Work-related deductions Lambourne case
New test “necessarily incurred”? I don’t think so.
Every so often a case comes along which spikes interest from tax professionals. The Lambourne case at the Administrative Appeals Tribunal (Lambourne v FC of T AATA 4562 http://www.austlii.edu.au/cgi-bin/viewdoc/au/cases/cth/AATA//2020/4562.html) is one such case. The facts are not complex, but some of the commentary can suggest a new principle regarding work-related deductions might be at play. It infers that where a taxpayer acquires goods at their own discretion and not at the direction of their employer then a deduction may not be allowable.
One paragraph in the judgement (para 101) seems to be causing consternation. It implies that to be entitled to a work-related deduction, one must have evidence that you would have needed to have acquired the relevant items to be continued to be paid.
“There is no evidence before the Tribunal that the applicant would not have continued to be paid in relation to his duties (be that his salary or allowances) if he had not purchased and supplied these items.”
What does the Tax Act require?
Section 8-1 of the Income Tax Assessment Act 1997(ITAA 1997) is the all-important legislative reference that governs the deductibility of outgoings for employees and reads as follows:
(a) it is incurred in gaining or producing your assessable income; or
For an employee not in business section 8-1(1)(a) is the relevant provision to determine whether an expense is deductible. The words necessarily incurred are not what the relevant legislation requires. Whilst necessarily incurred is not required there must be a strong nexus between the incurring of the expense and its connection to the earning of the income.
Facts surrounding Lambourne case in brief
The taxpayer was employed by the Australian Defence Force as an electronics technician with the Navy which also included amongst other duties acting as a military fitness leader. The ATO audited the taxpayer’s 2017 income tax return as his work-related expense claim was higher than expected compared to similar taxpayers. The items subject to audit were deductions claimed at labels D1, D3 and D5 totaling $10,795. In the main the taxpayer claimed Navy uniform clothing, HDMI box and hub splitter, various gym/fitness equipment for his duties as a military fitness leader, polarised glasses, a tablet/laptop and a scientific calculator.
As is commonplace with work-related deduction audits, it is not usual for the ATO to seek information from the taxpayer’s employer directly. This in itself does not determine the issue of deductibility or not, but it does provide an opportunity for the ATO to understand the duties that the taxpayer performs. This is confirmed in the ATO ruling TR 2020/1 as follows:
Para 31. “Although an employer's requirements do not determine deductibility, they are not irrelevant and, in particular, will generally assist in ascertaining the proper scope of an employee's income-earning activities to determine whether an expense has been incurred in the course of earning assessable income.  Furthermore, the fact that an employee incurs an expense on a voluntary basis (that is, not at the direction of their employer) does not necessarily preclude a deduction under section 8-1.
The ATO amended the taxpayer’s assessment and the taxpayer objected to the amended assessment which was later disallowed. The taxpayer with the help of his tax agent decided to pursue the matter at the Administrative Appeals Tribunal (AAT).
As with most cases before the Tribunal of this nature, it is the taxpayer that has the burden of proving that the assessment is excessive or otherwise incorrect. The key provisions in this particular case centred around the general deductibility and substantiation provisions contained in the ITAA 1997. Whilst there were substantiation issues also at play, these have been ignored as I only want to focus on deductibility aspect of the case.
There is no shortage of case law on work-related deductions. Australia is unique in that it allows employees to deduct employment-related expenses. In many overseas jurisdictions there is no ability to claim or the rules are much more restrictive, only allowing certain expenses that are wholly work-related, and no apportionment is allowed. Some countries have adopted a standard deduction with the ability to claim above a standard amount only under certain circumstances. To date, Australia has resisted reform in this area and taxpayers can claim an unlimited amount subject to meeting the deductibility and substantiation rules. On average across the entire population, an amount of $2,500 is claimed as work-related deductions.
Referring back to the Lambourne case, the taxpayer’s main argument was that the expenses incurred were necessary in the performance of his duties.
In paragraph 95 “The Tribunal accepts that the duties undertaken by the Applicant extend beyond that of those associated with his role as an Electronics Technician. Based on the evidence before it, the Tribunal accepts that the nine items in dispute relating to the D5 claim for other work-related expenses may have been used by the Applicant in carrying out his duties and that he may have [procured] them for such purposes. The question though is whether the outgoings related to the purchase of these items were incurred in the course of producing the Applicant’s assessable income. It is this point that is in contention. The Applicant contended that it was necessary for him to purchase the 9 items in order to be able to perform his duties and that they were a requirement, whereas the Respondent contends that they were purchased at the Applicant’s discretion not at the direction of or requirement of the Navy.”
Whilst the Tribunal accepted that the items may have been used in carrying out of his duties, it is not enough on its own.
Paragraph 94 highlights this point “The fact that a loss or outgoing has a relationship to a taxpayer’s employment or the carrying out of their duties is not enough. As provided by the High Court in Payne the question is “whether the outgoing was incurred in the course of gaining or producing actual or expected income. That is, is the occasion of the outgoing found in whatever is productive of actual or expected income?””
