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Subject: Legal expenses

Question

Are you entitled to a deduction for the legal expenses incurred to remove a restriction on your medical certificate that prevents you from being able to gain a promotion?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commenced on:

1 July 2011

Relevant facts and circumstances

You are a First Officer (co-pilot) working for an airline.

Due to a vision deficiency your medical certificate is restricted.

This restriction prevents you from being able to gain a promotion and become a Captain.

A Captain on a multi-crew aircraft is required to hold an Air Transport Pilot Licence (ATPL). You hold this licence however because of your medical certificate your ATPL privileges are restricted and it only allows you to operate as a co-pilot.

The restriction impacts your professional development as a pilot and your income earning potential.

Since you have been flying you have had no flight incidents or safety concerns. You have also passed all simulator checks and your peers and superiors have stated that they do not believe that your colour vision deficiency is a safety risk.

You have on a number of occasions requested that your medical restrictions be waived but you have continually been refused a waiver.

You are now appealing the restrictions through the Administrative Appeals Tribunal with two other gentlemen in the same situation.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Summary

You are not entitled to a deduction for the legal expenses you incur as they are not incurred in your current income earning activities and they are also capital in nature.

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.

For legal expenses to constitute an allowable deduction it must be shown that they were incidental and relevant to the production of the taxpayer's assessable income (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business (Herald and 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 80 ATC 4542; (1980) 11 ATR 276).

The nature of the expenditure must also be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190). The nature or character of the legal expense 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 expense incurred in gaining the advantage will also be of a capital nature.

There is a large amount of case law on distinguishing whether expenditure is capital or revenue in nature.  However, the guidelines for distinguishing between capital and revenue outgoings laid down in Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1938) 61 CLR 337; (1938) 45 ALR 10; (1938) 1 AITR 403; 5 ATD 87 (the Sun Newspapers case) provide the foundations for many later decisions on the topic. It was pointed out in the Sun Newspapers case that expenditure in establishing, replacing and enlarging the profit-yielding structure itself is capital and is to be contrasted with working or operating expenses. The test laid down in the Sun Newspapers case involved three elements, although none is in itself decisive:

· the nature of the advantage sought;

· the way it is to be used or enjoyed; and

· the means adopted to get it.

As regards the first two elements, the lasting or recurrent character of the advantage and the expenditure is important. Thus the courts have held, in the absence of special circumstances, that expenditure is capital in nature where it is made with a view to bringing into existence an asset or an advantage (tangible or intangible) for the enduring benefit of the business (British Insulated & Helsby Cables v. Atherton (1926) AC 205). In addition, it is the nature of the advantage sought by the taxpayer that is relevant.

Consequently, it is necessary to consider the reason for which your legal expenses were incurred.

In your case you are currently employed as a co-pilot. Due to the restriction on your medical certificate you are unable to be employed as a captain. You have incurred legal expenses in order to enable you to gain employment as a captain at some point in the future. Subsequently, the legal expenses are not incurred in earning your assessable income as they are not incurred in order to earn your current assessable income as a co-pilot and they are incurred at a point too soon to be incurred in earning assessable income from any future employment as a captain. Additionally, as the legal expenses are incurred to bring into existence an asset or advantage for the enduring benefit of yourself, they are capital in nature. Therefore you are not entitled to a deduction for the legal expenses you incur.

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