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Edited version of your private ruling
Authorisation Number: 1012564441596
Ruling
Subject: Deduction for legal expenses
Questions:
Are you entitled to a deduction for legal expenses incurred in pursuing funds which were misappropriated from your company?
No.
This ruling applies for the following periods
Year ended 30 June 2012
Year ended 30 June 2013
Year ended 30 June 2014
Year ended 30 June 2015
The scheme commences on
1 July 2011
Relevant facts and circumstances
A sum of money was misappropriated from your company.
You have incurred legal expenses attempting to recover the misappropriated money.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 8-1
Anti-avoidance rules
The application of Part IVA of the ITAA 1936 has not been considered as this topic is in the Personal Tax low-risk of Part IVA topics list as specified in ORCLA.
Detailed reasoning
Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for expenditure to the extent that it is incurred in the gaining or producing of assessable income, or in the carrying on of a business to gain or produce assessable income. No deduction is allowable to the extent that the expenditure is private, domestic or capital in nature.
In determining whether a deduction for legal expenses is allowable under section 8-1, 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.
Where the legal expenses arise as a consequence of the day to day activities of a business, the object of the expenditure is devoted towards a revenue end and the legal expenses are deductible (Herald & Weekly Times v FC of T 48 CLR 113; 2 ATD 169). Where, however, the expenditure is devoted towards a structural rather than operational purpose, the expenditure is of a capital nature and the expenses are not deductible (Sun Newspapers Ltd v FC of T (1938) 61 CLR 337; 5 ATD 87).
In your case, you incurred legal expenses to attempt to recover money misappropriated by an individual assisting you.
As such, the legal expenses are of a capital nature and are not deductible under section 8-1 of the ITAA 1997.
CGT consequences
Whilst the legal expenses are not an allowable deduction under section 8-1 of the ITAA 1997, the legal expenses may be included in the capital loss calculations.
The cost base and reduced cost base of a CGT asset each consist of five elements. The second element of the cost base and reduced cost base each comprise of incidental costs an entity incurs to acquire a CGT asset or that relate to a CGT event. The term 'incidental costs' is defined in subsection 110-35(2) of the ITAA 1997 to include remuneration for the services of a legal adviser.
In your case, you incurred legal expenses in pursuing the recovery of the misappropriated funds. Therefore these costs should be included in the second element of the cost base.
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