ATO Interpretative Decision
ATO ID 2003/484
Income Tax
Deduction: legal expenses - landlord defending a damages claim in respect of injuries suffered by a third party on their rental propertyFOI status: may be released
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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses that they incurred in defending a claim for damages, in respect of injuries allegedly suffered by a person who was visiting a tenant at their rental property?
Decision
Yes. The taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses that they incurred in defending a claim for damages, in respect of injuries allegedly suffered by a person who was visiting a tenant at their rental property.
Facts
The taxpayer and their spouse jointly own an income producing rental property.
A third party (the plaintiff) commenced legal proceedings for negligence claiming damages (the damages claim) against the taxpayer and their spouse, in respect of injuries suffered whilst visiting the tenant of the rental property. The injuries were said to have occurred as a result of the condition of the rental property.
The taxpayer and their spouse have incurred legal expenses in defending the damages claim.
Reasons for Decision
Section 8-1 of the ITAA 1997 allows a deduction for all losses or 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, or relate to the earning of exempt income.
Generally, legal expenses have been held to be deductible if the expenses have arisen as a consequence of the taxpayer's income earning activities provided that the legal expenses are not of a capital, private or domestic nature (Herald & Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169 (Herald & Weekly Times), Putnin v. Federal Commissioner of Taxation (1991) 27 FCR 508; 91 ATC 4097; (1991) 21 ATR 1245 (Putnin's Case) and Federal Commissioner of Taxation v. Snowden & Willson Pty Ltd (1958) 99 CLR 431; 11 ATD 463; (1958) 7 AITR 308 (Snowden's Case)).
The principles established in Herald & Weekly Times are not confined to recurring or common expenses (Putnin's Case and Snowden's Case).
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) 3 AITR 436; 8 ATD 190).
The principles espoused in Herald & Weekly Times were applied in Case C12 (1952) 3 TBRD 100 (Case C12). That case dealt with the trustees of a deceased estate, who let a city property to a number of tenants. A tenant's injured employee claimed damages against the trustees in respect of injuries she sustained on the rental premises. The Board, in allowing the trustees a deduction for the amount that they paid to settle the claim, stated that:
[the trustees] became liable... because they had let rooms to tenants...It was in the capacity of landlord that the outgoing was incurred...the expense incurred resulted from a risk which, to a landlord, is ever present...the expense claimed as a deduction was one which arose out of the letting of the building to tenants for the purpose of producing assessable income, and that it can properly be regarded as having been incurred 'in the course of' gaining or producing that assessable income...I cannot see that the outgoing produced "an enduring benefit" of any sort. I can see no justification ...for capitalising the expense. It seems to me to be one which should properly be set against revenue account.
The taxpayer and their spouse incurred the legal expenses in their capacity as landlords of the rental property. The expenses arose out of the letting of the premises to a tenant for the purposes of producing assessable income. There is a clear connection between their legal expenses and their rental income such that the expenses are incidental and relevant to the generation of their assessable rental income. There was no enduring benefit produced by the expenditure and therefore it is appropriate to treat the expense as being on revenue account.
Therefore, the taxpayer and their spouse are entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses that they have incurred in defending the damages claim.
Date of decision: 26 May 2003Year of income: Year ended 30 June 2003
Legislative References:
Income Tax Assessment Act 1997
section 8-1
Case References:
Hallstroms Pty Ltd v. Federal Commissioner of Taxation
(1946) 72 CLR 634
8 ATD 190
(1946) 3 AITR 436
(1932) 48 CLR 113
2 ATD 169 Putnin v. Federal Commissioner of Taxation
(1991) 27 FCR 508
91 ATC 4097 Federal Commissioner of Taxation v. Snowden & Willson Pty Ltd
(1958) 99 CLR 431
11 ATD 463 Case C12
(1952) 3 TBRD 100
Keywords
Cessation
Legal expenses
Rental expenses
Rental property
ISSN: 1445-2782
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