Private ruling: Legal Expenses – Unfair Dismissal – Revenue and Capital
Date of advice: 30 July 2018
Published: September 2018
Ruling period: Period ending 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Can a deduction for legal expenses incurred in an unfair dismissal case be claimed in 2018 income tax lodgement? | A1: Yes

Relevant facts and circumstances: You worked with your former employer for 5 years. You were terminated from your employment in early 2018 You had accumulated LSL. You were not paid an amount in lieu of notice. You were not paid an amount for accrued LSL After termination of employment you made an unfair dismissal claim with Fair Work Australia. You hired the services of X law firms to assist you (one firm to commence proceedings and one firm to continue proceedings after a certain point if need be). A conciliation conference took place. The outcome of the conciliation conference was a settlement. The settlement was for - 4 weeks’ notice in lieu, XYZ hours accrued LSL and X weeks ex gratia payment.

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

Reasons for decision: Summary: You are eligible to claim a deduction for legal expenses for the portion of legal expenses that is applicable to revenue recovery in the decision issued by Fair work Australia. | 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. Taxation Determination TD 93/29 states that if an employee incurs legal expenses in recovering wages, the legal expenses are an allowable deduction providing that the legal action relates solely to the recovery of wages. The ruling continues:- 5. However, 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. 6. There will often be occasions where the legal expenses are incurred in relation to proceedings that relate both to accounts that are revenue in nature as well as amounts which are capital in nature. For example, many proceedings in relation to wrongful dismissal will also involve the recovery of unpaid salary or wages. In these circumstances ‘….there must be some fair and reasonable assessment of the extent of the relation of the outlay to assessable income’ ( Ronpibon Tin N.L. v. FC of T (1949) 78 CLR 47 at 59). A compensation payment made by an employer to a former employee in settlement of an unfair dismissal action qualifies as an 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’s 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 taking legal action against your employer for unfair dismissal. This action has gone beyond a claim for revenue. As part of your legal costs were capital in nature therefore in accordance with Commissioners view expressed in TD 93/29 are not deductible under section 8-1 of the ITAA 1997. You have incurred legal expenses relating to payments which are both revenue and capital in nature. You have provided evidence of your payment and the various components as well as evidence of the accounts issued by your solicitors. Your solicitor accounts have not been itemised indicating only the amount for professional fees as well as GST and a total amount payable. Under these circumstances the Commissioner can make a calculation to decide the portion or percentage you can claim. The Commissioner calculates your revenue payment to be 55.91% of your total payment. Made up of the total payment divided by total revenue payments multiplied by 100 to obtain the figure percentage to apply to your fees.