Federal Commissioner of Taxation v Day 2008 ATC 20-064; [2008] HCA 53
On 12 November 2008, the High Court of Australia found that a Customs officer was entitled to claim a tax deduction for legal expenses that were incurred to defend disciplinary charges from his employer. This find-ing raises the prospect of employees claiming tax deductions for the legal costs of actions connected to keeping their employment.
The Customs officer („the taxpayer‟) was a „senior compliance officer.‟ He was charged by the Australian Customs Service („ACS‟) with “failure of duty” pursuant to section 61(2) of the Public Service Act 1922, over separate incidents in 1998 and 1999. According to ACS, he improperly used his Customs identification to seek information from a local court clerk regarding a search warrant that had been executed to allow the Australian Federal Police to search his workstation.
The taxpayer was demoted as a result of these actions.
The relevant disciplinary committee (a statutory in-quiry under the Public Service Act) found that the charge had been proved but ordered the taxpayer to be transferred to another position instead of demotion.
In the process of defending the charges, the taxpayer incurred legal costs of approximately $7, 903 for the first charge and $28 954 for subsequent charges. These costs were claimed as a tax deduction in the 2001-2002 year of income, in the taxpayer‟s tax return for that year. However, the Commissioner of Taxation re-fused to allow the deduction.
The taxpayer objected and then sought review of the Commissioner’s objection decision. The matter was taken to the Federal Court of Australia. The taxpayer argued that the expenses were deductible under section 8-1(1)(a) of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). Section 8-1 is the general deduction provision of the ITAA 1997, which allows taxpayers to claim a deduction for losses or outgoings that have been incurred in the gaining or producing of assessable income.
The Federal Court judge at first instance, Emmett J determined that the legal expenses were not tax deductible. His Honour stated that the conduct, the subject of the first charge, was not engaged in for the purpose of discharging or performing duties as an officer and thus the legal expenses attributable to the conduct were not tax deductible.
The matter was appealed to the Full Bench of the Federal Court of Australia. Spender and Edmonds JJ over-turned the judgment at first instance and found that the expenses were tax deductible. According to their Honour‟s, the primary judge erred in his conclusion that if the conduct that resulted in the charges was not engaged in for the purposes of producing assessable income then expenses in relation to defending those charges were not deductible. They believed that the deductibility of legal expenses in defending charges was not so limited. The matter was then appealed to the High Court (the Court) and was heard by Gummow, Kirby, Hayne, Heydon and Kiefel JJ.
Commissioner of Taxation argued that the expenses were not tax deductible. He contended that this was because the expenses were incurred to defend charges of conduct that was that was unconnected to the performance of the respondent‟s income producing activities and therefore could not be said to have been incurred in the course of gaining or producing assessable income.
Furthermore, the Commissioner accepted that the taxpayer was also under an obligation, imposed by section 56(d) of the Public Service Act, not to engage in improper conduct, but submitted that the obser-vance of that duty was not itself an activity which was productive of the taxpayer‟s income and was therefore not relevant.
The Commissioner then argued that the difference between conduct undertaken in performance of the tasks for which the taxpayer was employed and improper conduct that was in breach of section 56(d, was a distinction that section 8-1(1)(a) made necessary. It was found by the majority that, due to the taxpayer‟s position as an officer under the Public Service Act, this obliged him to observe standards of conduct that went beyond the performance of tasks associated with his role.
Consequently, this led him to being exposed to disciplinary action that had implications for maintaining his job or salary. Their Honours stated that it was “neither realistic nor possible to excise from the scope of the respondent’s service as an officer, elements which may be associated with tasks and so identify them as income-producing.”
Furthermore they believed that they could not view the charges as being remote from the taxpayer‟s office in the way that “private conduct giving rise to criminal or other sanctions may be”. Consequently, it became a necessity for the taxpayer to obtain legal advice and representation to defend any charges and preserve his employment.
The Court believed, that the issue of whether the charges were well founded, was not relevant as to the tax deductibility of the costs incurred in defending the charges. Finally, the majority found that expenses incurred by employees defending a charge that could lead to their dismissal “may not itself be sufficient in every case to establish the necessary connection to the employment or service which is productive of income.”
Tax deductibility is dependant on what is en-tailed in the employment and the duties which it imposes upon an employee. Accordingly, the Court found that in this case, the requisite connection was present, hence the costs in-curred in defending the charges which might lead to the taxpayers dismissal were deductible. Thus, the appeal was dismissed.