January 2021
Ruling period: Year ended 30 June 2020
Date scheme commenced: 1 July 2019

Ruling: Q1: Are the legal expenses an allowable tax deduction? | A1: No.

Relevant facts and circumstances: You were in vehicular accident in mid 20XX. The other party to the accident later made a complaint of misconduct with your employer. You were subsequently suspended while the matter was investigated. To defend yourself from the allegations you hired a lawyer to represent you. At the conclusion of the investigation your employment was terminated, and you were paid an eligible termination payment (ETP) equivalent to several weeks' wages. You lodged a claim for unfair dismissal. Your ex-employer offered you an additional amount of ETP which you rejected. Your ex-employer made a second offer of an additional amount of ETP worth several weeks' worth of wages which you accepted. The first ETP received was $X and the second ETP was $Y.

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 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. In determining whether a deduction for legal expenses is allowed, the nature of the expenditure must be considered. 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. The nature or character of expenses follows the advantage that is sought to be gained by incurring the expenses ( Hallstroms Pty Ltd v. FC of T (1946) 72 CLR 634; (1946) 8 ATD 190). 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 Commissioner of Taxation considers that expenses incurred in relation to an action for breach of a taxpayer's contract of employment, for example, an action for damages for wrongful dismissal, are capital in nature and not deductible (Taxation Determination TD 93/29 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities). Additionally, employment termination payments (ETP), which are considered to be capital payments, are 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. In your case, you instigated action against your employer claiming unfair dismissal. As stated above, expenses relating to damages for wrongful dismissal are considered to be capital in nature. As the legal expenses were incurred in seeking to gain a capital sum, they will also be of a capital nature and are therefore not deductible.