In Commissioner of Taxation v Day  HCA 53, the
High Court has ruled that an employee was entitled to claim a
deduction for the legal expenses incurred in defending disciplinary
charges. The charges led to his demotion but could have resulted in
The High Court decided that the taxpayer's duties as a
public officer and the possible consequences of internal
disciplinary proceedings formed part of what was productive of his
assessable income. This case reflects a recent judicial trend to
increasingly allow tax claims for legal expenses incurred to
protect an employee's income. Given the increasing number of
terminations and redundancies in the current economic environment,
the High Court's decision may mean that some employees are more
willing to take on their employers in Court.
The taxpayer, Shane Day, was a senior compliance officer with
the Australian Customs Service. He incurred legal expenses of
$37,077 in defending two separate charges of improper conduct as an
officer of the Public Service. The taxpayer claimed the legal
expenses as a deduction in his 2001-02 tax return. The claim was
disallowed by the Commissioner of Taxation.
The first incident of improper conduct related to a breach of
the Customs Code of Ethics and Conduct in 1998. The taxpayer was
suspended from duty for presenting his Customs identification card
to a Court Clerk in order to obtain information about a warrant to
search his workstation. An internal investigation found that it was
improper for the taxpayer to have represented that his visit to the
Court was for official purposes.
The second incident related to seven charges of improper conduct
in 1999 including the taxpayer's involvement in a false claim
for a diesel fuel rebate and the use of a work vehicle for a
non-work related purpose. For these charges, the taxpayer was
suspended without pay.
The taxpayer sought to claim his legal expenses for defending
the charges as a deduction under the relevant income tax
legislation. A taxpayer can generally deduct from their assessable
income 'any loss or outgoing to the extent that it is incurred
in gaining or producing' assessable income.
After the Commissioner's disallowance of the claim, the
taxpayer appealed to the Federal Court. Justice Emmett held that
the legal expenses were not deductible. A majority of the Full
Federal Court overturned Justice Emmett's decision by finding
that the expenses were in fact deductible. The Commissioner
appealed to the High Court. Justices Gummow, Hayne, Heydon and
Kiefel delivered the majority judgment. Justice Kirby
The Commissioner of Taxation's arguments
The Commissioner of Taxation argued that legal expenses are
deductible when incurred in connection with, or incidental to, the
However, the Commissioner argued that since the taxpayer's
expenses were incurred in defending conduct outside the scope of
his duties, the expenses could not have been incurred
"in" or "in the course of" gaining or producing
assessable under the relevant income tax legislation.
Furthermore, while the Commissioner accepted that the taxpayer
was under an obligation not to engage in improper conduct, the
Commissioner argued that this obligation was not an activity that
was relevant to the production of the taxpayer's income.
The High Court's decision
The taxpayer's legal expenses were allowable as deductions
on the basis that the taxpayer's duties as an officer of the
Public Service required him to observe standards of conduct that
extended beyond the normal standards required in the performance of
tasks associated with his office. Furthermore, the taxpayer was
subjected to disciplinary action that could have led to the
termination of his employment. Therefore, the High Court concluded
that what was productive of the taxpayer's income must be
understood given the particular circumstances of this case,
including the nature of the employment and the duties it imposes on
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Long experience representing many of Australia's leading employers has taught us that in employment litigation the identity of an employee's representative is a major factor in how employee litigation runs.
Australian employees receive certain entitlements (such as annual leave and superannuation) where contractors do not.
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