1 Are legal costs, excluding certain costs incurred in relation to newspaper articles, deductible under Section 8-1 of the Income Tax Assessment Act 1997 ?
Yes. Question 2 Are legal costs in relation to the newspaper articles deductible under Section 8-1 of the Income Tax Assessment Act 1997 ? Answer No. This ruling applies for the following period : 1 July 2019 to 30 June 2024 The scheme commenced on: 1 July 2019
X is employed under a contract of employment. X's employment has not been terminated, but X has been stood down pending an investigation into allegations of their work conduct. Some of the allegations were published in newspaper articles. X has incurred legal expenses to seek legal advice and representation in relation to these matters, including advice and representation for defamation matters arising from the publication of the allegations in the newspaper articles.
Section 8-1 of the ITAA 1997 Does IVA apply to this private ruling? No.
Question 1 Subsection 8-1(1) of the ITAA 1997 states: "(1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or.." Subsection 8-1(2) of the ITAA 1997 states: "(2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; or (b) it is a loss or outgoing of a private or domestic nature; ...." Taxation Ruling 2000/5 at paragraphs 2 and 3 states: "Employee costs 2. The following costs incurred by an employee are an allowable deduction: • costs of drawing up an employment agreement with an existing employer to replace an award or in accordance with a provision in the existing agreement; • costs associated with settlement of disputes arising out of an existing employment agreement including the cost of representation; • costs of changing the conditions of an existing employment agreement with the same employer - providing the existing agreement allows for changes - be it a variation, re-negotiation of an existing agreement or upon a promotion; and •
costs of renewing or extending a fixed term agreement which has a provision allowing for renewal or an extension at the end of a term. 3. The following costs incurred by an employee are not an allowable deduction: • costs of drawing up an employment agreement with a new employer; and • costs of drawing up an employment agreement upon re-employment with an employer following termination of a fixed term employment contract where the agreement makes no provision for renewal or extension." Taxation Ruling 2000/5 also gives the following examples of expenses that that are deductible in relation to employee costs: "Example 4. costs of extending an employment agreement 22. Jimmy has a three year employment agreement with ACME Deliveries, which provides for a new agreement to be renegotiated after two years and nine months. Further, if a new agreement is not reached the current agreement may be extended. 23. A deduction is allowable in respect of the renewed agreement and/or extension of the current agreement as this is provided for by the current agreement. That is, the expense is incurred in earning the employment income.
Example 6: expenses incurred in protecting an existing right under an employment agreement 26. Fred was employed under a three year employment agreement with Julie. The agreement provided for a tool allowance of $750 per year. After two years Julie discovered that the trade only allowed for a tool allowance of $100 per year. She refused to pay Fred more than $100 in future. Fred disagreed and took his complaint to the appropriate tribunal for arbitration. 27. Fred was represented by his lawyer who sent him an account for $250 for services rendered. Fred is entitled to claim the payment as a deduction. It is an expense incurred in protecting an existing right under the employment agreement. It is not an expense of a private or of a capital nature. 28. Julie was represented by her accountant, who charged her $350 for services rendered. Julie can claim the payment as a deduction because it is an expense incurred in the carrying on of her business." In accordance with Paragraph 1 of Tax Determination 93/29:
"... in deciding '... whether expenditure has the character of a capital or of a revenue payment... the advantage for which the expenditure was incurred must be identified and the manner in which it "is to be relied upon or enjoyed" must be considered...'. (Magna Alloys & Research Pty. Ltd. v. FC of T 80 ATC 4542 at 4548; 11 ATR 276 at 283)." And at paragraph 5: "5. However, if the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for breach of the contract of employment where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible. For example, legal expense relating to an action for damages for wrongful dismissal are not deductible." In the case of FC of T v Rowe 95 ATC 4691 (Rowe), legal expenses incurred by an employee in defending the manner in which he performed his employment duties were allowed. It found that: "...where there is an existing contract of employment, legal expenses incurred in maintaining that contract are not remote in time from the gaining of assessable income." And further:
"If an outgoing said to be deductible as having been incurred in gaining or producing assessable income can be seen to be incidental and relevant to that end, in the sense there is a real connection between the incurring of the outgoing and the activities which directly result in the gain or production of income, that will generally be the sufficient to make the outgoing". The legal costs incurred, apart from costs relating to the newspaper articles, were incurred in the gaining of assessable income by X pursuant to X's Contract of Employment. These costs are incidental and relevant to X's income earning activities pursuant to X's employment. Further these costs have been incurred consistent with paragraph 2 of Taxation Ruling 2000/5 in that they are " associated with settlement of disputes arising out of an existing employment agreement including the cost of representation" and, as in the case in Rowe , were incurred for the overarching purpose of preventing the termination of the Contract of Employment - or, in this case, preventing both termination or other disciplinary action taken under the contract - based on X's conduct as employee .
In this regard, the legal costs may be regarded as having been incurred in gaining or producing their assessable income from the Contract of Employment. It is noted that the nature of the advantage being sought by X, was one of a revenue item, and not one of an enduring nature which would be a capital item. Further, these costs were not of private or domestic nature. Therefore, the legal costs are deductible under Section 8-1 of the ITAA 1997 , apart from those relating to the newspaper articles. Question 2 ATO Interpretative Decision 2002/666 states: "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] HCA 34; (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." And; "In FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. No significance was placed by the court on the taxpayer's status as an employee. However, there must be an evident connection between the expenditure in instituting the proceedings and the taxpayer's earning activities. Legal expenses are also capital or private in nature where the legal action taken is to protect the taxpayer's personal good name and reputation (Case U102 87 ATC 621; AAT Case 72 (1987) 18 ATR 3515).
The taxpayer's legal expenses were not sufficiently connected with the income earning activities of the taxpayer and were essentially private or capital in nature and character. The need for them arose out of the taxpayer's reaction to what they saw as damage to their credit and reputation. The taxpayer's legal expenses incurred in taking defamation action are therefore not deductible under section 8-1 of the ITAA 1997 as they are considered to be insufficiently connected with the taxpayer's income earning activities and are private or capital in nature." [Emphasis Added] The legal costs incurred by X in relation to the newspaper articles are aimed at protecting X's personal good name and reputation. These are not sufficiently connected with X's income earning activities from their employment, and are therefore private or capital in nature. Therefore the legal costs incurred by X in relation to the newspaper articles are not deductible under Section 8-1 of the ITAA 1997 .