The ATO’s position on the deductibility of work-related expenses is set out in ruling TR 2020/1 - Income tax: employees: deductions for work expenses under section 8-1 of the Income Tax Assessment Act 1997. The relevant excerpts of the ruling which are pertinent to this case are paragraph 26 to 36 and are reproduced below.
Relevance of employer requirements
- A common issue relating to the deductibility of employee expenses is the relevance of express or implied conditions of employment. In this regard, a question that frequently arises is whether an expense becomes deductible merely because an employer specifically requires the employee to incur the expense.
- In these circumstances, the employer's requirements do not determine the question of deductibility. This question is always to be answered by reference to the statutory test which involves an objective determination of the connection between the expense and the employee's income-earning activities.
- For example, an expense that is private in nature or only a prerequisite to the earning of income does not become deductible only because of an employer's requirements.
Example 5 - not deductible despite employer's requirements
- Kayne is employed as a waiter in a wine bar and is required by his employer to wear a white collared shirt, black trousers and black shoes. Notwithstanding his employer's specific instructions, Kayne's clothing remains conventional, maintains its private nature, and is not expenditure incurred in earning his employment income.
- Other common examples are requirements that employees possess an ordinary driver's licence or present themselves in a well-groomed manner. Standards set by employers in this regard would not change the essentially private character of expenses in obtaining a driver's licence or maintaining a particular level of personal appearance.
- Although an employer's requirements do not determine deductibility, they are not irrelevant and, in particular, will generally assist in ascertaining the proper scope of an employee's income-earning activities to determine whether an expense has been incurred in the course of earning assessable income. Furthermore, the fact that an employee incurs an expense on a voluntary basis (that is, not at the direction of their employer) does not necessarily preclude a deduction under section 8-1.
Example 6 - deductible without employer's requirement
- Salome works as the practice manager for a suburban doctor's surgery. To help develop her skills in her current role she undertakes a Diploma of Practice Management. Her employer does not directly encourage her to do the course and does not offer any financial incentive or time off. Despite not having her employer's direct support, Salome can claim a deduction for the cost of undertaking the course as it will assist her in carrying out her current employment duties by improving the specific knowledge and skills she requires to do her job.
- By contrast, the encouragement of an employer will not make expenses of self-education deductible if they are not incurred in the course of producing assessable income but, rather, are associated with obtaining new qualifications to commence a new income-earning activity.
Example 7 - not deductible despite employer's encouragement
- Dermott is employed as a receptionist at a dental practice. His employer encourages him to undertake a Certificate III in Dental Assisting, offering study leave and a guaranteed job with increased salary as a dental assistant if he completes the course. Dermott cannot claim a deduction for the course fees despite his employer encouraging the study. The course does not assist him in carrying out his existing employment duties or improve the knowledge or skills he needs as a receptionist to earn his current income. As the study relates to a potential new job as a dental assistant, the expenses of that study are a prerequisite to earning income from a new role and not incurred in the course of earning his income.
- Although the directions of an employer do not determine the question of deductibility, they may have relevance for determining the proper scope of an employee's duties and income-earning activities. This may assist in determining whether a voluntary expenditure was incurred in the course of producing assessable income.
Example 8 - not deductible - outside scope of duties
- Barry drives a courier van provided by his employer. In the event that the vehicle breaks down, Barry's employer has provided him with a road service phone number and instructed him not to attempt to carry out any repairs himself. Barry cannot claim a deduction or depreciation for auto repair tools he may have purchased. He has been employed only to drive the van and the repair activities cannot be done in connection with his employment. As the expenses do not relate to his employment, they do not have the necessary connection with the earning of assessable income and are not deductible.
As can be seen from the ruling, the ATO’s position is quite clear. The AAT was addressing and responding to the argument that was put forward by the taxpayer and that there was no implied inference to a new test for deductibility of work-related expenses. The ATO to their credit has responded quickly to the uncertainty by providing the following response on 8 December 2020:
“The ATO view on 'discretionary' expenditure by employees and the relevance of employer requirements is set out in Taxation Ruling TR 2020/1 Income tax: employees: deductions for work expenses under section 8-1 of the Income Tax Assessment Act 1997. The Ruling says:
* Employer requirements do not determine the question of deductibility - it is always a question of relevant nexus to earning income
* Expenses with a sufficiently close connection to earning income will be deductible notwithstanding they are 'discretionary'
* Expenses without a sufficiently close connection do not become deductible simply because they are encouraged or required by the employer.
* Employer requirements can be relevant, however, to determine the proper scope of an employee's income-producing activities, which is relevant to assess the true character of an outgoing.
The recent Administrative Appeals Tribunal decision in Lambourne and the Commissioner of Taxation does not change the ATO view in terms of the application of s 8-1. We consider that comments made in the decision were not intended to introduce a necessity requirement into first limb of s8-1. Rather, they were made in response to arguments put for the taxpayer and in light of the specific facts and circumstances of the case. We do not think they represent an expression of any broader principle.”
For practitioners, it is a reminder to ensure that we are asking enough probing questions to ascertain the strong nexus between the outlay and income earning activity. The ATO have been doing a lot of compliance work on work-related expenses so practitioners need to be vigilant enough to ensure that they are applying proper principles around deductibility in case the practice or the client is reviewed.