Edited version of private advice

Authorisation Number: 1052073747910

Date of advice: 22 December 2022

Ruling

Subject: Deduction - legal expenses

Question

Can you claim a deduction for specific legal expenses in accordance with section 8-1 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XY

The scheme commences on:

20XW

Relevant facts and circumstances

You are a sole trader.

You paid legal fees in relation to public statements made about your work.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

All references made in these reasons for decision are to the Income Tax Assessment Act 1997 (ITAA 1997)unless otherwise stated.

Section 8-1 provides that:

8-1(1)

You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

8-1(2)

However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

Paragraphs 4 and 5 of Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions explain:

There is no statutory definition of the term 'incurred'.

As a broad guide, you incur an outgoing at the time you owe a present money debt that you cannot escape.

Legal expenses are deductible provided the legal action:

• arose out of, or concerns the day-to-day income producing activities of the taxpayer
• is not undertaken to protect the taxpayer's profit-yielding subject
• have more than a peripheral connection to the taxpayer's business
• may arise out of litigation concerning the taxpayer's professional conduct.

The character of legal expenses is determined by considering the reason for which the expenses were incurred. In Hallstroms Pty Ltd v. Federal Commissioner of Taxation [1946] HCA 34, Dixon J stated:

The claim is to deduct legal expenses, and legal expenses ... take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or the purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.

In Magna Alloys & Research Pty Ltd v. Commissioner of Taxation of the Commonwealth of Australia [1980] FCA 180 (Magna Alloys), the taxpayer company incurred legal expenses in defending several of its directors and agents who were charged in relation to the marketing practices adopted in selling the company's products. Although the defence was unsuccessful, the Court held that the legal expenses were deductible.

In making their decision, the Court found that expenditure incurred to protect the reputation and goodwill of a business is not of a capital nature where the attack on the reputation arose out of the day-to-day activities of the business. As noted by Brennan J:

Nor was the expenditure an outgoing of a capital nature. The capital of the business was in no way increased by the expenditure incurred. True it is that the expenditure protected the reputation and goodwill of Magna's business, but the attack which was made arose out of the day to day selling activities of that business and it was the business purpose of vindicating the methods by which it was conducted that brings the expenditure within sec. 51(1). Though goodwill is a capital asset of a business it is frequently earned and maintained by the daily activities of those engaged in the business. The valuable if intangible asset of goodwill frequently grows out of activities the cost of which is a charge on revenue account ...

Where expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible. The expenditure in establishing, replacing, and enlarging a business structure is capital expenditure, in contrast to working or operating expenses that are revenue in nature.

Legal expenses are also capital or private in nature where the legal action taken is to protect the taxpayer's personal good name and reputation (NT85/4364 and Commissioner of Taxation [1987] AATA 601).

We have considered your situation. You may claim a deduction in accordance with section 8-1 for the expenditure that you incurred for the legal fees.

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