1 Are you entitled to claim a deduction for the legal expenses incurred in relation to pursuing a total and permanent disability (TPD) payment from your superannuation fund under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
1 No. This ruling applies for the following period: Year ended 30 June 20XX The scheme commenced on: 1 July 20XX
You are not yet at retirement age. You are a member of a superannuation fund (your Superannuation Fund). During a holiday you were injured in an accident. As a result of injuries sustained in the accident, you can no longer work in your previous capacity. You engaged the services of a solicitor to assist you to lodge an application for a TPD claim. Your Superannuation Fund had a balance of $X. A TPD payment of $X was paid to your Superannuation Fund. This brought the balance to $X. On XX January 20XX you received a lump sum payment from your Superannuation Fund consisting of a taxable component - taxed element of $X! and a tax-free component of $X. Total tax withheld was $X. Your legal representatives deducted $X in legal and associated fees.
Income Tax Assessment Act 1997 section 8-1 Income Tax Assessment Act 1997 paragraph 8-1(2)(a)
Summary Section 8-1 of the ITAA 1997 does not allow a deduction for outgoings of a capital or private nature. Any expenses incurred to obtain a capital lump sum will also be of a capital nature and cannot be deducted. Detailed reasoning 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. Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income. 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). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. Legal expenses are generally deductible if they arise out of the day to day income earning activities ( Herald and Weekly Times Ltd v. Federal Commissioner of Taxation
(1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case )) and the legal action has more than a peripheral connection to the taxpayer's income producing activities ( Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276). If the advantage to be gained does not have an immediate connection to the duties undertaken to derive income and has more of an enduring and consequently capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer. Generally, legal expenses incurred to obtaining superannuation lump sum amounts are not deductible as the advantage being sought is capital in nature. ATO Interpretative Decision ATO ID 2001/667 Income tax Legal expenses - to recoup full entitlement to a superannuation lump sum payment
explains that 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. Whether a capital payment is specifically brought to account as assessable income does 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. The superannuation lump sum benefit, being a payment for the loss of the taxpayer's earning capacity into the future, is a capital receipt. The taxpayer incurred the legal expenses in order to obtain the superannuation lump sum before retirement age. Although the taxable component of the superannuation lump sum is included in the taxpayer's assessable income, the superannuation benefit retains its character as a capital receipt. Paragraph 8- 1(2)(a) of the ITAA 1997 excludes general deductions of capital, or of a capital nature. Application to your situation In your case, you incurred the legal expenses to pursue a TPD claim and the lump sum payment of your superannuation benefit.
The lump sum superannuation benefit that you received is a capital receipt. You are not eligible to a superannuation pension, so no amount of the lump sum payment is of a revenue nature. Although the taxable component of the TPD benefit is included in your assessable income, it retains its character as a capital receipt. As your legal expenses were incurred in obtaining a capital lump sum payment, they will also be of a capital nature and you cannot claim a deduction for the legal expenses under section 8-1 of the ITAA 1997.