ATO Interpretative Decision

ATO ID 2002/170

Income Tax

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Issue

Are legal expenses incurred by a taxpayer seeking damages for breaches to a management contract over a former investment property, allowable as a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision

Yes. Legal expenses incurred by a taxpayer seeking damages for breaches to a management contract over a former investment property are allowable as a deduction under section 8-1 of the ITAA 1997.

Facts

The taxpayer owned a property that was used to produce assessable income during the year of income. The taxpayer entered into a contract with a property manager in relation to the management of the rental property. The terms of the contract include:

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rental payments in arrears of two weeks are to be brought to the notice of the taxpayer; and

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expenditure on the rental property for repairs and maintenance cannot be incurred by the property manager without the consent of the taxpayer.

The property manager breached the above conditions and the taxpayer incurred legal expenses to recover:

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losses from non-collection of rents;

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unauthorised expenditure for repairs and maintenance on the property; and

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additional costs incurred in rectifying the unauthorised repairs and maintenance undertaken by the property manager but now incurred by the property owner.

Reasons for Decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

Legal expenses can be characterised as an outgoing on revenue account or an outgoing of a capital nature depending on the cause or purpose for which the legal expenses were incurred (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; [1946] HCA 34; 8 ATD 190; (1946) 3 AITR 436). Where the legal expenses arise as a consequence of the day to day activities of a business, and the object of the expenditure is devoted towards a revenue purpose, the legal expenses are deductible (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; [1932] HCA 56; 2 ATD 169).

As the legal expenses were incurred during the year of income for damages based on revenue account (lost rents and unauthorised expenditure on repairs and maintenance), the expenditure is related to gaining or producing assessable income. The taxpayer is therefore entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in seeking damages for breaches to the management contract over the investment property.

Amendment History

Year of income:  Year ended 30 June 2001

Legislative References:
Income Tax Assessment Act 1997
   section 8-1

Case References:
Hallstroms Pty Ltd v. Federal Commissioner of Taxation
   (1946) 72 CLR 634
   [1946] HCA 34
   8 ATD 190
   (1946) 3 AITR 436

Keywords
Deductions
Legal expenses
Rental property

Siebel/TDMS Reference Number:  DW233196; 1-59WWCOD

Business Line:  Small Business/Individual Taxpayers

Date of publication:  22 February 2002

ISSN: 1445-2782