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Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for the legal fees and damages incurred?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You are an employee.

Whilst working as an employee you were involved in an accident.

A summons was served on you.

You had to pay damages.

You incurred legal fees.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

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 except where the losses or 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.

Generally, the treatment of a settlement sum or damages payment will follow the treatment of the other legal costs incurred in relation to a particular matter.

The leading case on the deductibility of legal expenses is Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169. In this case the taxpayer was the proprietor and publisher of an evening newspaper who claimed outgoings (for legal advice, defence costs and damages awarded) in connection with libels the newspaper had published. A majority of the Full High Court allowed the deduction as publishing the newspaper was both the source of income and cause of the liability and secondly, the risk of libel was a regular and almost unavoidable incident or inherent risk of publishing.  

In FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. The activities which produced his income were what exposed him to the liability against which he was defending himself.  

In Case V116, AAT Case 4502 (1988) 88 ATC 737; 19 ATR 3703 the Administrative Appeals Tribunal allowed a deduction for legal expenses by a solicitor employed as a director of a company to defend defamation proceedings. Senior Member Roach stated that the duties of the solicitor's position created the risk of defamation proceedings and the legal expenses were:

Accordingly, for legal expenses to be deductible, you have to be able to show that it was the very act of performing the prescribed or authorised activities of your employment that exposed you to the legal expenses. If it is something other than employment duties that exposed you to the legal expenses, the necessary nexus with the earning of assessable income cannot be established and the expenses are not allowable.

You incurred legal expenses in defending yourself against charges that arose whilst performing your employment duties. The legal expenses and damages payments are directly related to the performance of your duties from which you earned your assessable income. Therefore the legal fees and damages payments are deductible under section 8-1 of the ITAA 1997.

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