Issue
Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in seeking entitlements under an employment contract on termination of employment?
Decision
No. The taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in seeking entitlements under an employment contract on termination of employment.
Facts
The taxpayer was employed under an employment contract that provided for a lump sum payment in lieu of notice on termination of their employment.
The taxpayer terminated their employment and their employer refused to make the lump sum payment provided for under the employment contract.
The taxpayer took legal action to recover the lump sum payment in lieu of notice of termination plus interest and costs. The case was dismissed.
The taxpayer incurred legal expenses in relation to this matter.
Reasons for Decision
Section 8-1 of the 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.
In determining whether a deduction for legal expenses is allowed 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). The nature or character of the legal expenses 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 expenses incurred in gaining the advantage will also be of a capital nature.
It follows also that the character of legal expenses is not determined by the success or failure of the legal action.
A lump sum payment in lieu of notice is considered to be a capital amount paid as compensation for the loss of the means of producing income ( Scott v. Commissioner of Taxation (1935) 35 SR (NSW) 215; (1935) 3 ATD 142). Such an amount is also considered to be an eligible termination payment (ETP) as it is a payment made in consequence of the termination of employment.
As an ETP, a lump sum payment in lieu of notice is included in assessable income under specific provisions of the Income Tax Assessment Act 1936 . However, the fact that a capital payment is specifically brought to account as assessable income will not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.
As the taxpayer incurred legal expenses attempting to obtain a capital payment, the legal expenses are also capital in nature and are therefore not deductible under section 8-1 of the ITAA 1997.