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Legal expenses incurred in enforcing period of notice held to be tax-deductible

Romanin v The Commissioner of Taxation [2008] FCA 1532

The facts:

Mr. Romanin was engaged on a temporary basis as acting General Manager and Company Secretary for University Co-operative Bookshop Ltd (the Co-op). He subsequently sought permanent employment as General Manager and CEO. His predecessor having been suspended in questionable circumstances, Mr. Romanin made it clear that he was only willing to accept the position if guaranteed a 12 month period of notice for termination.

He commenced employment with the Co-op and was paid in accordance with the provisions of the new agreement, although he did not sign a written contract. A few months later, the Co-op terminated Mr. Romanin’s employment, giving him only seven days notice and denying the existence of the contract.

Mr. Romanin commenced proceedings in the NSW Industrial Relations Commission, with the Commission ultimately finding that he was entitled to 12 months notice or payment in lieu thereof. He was awarded $202,829.90.

In successfully pursuing his claim, Mr. Romanin incurred significant legal costs. Over the course of five years he claimed in his tax return general deductions totalling $283,565.10 representing the costs of the litigation. The Tax Office determined that the deductions were not allowable. Mr. Romanin commenced proceedings in the Federal Court seeking an order setting aside that decision.

Gavel and block beside the scales of justice

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What the Court decided

The Federal Court held that Mr. Romanin’s legal expenses were deductible under s 8-1 Income Tax Assessment Act 1997 (Cth) as outgoings incurred in the course of gaining or producing his assessable income. There was a sufficient connection between the legal expenses incurred and the gaining of income. The outgoing was not disallowed as an outgoing of a capital nature, despite the fact that Mr. Romanin was pursuing a lump sum payment in lieu of notice.

Notable quotes from the judgment:

Per McKerracher J:

‘The principle said to flow from [Day’s] case is that legal expenses incurred by a taxpayer are deductible under s 8-1 where there is a sufficient nexus between the legal expenses incurred and the gaining or producing of assessable income. This may occur where the expenses are incurred in defending the income of the taxpayer in his or her employment.’

‘I accept Mr. Romanin’s submission that he pursued proceedings in the Commission to obtain income that was contractually owed to him and that the costs incurred in doing so are deductible…’

‘Income is of course received by people and entities in a variety of ways. The payment in a lump sum of the sum which would otherwise be income received by way of regular payments, does not of itself, in my view change the character of the payment.’

Take-away message:

For legal expenses to be tax-deductible, they must have been incurred in the course of gaining or producing assessable income, and the expenses must be of revenue, not capital, account. Romanin establishes that legal costs incurred in enforcing the terms of a contract of employment may be deductible, at least where the sum sued for represents remuneration contractually owed.

The authority that McKerracher J considered himself bound to follow in this case has recently been affirmed by the High Court (Commissioner of Taxation v Day [2008] HCA 53), which suggests that courts may continue to take a broad approach to deductibility of legal costs in certain employment matters.

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