Private ruling: Legal expenses relating to unfair dismissal
Published: June 2012
Ruling period: Year ending 30 June 2012
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for legal expenses associated with seeking legal advice regarding your dismissal from an employment position? | A1: No.

Relevant facts and circumstances: Your former employer terminated your employment without notice. You sought legal advice as to your rights, what actions could be taken against your former employer and the procedures to be completed. You sent a letter to your former employer regarding this which resulted in them offering to negotiate a better termination settlement. You did not commence any formal legal action against your former employer.

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

Reasons for decision: Summary: The expenses you incurred in obtaining advice regarding your unfair dismissal are capital in nature and not deductible. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the Income Tax Assessment Act 1997 (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. Generally, legal expenses incurred in an unfair dismissal action (seeking reinstatement and/or damages) are of a capital nature and therefore, not deductible. | Detailed Reasoning - Paragraph five of Taxation Determination TD93/29 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, 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. A compensation payment made by an employer to a former employee in settlement of an unfair dismissal action qualifies as an employment termination payment (ETP), as it is considered to be made 'in consequence of the termination of any employment of the taxpayer' (Taxation Ruling IT 2424, paragraph 24). For this reason an ETP, whether it is made in one lump sum or through several amounts, is capital in nature. ETP' are subject to special tax treatment that may result in some or all of the amounts being included in 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 assessable income. In your case, you incurred expenses in obtaining information about your rights and action that could be taken regarding the termination of your employment. A right is considered to be a capital asset. You then used this information to negotiate a settlement with your employer. The settlement is considered to be an ETP which is capital in nature. As your legal expenses related to items which were capital in nature, the legal expenses are also considered to be capital in nature. Therefore the legal expenses are not deductible under section 8-1 of the ITAA 1997.

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