Private ruling: legal expenses
Published: November 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Are you entitled to a deduction for legal expenses incurred in relation to your unpaid wages and leave? | A1: Yes. | Q2: Are you entitled to a deduction for legal expenses incurred in relation to your claim for unlawful termination? | A2: No.


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. For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's 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. Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business ( Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case )) and the legal action has more than a peripheral connection to the taxpayer's income producing activities ( Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276). | Detailed Reasoning - Annual leave and wages: Legal expenses incurred in recovering salary or wages are considered to be of a revenue nature and therefore deductible under section 8-1 of the ITAA 1997. Similarly, legal expenses incurred in recovering unpaid leave are generally allowable as they directly relate to gaining or producing assessable income. In your case you incurred legal expenses in relation to unpaid wages and unpaid leave and leave loading that you would normally derive. It is considered that the associated legal expenses in relation to your unpaid wages and leave payments related sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Termination: Taxation 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? states: If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for a breach of the contract of employment, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible. The Courts, Boards and Tribunals have consistently held that the legal expenses incurred by taxpayers in defending themselves against dismissal from their employment are of a capital nature unless they are defending the way they carry out their day to day employment duties. This is because: • the legal expenses can be regarded as having been incurred once and for all, and • the advantage sought to be gained is the preservation of the taxpayers employment. For example, in Case L26 79 ATC 126, a majority of the Board of Review No. 1 held that legal expenses incurred by a school teacher in appealing to a statutory board against her dismissal were not deductible. Legal expenses incurred relating to unlawful termination are not deductible as they are considered to provide an enduring advantage and are therefore capital in nature. ( Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184). Although a termination payment received may be subject to special tax treatment that results in the amount being included in assessable income, this does not change the character of the payment from being capital in nature. In your case, a portion of your legal expenses related to your unlawful termination claim. Legal expenses incurred in relation to the unlawful termination do not sufficiently relate to your day to day employment duties. Furthermore such expenses are not deductible as they are capital in nature. Therefore no deduction is allowable under section 8-1 of the ITAA 1997 for the associated legal expenses. | Detailed Reasoning - Apportionment of expenses: As your legal expenses are not fully deductible, you 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. Where 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 ordinary assessable amount as compared to the total amount being sought. The relevant percentage that relates to your ordinary assessable income can then be applied to the legal expenses incurred.

Relevant facts: You were terminated by your employer for lodging a Fair Work claim regarding missing annual leave, leave loading and wages. | Being an unlawful termination you then lodged a second Fair Work claim for a general protection matter leading to termination. | You attempted to resolve the matter without cost, using free legal advice, however the mediation was unsuccessful. | You then engaged the services of a lawyer to address both Fair Work claims. A settlement with your former employer was reached. | You received a settlement sum covering your previous unpaid income and loss of income due to the unlawful termination. This sum will be declared on your tax return as part of your employment income as required by the deed. | The settlement sum covers all claims without specific attribution and there is no provision for any compensation of legal fees. | Your lawyer did not separate the two claims in the invoices.