Private ruling: Legal expenses
Published: October 2013
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Are you entitled to a deduction for legal expenses to the extent of pursuing your unfair dismissal action? | A1: No. | Q2: Can legal expenses incurred in seeking reinstatement of your employment that are capital in nature be applied against a present or future capital loss? | A2: No.

Relevant facts and circumstances: You were dismissed from your employment. You sought legal representation to commence legal action against your former employer. You lodged an application for relief in relation to unfair dismissal. You sought reinstatement as your primary remedy, with monetary compensation only sought if reinstatement was not deemed practical. The legal action was not successful and you were not reinstated, re-employed or compensated monetarily.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 118-37

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 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. The Courts, Boards and Tribunals have consistently held that legal expenses incurred by taxpayers in seeking to regain their employment following dismissal are not deductible. The expenses have been incurred too early to be regarded as having been incurred in gaining or producing the taxpayer's income from that employment. The purpose of the expenditure is to re-establish an income stream or for gaining an enduring benefit, that is, the reinstatement of the employment position. In Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859, a solicitor was denied a deduction for expenses incurred in defending certain allegations before the Statutory Committee of the Law Society of New South Wales. The Committee ordered the taxpayer be suspended from practice for a certain period, and to pay the costs of the Law Society. Failure to pay these costs would have resulted in the taxpayer being further suspended from practice until they were paid. It was held that the obligation to pay the Law Society's costs was fundamental to the taxpayer's continuing right to derive his principal source of income through the practice of his profession. That right to earn money was regarded as a profit-yielding subject or as a structural asset. It was held that expenses of defending or acquiring a profit-yielding subject or structural asset are of a capital nature, and that the taxpayer's expenses were not deductible. In Case X84 90 ATC 609; AAT Case 6528 (1990) 21 ATR 3721, the Member held that legal expenses incurred by a medical practitioner in defending charges brought against him at a Medical Disciplinary Tribunal inquiry, were not deductible because the expenditure was incurred to protect a structural asset, that is, their registration as a medical practitioner, and was of a capital nature. Taxation Determination TD 93/29 also points out at paragraph 5 that legal costs incurred for wrongful dismissal are not deductible because they are capital in nature. In your case you incurred legal expenses in an attempt to have your employment reinstated. The right to your employment is considered to be a structural asset which is capital in nature. As the nature of legal expenses follows the nature of the advantage sought, the legal expenses that you incurred in defending the action are also capital in nature. Therefore, as your legal expenses are capital in nature, you are not entitled to a deduction under section 8-1 of the ITAA 1997. | Detailed Reasoning - Capital loss: A capital gain or capital loss made from a capital gains tax (CGT) event relating directly to a wrong you have suffered in, or as a result of, your occupation is disregarded by virtue of subsection 118-37(1) of the ITAA 1997. The CGT event, in your case, which gave rise to the capital gain, was the right to seek compensation. In calculating the capital gain that may form part of your assessable income, the legal expenses incurred in gaining that compensation are deducted from the gross proceeds and it is the net amount that is potentially assessable under the CGT provisions of the ITAA 1997. However because of the operation of section 118-37 of the ITAA 1997 such an event is disregarded. The legal expenses therefore form part of a CGT event and are not able to be carried forward as a reduction of any future capital gain.