Category Archives: Industrial relations law

High Court rules on the tax deductibility of employment – related legal expenses

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.

Implied duty of good faith and fair dealing

Russell v The Trustees of the Roman Catholic Church for the Archdiocese of Sydney [2008] NSWCA 217

On 10 September 2008, the Supreme Court of NSW, Court of Appeal (the Court) has emphasised the lim-ited scope of any implied duty of “good faith and fair dealing” in employment contracts.

A teacher (“R”) had been employed by the Roman Catholic Church (the Church) as the Director of Music at St Mary‟s Cathedral in Sydney. R commenced employment in 1976. He was responsible for the general management of the choir, including teaching and training members, conducting at church services, concerts and rehearsals. He also arranged and accompanied the choir on various overseas tours. There was no writ-ten documentation with any express provisions of the contract of employment.

In 1982 Mr David O‟Grady began work as a sacristan at St Mary‟s Cathedral. At the Dean of the Cathe-dral‟s request, he lived in R residence. In 1999, R was arrested and voluntarily stood down. The arrest re-lated to sexual misconduct claimed by a former choir member, Mr Buckley. Bail was granted and R re-turned to his duties under the condition he would be supervised. In March 2000 the committal proceeding began. Mr Buckley failed to attend and all charges against R were dismissed. He resumed full duties with-out any conditions or restrictions.

From February to August 2002 there were communications between the Catholic Commission for Employ-ment Relations (CCER) and the New South Wales Ombudsman‟s Office. This led the Church to conduct an internal enquiry. In August, the Ombudsman‟s office wrote to the Church stating that it would investigate the CCER‟s conduct. It required documents and records relating to the Church‟s checks of R‟s performance of duties.

Once again R conducted his duties under full supervision. He expressed concern at the lack of information that had been provided with. In October 2002 R, his advisor, a Church investigator and the Dean of the Cathedral, attended a meeting where R denied each of the allegations against him. By letter, the Dean requested the attendance of R at a meeting on 10 December. At this meeting, R was in-formed that the allegation of indecent assault had not been sustained. However, preliminary findings of neglect had been sustained on the balance of probabilities. A review of his suitability to continue employment had been recommended as disciplinary action. On 31 January 2003, the Dean consulted with the Cardinal Archbishop, who approved the decision to terminate R‟s employment.

R commenced proceedings in the NSW Industrial Relations Commission (NSWIRC), for the reinstatement of his employment under section 84 of the Industrial Relations Act 1996 (NSW). It was concluded that R‟s termination was unreasonable. Deputy President Harrison did not consider reinstatement „impractical‟ and ordered reinstatement with „restitution of wages and continuity of services for all purposes.‟ R continued his employment after his reinstatement on 1 June 2004, he was paid income that he did not receive while he was not working.

R then commenced proceedings in the Supreme Court of NSW and claimed damages for wrongful termination and for breaches of two implied terms in the employment contract. The damages included the cost of the proceedings, the expenses of a media consultant, injury to reputation and damages for distress, embarrass-ment, humiliation and hurt to feelings.

Damages were also claimed for negligence. Additionally aggravated and exemplary damages were claimed. The Supreme Court found in favour of the church. It determined that the Church had breached its duty, re-garding the implied terms of the contract, however the breach occasioned no damage and no damages were awarded.

In spite of this, the Court also found that there were two duties implied by law in R‟s employment contract. These two duties were, that that the Church would:

  • “act in good faith” towards R; and
  • “the Church would not conduct itself in a manner likely to destroy or seriously damage the relation-ship of mutual confidence and trust between the parties.”

In 2008 the matter was appealed to the Supreme Court of NSW, Court of Appeal.
Issues to be determined by appeal. There were numerous issues that were to be determined in the appeal:

  • Did the church breach R‟s employment contract by dismissing him without reasonable notice?
  • Did the church breach the implied term of good faith, mutual trust and confidence in the employment contract by its investigation of R‟s conduct and the termination of his employment?
  • If implied terms were breached, could R recover damages for distress, humiliation, injury to feelings or loss of reputation?
  • Could R recover the costs of the proceedings in the NSW IRC as mitigation of loss resulting from the termination of employment without reasonable notice?
  • Could R recover the costs involved in hiring a public relations consultant to mitigate loss caused by the adverse publicity resulting from the termination without reasonable notice? And
  • Could R recover damages for injury to reputation and injury to feelings for breach of contract arising from termination without reasonable notice.

The Church argued against the Supreme Courts decision that there was an implied term of good faith in the employment contract and an implied term not to act in a manner likely to destroy or seriously damage a relationship of mutual trust and confidence. It maintained that a reasonable period of notice would have been 6 months rather than 12 months. Due to the fact that one of the allegations involved misconduct regarding children, the Church was at liberty to summarily dismiss an employee under the relevant legislation at the time, the Child Protection (Prohibited Employment) Act 1998 (NSW). This was only permissible if the Church was satisfied that the alleged conduct had actually occurred. In spite of this, the NSWIRC found that the a allegations were not substantiated.

The guidelines that covered investigations to be conducted by the ombudsman merely required that the investiga-tors “should be mindful of the principles of procedural fairness.”
Moreover, due to the fact that R had been reinstated with his entitlements preserved, the question of “reasonable notice” did not need to be considered.

R had an oral contract of employment, which did not contain much detail. It did not contain any express terms relating to duties of good faith, mutual trust and confidence. The alleged breach of procedural fairness related to interviewing a witness by telephone instead of in person, because the witness was interstate at the time, did not amount to a breach of good faith, mutual trust and confidence. No breach of any implied term of good faith towards the employee was established. The case did not involve constructive dismissal, but actual dismissal based on adverse findings in a report.

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The court stated that R failed to establish a causal connection between the breach of contract and the losses that he suffered. In spite of this, a face to face interview with the witness was unlikely to have altered either the report‟s findings or the Church‟s decision to dismiss him.
It was argued by R that some of the costs incurred were related to mitigating the effect of his wrongful dis-missal. This included taking steps such as hiring a public relations consultant. However, the court held that R was not entitled to recover the costs of proceedings in the NSWIRC. These costs stemmed from the allegation of unfair dismissal, not from any earlier breach of contract.

R‟s contract of employment prohibited the recovery of damages for breach of any implied term of good faith or mutual trust and confidence. Thus an award of general damages for distress, humiliation, injury to feelings or loss of reputation following a successful unfair dismissal claim, had no basis.

The expense incurred in hiring the public relations consultant was an attempt to deflect publicity created by the NSWIRC proceedings, rather than expenses in relation to damages incurred by R. The breach of contract was not the bad publicity, thus there was no causal link. To be more precise, the breach was a failure to give reasonable notice of dismissal. The Court examined numerous cases discussing this issue of damages. They concluded that the industrial relations legislation has limited the basis of relief to unfair dismissal, which includes reinstatement and or compensation for economic losses. This is instead of providing a more general remedy for the unfair administration of an employment contract. Hence, there was no basis for an award of general damages for distress, humiliation, injury to feelings or loss of reputation.

Therefore, the damages that were sought by R, could not flow from the termination of his employment con-tract, consequently the appeal was limited to questions of loss flowing from any breaches of its implied terms. Thus, there was no breach of any duty of good faith, and even if there had been, damages would not have been recoverable for it.

As a result, Giles, Basten and Campbell JJ dismissed R‟s appeal against part of the ruling by Supreme Court Justice Rothman. Basten J, in particular, accepted Rothman J‟s findings that the implied duties existed in Australian common law, but characterised them as a “single obligation” of good faith and fair dealing.