Edited version of private ruling

Authorisation Number: 1011804867673

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Ruling

Subject: legal expenses

Question

Are you entitled to a deduction for legal expenses incurred?

Answer: Yes.

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences on:

1 July 2009

1 July 2010

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling

· Copy of employment contract

· Copy of letter from employer

· Copy of letter from employer's solicitors

· Deed of Release

· letter from solicitors

You were employed as a general manager of an Australian company.

During your employment you commuted between cities.

You regularly forwarded emails and files between your employer's office and your home to continue to complete tasks and correspondence.

Your contract was terminated as your employer accused you of providing sensitive company information to a third party.

You surrendered your employer's laptop and blackberry.

You sought legal advice as your employer's solicitor was instructed to commence preparation of legal proceedings pertaining to your employment.

Legal proceedings included court orders to:

· restrain you from unlawful disclosure of confidential information,

· deliver to your employer any or all records of confidential information or property of Landmark in your possession,

· disclose the identity of persons to whom you have passed confidential information or other intellectual property of your employer, in breach of your employment contract, and a description the information or property so disclosed, and

· damages.

The legal proceedings were likely to require the following evidence relating to the period of your employment:

· email communications to and from any computer used by you

· email communications to and from your personal computer

· telephone records including calls and SMS messages sent and received from any telephone used by you including home telephone , blackberry or other mobile phones

· any laptop or desktop computer used by you

· documents comprising or containing confidential information or other intellectual property of your previous employer.

For this reason your solicitor was provided access to your personal laptop to enable verification that all files and property relating to your previous employer were deleted and allowing your employer's solicitor to conduct an independent forensic analysis.

You were requested by your employer to provide a written undertaking that you will:

· not disclose to any person any confidential information or intellectual property of your previous employer in breach of your contract

· deliver any and all records of confidential information or other property of your previous employer in your possession

· disclose to your previous employer the identity of all persons to whom you have passed confidential information or other intellectual property in breach of your employment contract

· preserve the evidence

· cooperate with your previous employer to deliver copies of evidence.

You sought legal advice and incurred expenses to enable you to agree and delete from your laptop hard drive all files that were considered the property of your previous employer.

You and the company signed a deed of release in agreeing to settle the dispute on a without admissions basis.

You did not seek re employment with the company as your relationship had soured.

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.

In determining whether a deduction for legal expenses is allowed, the nature of the expenditure must be considered. 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 nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business. (Herald Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T ( 1980) 49 FLR 183; (1980) 11 ATR 276;80 ATC 4542).

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry cleared him of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties, in order to defend the threat of dismissal, were allowable. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income.

Where an expense is incurred involuntarily, your motives in pursuing action will be irrelevant to the determination of its deductibility. It is the objective circumstances which compel you to incur the expense which determine its deductibility (Shokker v. FC of T 99 ATC 4504; 42 ATR 257).

In Putnin v. FC of T 91 ATC 4097; (1991) 27 FCR 508 an accountant was trustee under a particular deed of arrangement. They administered the estate without obtaining an assignment of the debtor's share in a company and the share was subsequently dealt with by the debtor. They were later charged with conspiring with the debtor to defraud the Commonwealth and incurred legal expenses in defending this action. The court found the expenditure arose out of his prosecution, in which they were defending their activities by which income had been earned and they were allowed a deduction for this legal expenditure.

Their Honours stated:

It may be a natural incident of the conduct of the operations of a particular kind of business that claims of the commission of torts, or even crimes, may arise, although it is to be hoped not often, and have to be repelled.

In Elberg v FC of T 38 ATR 623; a doctor was charged with dishonestly obtaining property by deception. The charges alleged they falsely held themselves to be on duty with their employment when they actually deriving income from their private practice. Merkel J said:

In my view, as in Putnin, the present case is one which concerns expenditure which may relevantly be described as involuntary. Also, as in Putnin, and I would add Rowe, Magna Alloys…and Herald and Weekly Times, the expenditure arose out of proceedings in which the taxpayer was defending her activities in a particular operation of her business, in the present case, as a doctor, by which she earned her income.

In your case, on termination of your employment, solicitors on behalf of your previous employer were preparing to undertake legal proceedings against you regarding an alleged breach of your contract. You surrendered your personal laptop to your solicitor to allow an independent forensic analysis to identify and verify all files and property relating to your previous employer were deleted which was a requirement at the agreed settlement.

It is accepted that the action was initiated by your previous employer and the expenses you incurred in defending the action were involuntary. You were consequently required to defend the way in which you performed your duties.

It is considered that your legal expenses are sufficiently connected to your income earning activities and are not capital or private in nature. Therefore, the legal expenses you have incurred are deductible under section 8-1 of the ITAA 1997.

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