Private ruling: Deductibility of legal expenses
Date of advice: 27 July 2018
Published: September 2018
Ruling period: Year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Are you entitled to a deduction for your legal costs? | A1: Yes.

Relevant facts and circumstances: You were employed by a company under a consulting agreement. The duration of the contract was for one year with an option to extend by mutual agreement. After only a few months into the contract the company decided not to renew. You proceeded to issue a final invoice including a one month notice period claim in accordance with the consulting agreement. The company refused to pay the invoice. You discussed your issues with lawyers and you proceeded to issue a Letter of Demand, to which they claimed there would be a counterclaim. The counterclaim never eventuated. You subsequently proceeded to a mediation hearing at which no agreement was reached. A further means hearing was required for the company to prove whether they could pay. The company continued to drag it out but eventually a court default judgement was made against them for the full sum plus court costs. The company did not pay and have now gone into administration and it is highly unlikely that you will receive any funds. Legal costs included: ● Lawyer fees ● Court costs ● Bailiff Costs ● GST

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

Reasons for decision: Summary: Your legal expenses in seeking to enforce payment of a contractual entitlement have the necessary connection to your assessable income and are deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) discusses what is allowable as a deduction. It points out that as long as the expenses are directly connected to your income earning activities they will be deductible. Alternatively, if the expenses are private or domestic in nature they will not be directly related to your assessable income and are not allowable deductions. Likewise, expenses that are capital in nature are treated differently under separate legislation. In determining whether or not your deduction for legal expenses is allowed, the advantage that is sought to be gained by incurring those expenses is to be examined. If the advantage to be gained is of an income nature, then the expenses will also be of an income nature. Hence, the character of legal expenses is not determined by the success or failure of the legal action. A similar case to yours is discussed in ATO interpretative Decision ATO ID 2010/131 Income Tax: Legal Expenses: payment in lieu of notice under an employment contract. In that case an ex-employee sought to enforce a contractual entitlement to a lump sum payment in lieu of notice. The ex-employee pursued proceedings to obtain income that was contractually owed to him. The court believed that the character of the advantage sought was held to be of an income nature and that the costs incurred in doing so were deductible. In the circumstances here, the same conclusion follows. That is, your legal expenses in seeking to enforce payment of a contractual entitlement have the necessary connection to your assessable income and are deductible under section 8-1 of the ITAA 1997.