Private ruling: Legal and settlement expenses
Date of advice: 30 March 2026
Published: 22 June 2026
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are your legal fees and disbursements incurred in defending the court proceedings deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Is your personal settlement contribution of $XX,XXX deductible under section 8-1 of the ITAA 1997? | A2: No.

Relevant facts and circumstances: You are employed in Position A with Company B. At the request of several members of an entity (the Entity), you authored and distributed a document about concerns in relation to the conduct of the Entity. In doing so you utilised your skills and knowledge from your field of employment but you were not paid. This unpaid work was not undertaken as part of your employment duties with your employer Company B. Legal action against you was commenced due to your preparation and distribution of the document. You engaged legal services to defend the action. The matter was settled after your agreement to provide a signed letter of apology and withdrawal to the claimants and to pay a settlement amount. The insurance you have due to your field of employment covered part of your legal and settlement expenses. You have a long and distinguished history of service to the Entity. Shortly before authoring and distributing the document, you had unsuccessfully taken private legal action against certain leaders of the Entity who subsequently were part of the legal action against you for the document you produced.

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

Reasons for decision: Detailed Reasoning - Legal and settlement expenses: 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 (the positive limb) except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income (the negative limbs). A deduction for legal expenses by an employee depends on the particular facts of a case. For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income, ( Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; [1949] HCA 15; (1949) 4 AITR 236; (1949) 8 ATD 431). Also, 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. FC 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 (such as an enduring benefit), then the expenses incurred in gaining the advantage will also be of a capital nature. The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day-to-day income producing activities of the taxpayer ( The Herald and Weekly Times Ltd v. FC of T (1932) 48 CLR 113). The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business or income earning activities. If the expenses were incurred in protecting the taxpayer's underlying profit yielding structure or assets of a business, they are considered to be capital in nature and will not be deductible. In addition, legal expenses are also capital in nature where the legal action taken is to protect the taxpayer's personal good name and reputation, or to protect their position or standing in their income-earning field ( Case U102 87 ATC 621; AAT Case 72 (1987) 18 ATR 3515). Where the principal reason for incurring the legal expenses is defending the actions of the taxpayer in carrying out their employment duties through which they gain or produce assessable income, such expenses are characterised as being of a revenue nature and are deductible (Case V116 88 ATC 737; AAT Case 4502 (1988) 19 ATR 3703). Similarly, in FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. Also, in Federal Commissioner of Taxation v Day [2008] HCA 53 ( Day ) the taxpayer was allowed a deduction for his legal expenses incurred in defending disciplinary charges brought against him by his employer. Where a taxpayer defends their actions, or manner, in carrying out their employment duties, a natural consequence is that they will also be protecting their continued employment which is an enduring benefit. However, despite this, in the relevant cases referred to above, the courts have held that the legal expenses are more accurately characterised as revenue rather than capital expenses as they directly relate to their income producing activities, being their employment duties. Generally, the treatment of a settlement sum or damages payment will follow the treatment of the other legal costs incurred in relation to a particular matter. | Detailed Reasoning - Application to your circumstances: Your legal expenses and settlement sum were not incurred in defending your actions or manner in undertaking your employment duties with Company B. Rather the expenses relate to pro bono work in producing and distributing a report concerning the Entity. As the expenses relate to unpaid work, they were not incurred in earning assessable income. Therefore, the positive limb of section 8-1 of the ITAA 1997 has not been met. In any case, it is also considered that a deduction would be prevented by at least one of the negative limbs of section 8-1 of the ITAA 1997. The expenses are considered both capital in nature and private or domestic in nature. The advantage sought in incurring the expenses was the protection of a capital item being your current practising certificate and as a consequence, an enduring benefit being your continued employment with Company B. Expenses incurred by a taxpayer in personally defending a claim of defamation would ordinarily be private in nature. An exception would be where a taxpayer made the statement in the course of earning their employment income, for example, where a newspaper reporter is sued for defamation in relation to a newspaper article they authored. In that