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Edited version of your written advice
Authorisation Number: 1051449518297
Date of advice: 15 November 2018
Ruling
Subject: Legal fees
Question
Are the legal expenses you incurred in respect of ‘the Supreme Court Proceeding’ deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
Yes, the legal expenses are deductible under section 8-1. This is because they were incurred in gaining or producing the taxpayer’s assessable income, and are neither capital nor private in nature.
This ruling applies for the following periods:
Year ending 30 June 2015
Year ending 30 June 2016
The scheme commences on:
1 July 2014
Relevant facts and circumstances
● You are an Australian resident individual taxpayer.
● Between 1 July 20XX and 30 June 20XX, you incurred legal fees with a Law Firm in relation to court proceedings arising out of the operation of certain schemes by the company, in respect of which you were a director. The period of operation of the schemes was from 1 July 19XX through to 30 July 20XX.
● The legal work was undertaken by your Solicitors pursuant to a costs disclosure letter provided to you in 20XX.
● You also incurred legal fees with your Law firm in the 20XX and 20XX income years in relation to other areas of work, but those fees are not the subject of, and have been excluded from, this application.
The work carried out falls into three broad categories. Legal expenses incurred in the third category relate to the matters described as the Supreme Court Proceeding. On July 20XX certain companies in the group commenced proceedings against you in the Supreme Court.
The legal fees you incurred in FYXX related broadly to consideration of the merits of the plaintiffs’ claim and related matters.
The legal fees you incurred in FYXX also related to certain procedural matters.
● Prior to 20XX, you returned amounts in your tax returns as distributions from ‘Various Joint Ventures’. No amounts were included in your assessable income from salary and wages or personal services income.
● The distributions in the years ended 30 June 20XX to 30 June 20XX arose from your role in the operation of the schemes.
● Broadly, the schemes involved commercial property development and recruiting investors for the schemes. Your role involved managing and operating the schemes.
● You received and recorded distributions from the scheme companies as assessable income in your tax returns.
● You did not receive any payments from any of the companies in the group from the year ended 30 June 20XX to the year ended 30 June 20XX inclusive.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Summary
The legal expenses were incurred for the purpose of defending the manner in which you carried out your role as a director from which you derived assessable income. The expenses were not of a capital or private nature. Therefore the legal expenses that relate to the Supreme Court Proceeding are deductible under section 8-1.
Detailed reasoning
Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.
Therefore, in determining whether a deduction is allowable under section 8-1, the nature of the expense must be considered.
For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations, (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).
Further, legal expenses are generally deductible if the expenses 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 your case, certain companies in the group commenced proceedings against you in the Supreme Court.
You incurred legal expenses in defending yourself against these claims.
The legal expenses relate to your role as a director and we accept that you were remunerated for this role.
In incurring the expenses you were seeking to defend the manner in which you carried out these roles (actual and imputed). As such, it would be reasonable in these circumstances that the legal expenses are fully deductible under section 8-1:
● the legal expenses have a sufficient connection with the activities by which you gained or produced your assessable income (as you received remuneration which we accept was paid to you in your capacity as a director); and
● the legal expenses are of an income nature as they were incurred for the purpose of defending actions that were undertaken by you in carrying out your directorship (ie defending actions that were undertaken by you in your roles as a director/trustee).
The objective purpose in defending the charges the subject of the Supreme Court Proceeding was to defend the way in which you carried out your role as a director in the group companies. As such, the legal expenses were incurred in gaining or producing your assessable income for the purposes of section 8-1.
The legal expenses are not capital in nature. They arose out of your day to day business activities and conduct as a person operating unregistered managed investment schemes. They do not relate to the acquisition or preservation of any structural asset.
We also consider that the legal expenses are not private in nature. While the Commissioner states in the Decision Impact Statement for FCT v Day [2008] HCA 53 that ‘costs of defending criminal charges will rarely, if ever, be deductible under section 8-1’, we consider that the exception to this general rule is where the charge is brought under a provision of a statute that the taxpayer is subject to only by virtue of their employment or income earning activities. In your case, defending charges brought under the Corporations Act 2001 qualify as being charges arising under legislation specific to your income earning activities as a company director. As such, the expenses cannot be characterised as being of a private nature.
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