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Edited version of your private ruling
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Ruling
Subject: Deduction-legal expenses
Question
Are you entitled to a deduction for legal expenses you incurred in relation to a boundary dispute with your neighbour?
Answer: No.
This ruling applies for the following period:
Year ended 30 June 2011
The scheme commenced on:
1 July 2010
Relevant facts
You purchased a property.
The property has been used for primary production purposes.
While harvesting your crop, you realised the location of your boundary with your neighbour's property was incorrect.
A legal dispute arose with your neighbour over the location of the boundary.
You have incurred surveyor and legal expenses in regard to the legal dispute over the boundary of your property.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 8-1
Income Tax Assessment Act 1997 subsection 110-25(6)
Reasons for decision
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 or are necessarily incurred in carrying on a business for the purposes of gaining or producing such income, except where the outgoings are of a capital, private or domestic nature.
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 nature, then the expenses incurred in gaining the advantage will also be of a capital nature.
Expenditure made in order to preserve an asset is generally considered to be of a capital nature and therefore is not deductible, whereas working or operating expenses are considered of a revenue nature and hence deductible.
The following guidelines for determining whether a loss or outgoing is of a capital nature have been set down by the High Court in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 5 ATD 23; 5 ATD 87; 61 CLR 337:
o the expenditure is related to the business structure itself, that is, the establishment, replacement or enlargement of the profit-yielding structure rather than the money earning process, or
o the nature of the advantage has lasting and enduring benefit, or
o the payment is 'once and for all' for the future use of the asset or advantage rather than being recurrent and ongoing.
In your case, you incurred legal expenses over the location of the boundary of your property. The legal expenses in question did not arise out of the day to day activities of your business activity. The character of the expense is such that it was incurred in defending your title to a capital asset and as such provides an enduring benefit which is capital in nature.
Your legal expenses incurred in this legal action are therefore not deductible under section 8-1 of the ITAA 1997.
Capital gains tax
Although your legal expenses are not deductible, they may be included in the cost base of your property for capital gains tax (CGT) purposes providing the property was acquired on or after 20 September 1985.
The cost base of a CGT asset can be made up of a number of elements including capital expenditure incurred to preserve or defend your title to an asset, or your right over an asset (subsection 110-25(6) of the ITAA 1997).
Further information on calculating your capital gain or capital loss is available in the Australian Taxation Office publication Guide to capital gains tax 2010-11 which can be accessed on our website at www.ato.gov.au.
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