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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your private ruling

Authorisation Number: 1012567209098

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for the legal expenses incurred?

Answer

No.

Question 2

Are you entitled to a capital loss for legal expenses incurred?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You were an employee at a firm.

Clientele followed you from firm to firm.

Your initial employer asserted that a restraint of trade agreement had been breached and commenced action against you.

You incurred legal fees defending yourself.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 102-20

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 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).

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.

Taxation Ruling TR 2000/5 sets out the Commissioner's view of the application of section 8-1 of the ITAA 1997 to costs incurred by employees and employers in preparing and administering employment agreements. Employment agreements are a written, legal and binding confirmation of the employer/employee relationship (paragraph 11 TR 2000/5).

As outlined in TR 2000/5, a deduction is allowed for an employee for costs associated with settlement of disputes arising out of an existing employment agreement including the cost of representation. Your employment agreement with your previous employer is no longer current. Therefore your disputes do not arise out of an existing employment agreement.

In your situation, you were defending action taken by your previous employer. The action by your former employer was to enforce a restraint of trade clause in your previous employment agreement. The action was not prompted or caused as a consequence of the performance of your then current duties.

The expenses you incurred did not relate to the duties of your previous employment or your new employment and therefore, not incurred in earning your assessable income from either.

Although the claims may relate in part to the period of time you worked with your previous employer, the nexus to your income earning activities with your previous employer is not sufficient.

Therefore, you are not entitled to a deduction for the legal expenses incurred under section 8-1 of the ITAA 1997.

Capital losses

Under section 102-20 of the ITAA 1997 you make a capital gain or capital loss as a result of a capital gains tax (CGT) event.

CGT events are the different types of transactions or events involving a CGT asset.

A CGT asset is:

In your case, you do not hold a contractual right or any other relevant CGT asset.

Therefore the CGT provisions do not apply and you are not entitled to a capital loss for the legal expenses incurred.

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