Private ruling: Deductibility of legal expenses
Published: September 2012
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Questions and answers | Are you entitled to a deduction for damages for breach of your employment contract? | No. | Are you entitled to a deduction for legal fees incurred in relation to breach of contract? | No.

Relevant facts and circumstances: You took your former employer to court. Your former employer sued for breach of contract. You and your former employer reached an agreement whereby you were required to pay your former employer damages. You incurred legal fees.

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 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. | Detailed Reasoning - Breach of contract: The payment for damages to your former employer by you is not related to the earning of assessable income. The payment represents expenditure incurred by you for breaching the terms of the employment contract. You undertook activities which resulted in a breach of your employment agreement with your previous employer. The activities to which the breach related were not employment duties and did not arise as a consequence of the performance of your duties from which you derived assessable income. Accordingly, the damages paid for breach of employment contract is not an allowable deduction under section 8-1 of the ITAA 1997 as it was not incurred in gaining or producing assessable income. | Detailed Reasoning - Legal expenses: Taxation Determination TD 93/29 examines the deductibility of costs incurred in taking legal action to recover wages. Legal expenses are an allowable deduction where a taxpayer is seeking the recovery of wages only. In deciding whether expenditure has the character of a capital or of a revenue payment the advantage for which the expenditure was incurred must be identified and the manner in which it is to be relied upon or enjoyed must be considered. Salary or wage income is only assessable when it has been derived and salary and wages are generally derived when they have been received. 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 are not deductible. In your case you incurred legal costs associated with a dispute arising over your employment contract. You were taken to court by your former employer for breach of that contract and incurred legal fees. You are not entitled to a deduction for the legal expenses associated with the breach of your employment contract under section 8-1 of the ITAA 1997 as the legal action did not relate to a claim for a revenue item such as wages, and therefore the expenses were not incurred in the gaining or producing of assessable income.

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