ATO Interpretative Decision

ATO ID 2002/938

Income Tax

• This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

Issue

Are legal fees incurred by a taxpayer in defending the financing arrangement for the purchase of a motor vehicle deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision

No. Legal expenses incurred by a taxpayer in defending the financing arrangement for the purchase of a motor vehicle are not deductible under section 8-1 of the ITAA 1997.

Facts

The taxpayer entered into a hire purchase financing arrangement for a new motor vehicle which is used solely for business purposes.

An error was made which resulted in an understatement of the purchase price being financed.

This error had the effect of reducing the amount of monthly instalments payable by the taxpayer.

The lessor and the taxpayer were unable to settle the dispute and the lessor proceeded with legal action.

The taxpayer incurred legal expenses in defending the legal action.

Reasons for Decision

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

In determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436 per Dixon J). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses.

Where legal expenses arise as a consequence of the day to day activities of a business, the object of the expenditure is devoted towards a revenue end and the legal expenses are deductible (Herald & Weekly Times v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169). However, where the expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible (Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87; (1938) 1 AITR 403).

In the case Kennedy Holdings and Property Management Pty Ltd v. Federal Commissioner of Taxation (1992) 39 FCR 495; (1992) 92 ATC 4918; (1992) 24 ATR 321, a payment by a lessor to the lessee to terminate the lease in order to grant a new and more profitable lease to a new tenant, was held to be capital in nature and not deductible. The payment secured a permanent advantage, that is, the surrender of the lease with the option to renew.

Although the taxpayer's vehicle is used to produce income, the expenditure was incurred to protect the financing arrangement which determined the cost of the asset from which the taxpayer derived income.

The advantage sought in preserving the financial arrangement is capital in nature. Accordingly, the legal expenses incurred by the taxpayer in relation to the financing arrangement are considered capital and not deductible under section 8-1 of the ITAA 1997.

Amendment History

Year of income:  Year ended 30 June 2000 Year ended 30 June 2001 Year ended 30 June 2002

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) 8 ATD 190
   (1946) 3 AITR 436

Keywords
Legal action
Legal expenses
Finance charges
Hire purchase

Siebel/TDMS Reference Number:  DW412440; 1-5N0CME4

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  30 September 2002
Date reviewed:  31 March 2017

ISSN: 1445-2782