situation, it would be expected that the taxpayer's employer would also be a defendant to the defamation claim. You implied that you only authored and distributed the report on the direction of certain members of the Entity and that there was no element of personal motivation on your part. However, we believe that the following surrounding facts indicate otherwise: • Your long and distinguished history of service to the Entity clearly shows that you care deeply for the organisation. • Shortly before you authored and distributed the report on concerns in relation to the conduct of the Entity, you unsuccessfully undertook private legal action against certain leaders of the Entity. The fact you commenced those proceedings demonstrate that you were willing to take strong personal action where you had concerns about certain leaders in the Entity. • The parties that took action against you for the document you authored and distributed included the leaders of the Entity that you previously took action against. • The claimants chose to take action only against you even though you imply that you were merely acting under the direction of others. Although you were engaged by certain members of the Entity in relation to the report, having regard to the above surrounding facts, it is considered that there was also a significant personal element to your authoring and subsequent distribution of the report. Therefore, the legal and settlement expenses you incurred as a result are private in nature. | Detailed Reasoning - Your contentions: You contend that the decision of Day supports your claim for deductibility. However, we consider that Day can be distinguished from your case. In Day the taxpayer, a Customs officer, incurred legal expenses in defending 3 sets of disciplinary charges brought against him by his employer, the Australian Customs Service: (1) The First Charge related to the alleged failure of the taxpayer to fulfil his duty as an officer in that he presented his official Customs identification card, in circumstances which were not work related, to gain access to a court officer in order to obtain information regarding a search warrant which had authorised a search of his workstation. (2) The Second Charges related to alleged failures of the taxpayer on various dates to fulfil his duty to accurately record attendance at work. (3) The Third Charges related to the alleged failures of the taxpayer to fulfil his duty as an officer in a number of instances, including that the taxpayer had failed to inform Customs of relevant information relating to a claim for a diesel fuel rebate by the partner of another Customs officer, had lent improper support and assistance to the other officer and was knowingly concerned in the creation of a false diary which supported the claim, had used a work vehicle for non-work related purposes, had falsely recorded his attendance records, and had failed to communicate certain information concerning an investigation into another person. The circumstances in Day are fundamentally and materially different to those in your case in that the action taken against you was not by your employer and the claims made against you was for conduct that you undertook which had nothing to do with your employment at Company B. You also contend that our Decision Impact Statement on Day supports your claim for deductibility. However, it states: The Court found, on the facts of this case, that the legal expenses incurred by the taxpayer in relation to the disciplinary action taken by his employer are not outgoings of a private or domestic nature. Crucial to this view was the fact that the terms of employment exposed the taxpayer as an employee to the employer action, and therefore to the need to incur the legal expenses. The employer brought the action, and the legal expenses were incurred in respect of proceedings internal to the employment relationship. The Decision Impact Statement on Day clearly states that a crucial element of the decision was the fact that the taxpayer was defending an action brought against him by his employer which is not the situation in your case. | Summary: Your legal and settlement expenses were incurred in relation to unpaid work and therefore were not incurred in earning assessable income. Even if the positive limb of section 8-1 of the ITAA 1997 was satisfied, a deduction would still not be allowed as at least one of the negative limbs is applicable. In fact, we consider that both the capital and private negative limbs apply. The expenses are capital in nature as they were incurred in protecting a capital item being your current practising certificate and to obtain an enduring benefit being your continued employment with Company B. There was no competing revenue nature to the expenses as they had no connection to your employment duties with Company B. The expenses are also private in nature as they were incurred in defending defamation action taken against you personally and the action was not taken against you due to your employment. Also, the surrounding facts indicate that there was a significant private element to your authoring and distribution of the report on concerns in relation to the conduct of the Entity leadership. Your principal argument in support of your deduction claim is to rely on the decision in Day . However, Day can be distinguished on the basis that critical facts in your case are fundamentally different as unlike in Day , the action was not taken against you by your employer, and it was for conduct that had nothing to do with your employment.