Edited version of private ruling

Authorisation Number: 1011749097724

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Ruling

Subject: Legal expenses

Question

Are the legal expenses incurred an allowable deduction?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are an Australian resident.

You were arrested and charged with a criminal offence.

You were taken off full duties after the arrest and placed under internal investigation.

You engaged a solicitor who briefed a barrister to represent you at the hearings. The fees that you paid were for the legal expenses relating to your representation in court.

The Magistrate made a determination that the charge be dismissed.

The chair of the internal review advised that no further action was necessary.

You have returned to full duties.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

The legal expenses were paid to defend yourself against charges in a court of law. The expenses are private in nature and no deduction is allowable.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 ( 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, or relate to the earning of exempt income.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478), 

· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

In determining whether a deduction for legal expenses is allowed 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) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital, domestic or private nature, then the expenses incurred in gaining the advantage will also be of a capital, domestic or private nature.

 The courts on a number of occasions have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer's business or employment. In FC of T v Rowe (1995) 31 ATR 392; 95 ATC 4691, an employee incurred legal expenses in defending the manner in which he performed his employment duties. The court accepted that such expenses were allowable and no significance was placed on the taxpayer's status as an employee.

 In your circumstances, you were advised that to maintain your employment you would need to successfully defend the charge brought against you. You identify the reason for defending the charge as the maintenance of your employment and therefore your income.

 The general principle is that a deduction is allowed where the legal expense has arisen as a consequence of the day to day activities of the business or employment whether or not the expenses are common or recurring (Herald and Weekly Times v FC of T 48 CLR 113; 2 ATD 169, Putnin v FC of T 91 ATC 4097; 21 ATR 1245).

As you discussed in your application, Commissioner of Taxation v. Day [2008] HCA 53 (Days case) was concerned with legal expenses. The majority approach in this case was that an expense will satisfy the test outlined in paragraph 8-1(1)(a) of the ITAA 1997 if the occasion of the expense is found in whatever is productive of actual or expected income. They indicated that a broad approach should be taken in determining what activities produced the actual or expected assessable income, and that it is not only the day to day tasks performed by the employee that gain or produce this income.

The criminal law applies regardless of any employment obligation, and the duty to obey and to respond to criminal proceedings is owed by every man or woman to the Crown as a subject of the law, and not as an employee to the employer. Costs incurred in defending criminal proceedings, in the Commissioner's opinion, are private expenses even when an employee is liable to be dismissed from employment on conviction.

Your situation can be distinguished from Days case because the occasion of the legal expenses you incurred is not found in activities related to the production of your actual or expected assessable income. You incurred your legal expenses defending yourself before the court. That is, your legal expenses did not relate to charges brought against you by your employer as in Days case. The act of engaging a lawyer cannot be said to relate to the production of your actual or expected assessable income, therefore, the decision in Days case is not applicable to your situation.

The legal expenses you have incurred do not relate to charges arising out of actions you undertook in the course of your employment. The charge arose from events outside of your employment, the nature of the charges was that of something unrelated to your duties. As such, the legal expenses were not incurred in earning your income from that employment.

In your case these is a lack of nexus between the legal expenses and your duties, the expenses lack the character of being incurred in the course of earning your assessable income. Even if there is a connection between the expenses and your continued employment, the connection is too remote and in any case, they are deemed to be either of a capital, private or domestic nature.

Therefore the expenses are not deductible under section 8-1 of the ITAA 1997.

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