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Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for a payment made to an entity (the assignee) to release you from a debt claim for lease payments and associated interest in relation to a former scheme?

Answer

Yes

Question 2

Are you entitled to claim a deduction for the legal costs incurred in relation to the proceedings?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You participated in a scheme commencing in the late 1980's.

Under this scheme you entered into a lease agreement with a company, Y Ltd, for an interest in a separate parcel of land owned by Y Ltd. Trees were to be established, grown, maintained and harvested on your land for a management fee.

Lease payments were expected to be paid yearly.

The scheme was structured so that you (and others) would be carrying on a business.

The scheme wasn't successful and the promoter/operator collapsed.

The rights in relation to the leases were assigned by Y Ltd to another company, Z Ltd.

Z Ltd notified you of the assignment and alleged that you defaulted in your obligations to make lease rental payments and demanded payment of the outstanding lease rental payments and interest.

Z Ltd lodged a series of legal claims against you (and others) to recover unpaid lease rental due under the lease agreements and interest.

All parties ultimately settled on a lesser amount. Under the Deed of Settlement, you were released from all claims, court proceedings, damages, payments, costs and expenses, penalties and liabilities made in or arising out of the lease agreement for an agreed settlement payment.

The Deed of Settlement and the attached Schedule do not specify any dissection of amounts.

You also paid an amount for legal expenses required to defend the proceedings.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

We have concluded that the amount of a settlement payment that is referable to lease and associated interest expenses is characterised as having the requisite connection with your assessable income and does not have an enduring benefit.

Accordingly, these expenses are revenue in nature and you are entitled to a deduction for the amount of the settlement payment.

For the same reasons you are also entitled to a deduction for the associated legal expenses you incurred in relation to this action.

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 that they are incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

Lease expenses

You are entitled to claim deductions for lease payments under section 8-1 of the ITAA 1997 in carrying on a business for the purpose of producing assessable income.

In Evenden v FC of T 99 ATC 2297, the AAT allowed a taxpayer a deduction for lease shortfall payments incurred after the cessation of her business.

In the decision of the Federal Court in Placer Pacific Management Pty Ltd v FCT (1995) 31 ATR 253, the AAT held that the cessation of the business was no impediment to a deduction for the lease payments as the occasion of the loss or outgoing was to be found in the leases entered into between the taxpayer and the lessors.

Lease payments are not capital in nature. You do not acquire an enduring asset or benefit.

Therefore the amount of the settlement payment representing outstanding lease fees and associated interest is deductible.

Legal expenses

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 revenue nature, then the expenses incurred in gaining the advantage will also be of a revenue nature.

The legal expenses must be related to the production of assessable income or the carrying on of a business to be deductible under section 8-1 of the ITAA 1997.

In your case, the legal expenses arose in connection with carrying on a business for the purpose of gaining or producing assessable income.

The legal expenses are accordingly revenue in nature and are deductible under section 8-1 of the ITAA 1997.

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