Private ruling: Legal expenses
Date of advice: 2 October 2015
Published: October 2015
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Are the legal expenses you incurred whilst disputing allegations regarding suitability for continued employment in your current position an allowable deduction? | A1: Yes.

Relevant facts and circumstances: You are employed by a care organisation. A discharged patient made allegations to your employer that you were not suitable for your role. You engaged lawyers to defend yourself against these allegations.

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 a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature. A number of significant court decisions have determined that for an expense to be an allowable deduction: • it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense ( Lunney v. FC of T ; (1958) 100 CLR 478), • there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income ( Ronpibon Tin NL v. FC of T , (1949) 78 CLR 47), and • it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income ( Charles Moore Co (WA) Pty Ltd v. FC of T , (1956) 95 CLR 344; FC of T v. Hatchett , 71 ATC 4184). For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income. Also, in determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, 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). When 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 ( Inglis v. FC of T 87 ATC 2037; and Case V116 88 ATC 737; AAT Case 4502 (1988) 19 ATR 3703). The High Court in Federal Commissioner of Taxation v. Day (2008) 236 CLR 163; 2008 ATC 20-064; (2008) 70 ATR 14 held that for an employee's legal expenses to be deductible, the occasion for the expenses must be found in their employment. It also held that the scope of a particular taxpayer's employment is not confined to the day-to-day activities performed by the employee. In the circumstances of Day the High Court had regard to the nature of the employment and the fact that the taxpayer was exposed to the action by reason of his employment. In your case, it is the Commissioner's view that the occasion for your legal expenses was your employment. It was your employment which exposed you to the allegations from the former patient and you incurred the expenses in order to continue your employment. Therefore, it is considered that there is sufficient connection between your legal expenses incurred in defending the allegations and your employment; as such, the legal expenses are deductible under s 8-1 of the ITAA 1997.