Private ruling: Legal expenses
Date of advice: 10 December 2018
Published: April 2019
Ruling period: Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 2016

Ruling: Q1: Are your legal expenses in relation to unpaid bonuses deductible? | A1: Yes

Relevant facts and circumstances: You were employed by a company for two years. Your employment was terminated. You engaged the services of a lawyer. You sought payment of unpaid bonuses. You commenced legal action with the Fair Work Commission seeking an unfair dismissal remedy however you did not seek to regain your employment, only the unpaid bonuses. A Deed of Settlement was entered into. An out of court settlement was negotiated for an amount being the unpaid bonuses. You incurred legal expenses.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1

Reasons for decision: Summary: 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. 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. It also follows that the character of legal expenses is not determined by the success or failure of the legal action. Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources during the year. Salary and wages, including leave payments, is considered ordinary income as it is paid directly as a result of personal services an employee renders for their employer. 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 ITAA 1997 states that where legal expenses are incurred in pursuing an amount of assessable income which is owed, such as salary and wages, those legal expenses are directly incurred in the process of deriving assessable income and therefore deductible. Similarly, legal expenses incurred in recovering unpaid bonuses and accrued leave are generally allowable as they sufficiently relate to gaining or producing assessable income and are therefore deductible under section 8-1 of the ITAA 1997. If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for 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. In your case, you incurred expenses in taking legal action against your employer for unpaid bonuses. Your legal action has not gone beyond a claim for revenue hence the legal costs are deductible, as they are incurred in deriving assessable income and because they are not capital in nature.