Legal expenses and CGT

Are the capital gains tax provisions of Income Tax Assessment Act 1997 (ITAA 1997) applicable when a taxpayer incurs legal expenses?

Yes. Where the legal expenses incurred are of a capital nature the capital gains provisions of the ITAA 1997 are applicable.

You were employed as an account manager.

The taxpayer's employment agreement may be terminated by the taxpayer giving their employer one month's written notice if there is a diminution or threatened diminution of their job content, status, responsibility or authority. In the event that the taxpayer give notice for any of these reasons, the employer shall give either 26 weeks' notice (or payment in lieu) or a period of notice (or payment in lieu) equal to the taxpayer's total completed years of service multiplied by two up to a maximum of 52 weeks, whichever is the greater'

The taxpayer considered that they had suffered a diminution or threatened diminution of their job content, status, responsibility and authority.

The taxpayer terminated their employment by giving one month's written notice.

The taxpayer's employer refused to make a payment in lieu of 26 weeks notice that the taxpayer considered they were entitled to.

The taxpayer took legal action to recover the payment in lieu plus interest and costs. The case was dismissed.

The taxpayer incurred legal expenses in relation to the above matter.

The payment is considered to be of a capital nature.

The taxpayer's employment contract was terminated after 20 September 1985 and the legal expenses are of a capital nature it is necessary to consider whether the capital gains tax (CGT) provisions of the ITAA 1997 are applicable.

Section 102-5 of the ITAA 1997 provides that the assessable income of a taxpayer includes any net capital gain made by the taxpayer during the income year.

A net capital gain is calculated as the taxpayer's total capital gains for the income year less the sum of the taxpayer's total capital losses for the income year and any previously unapplied net capital losses from earlier income years.

A taxpayer can only make a capital gain or a capital loss if a CGT event happens.

In the taxpayer's case, CGT event C2 'Cancellation, surrender and similar endings' is applicable.

CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends by the asset being redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, forfeited or expiring. The time of the event is when the taxpayer enters into the contract that results in the asset ending or, if there is no contract, when the asset ends. The taxpayer makes a capital gain if the capital proceeds from the ending are more than the asset's cost base. The taxpayer makes a capital loss if the capital proceeds are less than the asset's reduced cost base.

The right to sue is an asset for CGT purposes. The right to sue is acquired at the time of occurrence of the breach of contract, personal injury or other compensable damage or injury. The right to sue is disposed of when a court order is made or an out of court settlement is reached.

As a result of your legal action you incurred legal expenses but did not receive the 26 weeks of pay payable to you under your employment contract which would have been assessable as an ETP. Therefore you made a capital loss. A capital gain made in relation to an ETP is disregarded. However a capital loss made in relation to an ETP is not disregarded under any section of the ITAA 1997. A capital loss cannot be deducted from a taxpayer's assessable income but can reduce a capital gain in the current income year or a later income year.