Private ruling: Legal expenses
Published: January 2015
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Are you entitled to a deduction for the legal expenses incurred? | A1: No.

Relevant facts and circumstances: You left your employment. At the cessation of your employment you were required to return a company computer. You made a backup copy of this computer for the purposes of evidence for a claim for unpaid wages and entitlements, including superannuation and annual leave. This backup was claimed by your former employer to be a breach of the employment contract. You were approached about a new employment opportunity and began contracting services with a competitor. Your new and former employer shared a mutual client. Your former employer claimed the engagement with your new employer to be a breach of your employment contract. Your former employer obtained a court order to search and seize your backed up copy of the laptop and any other company information from your place of residence. An injunction against working for the competitor, the mutual client and one other ancillary client was also issued. You engaged legal representation.

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. For legal expenses to constitute an allowable deduction it must be shown that they were incidental and 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) 4 AITR 236; (1949) 8 ATD 431). The nature of the expenditure must also be considered ( Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190). The nature or character of the legal expense 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 expense incurred in gaining the advantage will also be of a capital nature. Where expenditure is incurred for the purpose of securing an enduring benefit, rather than a revenue purpose, the expenditure is capital in nature and is not deductible ( Sun Newspapers Ltd v. FC of T (1938) 61CLR 337; 5 ATD 87; (1938) 1 AITR 403). Taxation Ruling TR 2000/5 sets out the Commissioner's view of the application of section 8-1 of the ITAA 1997 to costs incurred by employees and employers in preparing and administering employment agreements. Employment agreements are a written, legal and binding confirmation of the employer/employee relationship (paragraph 11 TR 2000/5). As outlined in TR 2000/5, a deduction is allowed for an employee for costs associated with settlement of disputes arising out of an existing employment agreement including the cost of representation. Your employment agreement with your previous employer is no longer current. Therefore your disputes do not arise out of an existing employment agreement. In your situation, you were defending action taken by your previous employer. The action was not prompted or caused by the performance of your previous employment duties. The expenses you incurred did not relate to the duties of your previous employment or your new employment and therefore, not incurred in earning your assessable income from either. Although the claims may relate in part to the period of time you worked with your previous employer, the nexus to your income earning activities with your previous employer is not sufficient. Additionally, you were defending your right to work for your new employer and the clients. Costs incurred defending a right to practice a profession or employment, are capital in nature as you are seeking an enduring benefit and the associated expenses are incurred to protect this right. Therefore, you are not entitled to a deduction for the legal expenses incurred under section 8-1 of the ITAA 1997.