Private ruling: Legal expenses
Published: November 2013
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014
Date scheme commenced: 1 July 2011

Ruling: Q1: Are you entitled to a deduction for legal expenses? | A1: 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. 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. In Commissioner of Taxation v Shane Day [2008] HCA 53 ( Days Case) the concern was with the deductibility of legal expenses incurred by a public servant in defending charges in respect of conduct which occurred outside the course of taxpayer's normal day-to-day duties. The legal expenses were incurred in responding to disciplinary action internal to the employment relationship and existing for no other purpose. Your circumstances are not analogous with Days Case because you were not responding to internal action. Rather, you were seeking to have the nature of a contract changed. Furthermore, your action was taken after you had ceased to have a relationship with The Company. Taxation Ruling TR 2000/5 sets out the Commissioner's views about the application of Section 8-1 of the ITAA 1997 to costs incurred by employees and employers in preparing and administering employment agreements. You were neither preparing nor administering an employment agreement. Therefore, TR 2000/5 does not have application in your circumstances Taxation Determination TD 93/29 states: 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 where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible. For example, legal expense relating to an action for damages for wrongful dismissal are not deductible. A redundancy payment, being compensation for the loss of the expectation of continuity of service, is a payment that is capital in nature. Such a payment is made to compensate the taxpayer for the loss of their employment position and is regarded as a capital payment ( Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184). Redundancy payments are treated as employment termination payments and subject to special tax treatment that may result in some or all of the amount being included in your 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 your assessable income. Therefore as a redundancy payment is capital in nature, the legal expenses incurred in obtaining a better redundancy payment will also be capital in nature. In Romanin v. FC of T 2008 ATC 20-055; [2008] FCA 1532; 73 ATR 760 ( Romanin ) the court considered the deductibility of legal expenses incurred by the taxpayer for proceedings at the Industrial Relations Commission. In the proceedings, the taxpayer argued that an employment contract existed where they were entitled to 12 months notice, or a payment in lieu of this notice. The employer had denied such a contract existed and had given seven days notice. The proceedings found in favour of the taxpayer and the employer was ordered to pay them the total value of the employment package for the period of 12 months less any salary and other earnings that they had earned in alternative employment during the 12 months following the termination of his employment. The legal expenses were found not to be capital in nature because the character of the advantage which the taxpayer sought in bringing the proceedings was on revenue account, namely receipt of his contractual entitlement to salary he would have received had he been given 12 months notice. Your case can be distinguished from Romanin in a number of ways. The first is because it was you who ended the working relationship when you advised that the position was untenable. This means that you could not then be seeking a payment in lieu of notice as it was not The Company who terminated your relationship. Furthermore, by invoicing the Company for your services, it is clear that both you and The Company had considered you to be a contractor and not an employee. After you ended the relationship, as you had not worked or invoiced the Company it cannot be considered that you were seeking unpaid income amounts. You sought to have your relationship classified as an employment contract and thereby creating an entitlement to annual leave and other employment entitlements. The legal expenses are considered to be of a capital nature and as such, a deduction is not allowable.

Relevant facts: You entered into a contract in 20XX with a Recruitment agency to perform services for the Company. | Part of the contract was that in the event of termination, the Recruitment agency would provide you with reasonable notice, or pay in lieu of that reasonable notice. | In 20XX, you entered into an implied contract with the Company that replaced the original contract. | You invoiced the Company monthly for your services. | The Company paid out the contract with the Recruitment agency as they wanted you to work for them. | In 20XX, The Company advertised the position at an annual rate less than what you were receiving under your contract. | The Manager of The Company requested you should apply for the advertised position in 20XX. | Some days later, the Manager of The Company stated that in order to retain your position, you would have to apply for the position or risk not having the role. | Later again in the same month, you had another conversation where you asked about the implications for you of the advertised position. You were told that if you wanted to keep your role, you would have to reapply. | On that same day you sent a letter to The Company's stating that your position had become untenable. | You considered that your loss was equivalent to the different between the amounts of compensation you would have been paid if the contract had been correctly characterised and sought compensation equivalent to 12 month's termination payment. | You also sought, among other things: | · A declaration that the Company contract was a contract of employment that bound you to the Company until 20XX. | · A declaration that by advertising the position, the Company had breached the contract, | · Damages for breach of good faith