Edited version of your written advice

Authorisation Number: 1051281647322

Date of advice: 13 September 2017

Ruling

Subject: Work-related expenses

Question 1

Are you entitled to a deduction for legal expenses incurred in defending a criminal charge?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are employed at a government department.

In Month A 20XX you were informed by your manager that you were being stood down from normal duties due to a complaint lodged against you.

The complaint was based on an allegation made by a youth worker that in Month A 20XX, you slapped the alleged victim across the face and back of the head while undertaking work duties.

During the time of the alleged incident, at no point did the alleged victim mention to you or anyone else that you slapped them even though two uniformed police officers were present.

You were charged with common assault.

You sought legal advice from a solicitor to defend the charge.

A barrister was engaged by your solicitor as the matter proceeded to a court hearing.

In Month B 20XX, while your legal representatives were perusing material subpoenaed from your employer, they discovered paperwork which show that the internal investigator had spoken to the alleged victim. The alleged victim did not confirm that you had hit or harmed the alleged victim in any way and that you were merely comforting the alleged victim. There were also photos taken by the investigator which disproved the youth worker’s allegation.

Your barrister informed the prosecutor of the information discovered who then decided that they had no evidence to offer.

The magistrate subsequently dismissed the case against you.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1.

Income Tax Assessment Act 1936 section 51.

Reasons for decision

Summary

You are entitled to a deduction for legal expenses incurred in defending a criminal charge.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income, except to the extent that they are outgoings of a capital, private or domestic nature, or relate to the earning of exempt income.

In determining whether a deduction for legal expenses is allowable 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.

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 (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).

In Elberg v. FC of T (1998) 82 FCR 440; (1998) 98 ATC 4454; (1998) 38 ATR 623 (the Elberg Case), a deduction for legal expenses incurred by a medical practitioner in defending criminal charges of obtaining property by deception arising out of the conduct of her medical practice was allowed, because the expenses related to activities by which the taxpayer earned her income (even though they did not relate to the core activity of medical treatment).

Even though the above case deals with a taxpayer in business, the Full Federal Court in FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, (the Rowe Case) considered that the principles laid down by such cases can still be applied to taxpayers who are not in business. In the Rowe Case, the taxpayer, an engineer employed with a shire council incurred legal costs in defending charges that he was negligent in the manner in which he executed his engineering duties. An independent statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The court accepted here, that legal expenses incurred in defending the manner in which a taxpayer performed their employment duties, were allowable.

In affirming that the legal expenses were allowable, Beaumont J said:

Since the inquiry was centrally concerned with the day to day aspects of the respondent's employment, it ought to be concluded that the respondent's costs of representation before the Inquiry was incurred by him in gaining assessable income.

Further, Burchett J commented:

…these expenses should be recognised as incurred by the respondent in defending the manner of his performance of his duties. It was only by so justifying himself that he could make a successful defence against dismissal. When the matter is seen in this light, it falls squarely within the rule discussed in Putnin v FC of T 91 ATC 4097; (1991) 27 FCR 508. To adapt language there quoted (at ATC 4100; FCR 511) from the Herald and Weekly Times Limited v FC of T (1932) 2 ATD 169 at 170-172; (1932) 48 CLR 113 at 117-119, the liability in question was incurred, or the claim was encountered, because of the very act of performing the work by which the respondent earned assessable income. The activities which produced the assessable income were what exposed the taxpayer to the liability discharged by the expenditure.

The case Putnin v. Federal Commissioner of Taxation (1991) 27 FCR 508; 91 ATC 4097; 21 ATR 1245 (the Putnin Case) involved an accountant working in the insolvency field. As trustee under a particular deed of arrangement, he administered an estate without obtaining an assignment of the debtors share in a company. The share was subsequently dealt with by the debtor. The taxpayer was later charged with conspiring with the debtor to defraud the Commonwealth. He was later acquitted of the charge but incurred legal expenses relating to his defence.

It was held that the legal expenses were deductible under section 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as they were incurred for the purpose of gaining or producing his assessable income. The action arose from the activities by which the taxpayer earned his income and the mode of his performance of a particular task he undertook in the course of business operations. The expense was not considered capital in nature as the criminal proceedings arose in relation to his day to day activities.

It is clear from case law that legal expenses will be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer and are relevant to the performance of the taxpayer's duties. When the principle reason for incurring the legal expenses is defending the actions of the taxpayer in carrying out their employment duties through which they gain or produce assessable income, such expenses are characterised as being of a revenue nature and are deductible (Inglis v. FC of T 87 ATC 2037; and Case V116 88 ATC 737; AAT Case 4502 (1988) 19 ATR 3703).

In your case, you were performing normal duties during your employment when the alleged incident occurred. The legal action in question had more than a peripheral connection to your income producing activities as the activities which produced your income were what exposed you to the charges you were defending. Furthermore, there was evidence uncovered by your legal representatives which disproved the allegations against you. This shows that your conduct was not outside the scope of your duties and by incurring the legal expenses, you were, as in the Rowe case, defending the way you carried out your employment duties.

It is considered that the facts in your case are comparable to the facts in the Rowe Case, the Putnin Case and the Elberg Case. As such, the legal expenses you incurred are deductible under section 8-1 of the ITAA 1997.

Consequently you are entitled to a deduction for the legal expenses you incurred in defending this charge.

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