Edited version of private advice

Authorisation Number: 1052389633581

Date of advice: 29 May 2025

Ruling

Subject: Legal expenses

Question 1

Is the Partnership entitled to claim a deduction for legal fees incurred for obtaining legal right of carriageway under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No. The legal fees were not incurred in connection with the income producing activity of the Partnership. The legal fees were incurred to protect a right connected to a CGT asset, hence are capital in nature and not deductible under section 8-1 of the ITAA 1997. The expenses will form part of the cost base of the CGT asset for the purpose of determining any capital gains or losses when the asset is sold pursuant to subsection 110-25(6) of ITAA 1997.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Individual A and Individual B purchased vacant land in 19XX.

Individual A and Individual B built a residential dwelling on the land shortly after the purchase and lived there for about a year (the land and the house collectively referred to as the Property).

Since its acquisition, the Property was accessed from a sealed public road, over an approximately nine-kilometre route consisting of a combination of rights of carriageway, crown roads and an existing track on the neighbouring land owned by a third-party entity (Defendant).

Individual A and Individual B leased out the Property from approximately 19XX and received rental income.

Individual A and Individual B then registered their Partnership in April 20XX. The Partnership registered for GST in July 20XX. The exact termination date of the lease is unknown.

In 20XX, the Defendant locked the gates on the Defendant's land making the Property inaccessible to Individual A and Individual B's tenants. As the Property was no longer accessible, the tenants left the Property. The Property has not been rented since the Defendant locked the gates.

In the 20XX income year, Individual A and Individual B took legal action against the Defendant under section 88K of the Conveyancing Act 1919 (NSW) for a statutory easement in the form of a carriageway over part of the Defendant's Land.

The Supreme Court ruled in favour of Individual A and Individual B and the legal right of carriageway on the Defendant's land was registered on the Property's title. Individual A and Individual B received keys to the gate locks on the Defendant's land and were able to access the Property in 20XX.

The Partnership's ABN and GST registration had been cancelled in 20XX. However, the Partnership intends to reinstate its ABN.

The Partnership incurred legal expenses during the relevant years.

The Partnership intends to sell the Property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 110-25(6)

Reasons for decision

Issue

Business - legal fees - easement

Question

Is the Partnership entitled to claim a deduction for legal fees incurred for obtaining legal right of carriageway under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

No. The legal fees were not incurred in the income producing activity of the Partnership. The legal fees were incurred to protect a right connected to a CGT asset, hence are capital in nature and not deductible under section 8-1 of the ITAA 1997. The expenses will form part of the cost base of the CGT asset for the purpose of determining any capital gains or losses when the asset is sold pursuant to subsection 110-25(6) of ITAA 1997.

Detailed reasoning

Section 8-1 of the 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, or private or domestic in nature.

In determining whether a deduction is allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v FC of T [1946] HCA 34; (1946) 72 CLR 634; (1946) 8 ATD 190 per Dixon J page 647-648). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses.

Where the legal expenses arise as a consequence of the day-to-day activities of a business, the object of the expenditure is generally revenue in nature and the legal expenses are deductible under section 8-1 of ITAA 1997 (Herald & Weekly Times v FC of T [1932] HCA 56; (1932) 48 CLR 113; (1932) 2 ATD 169).

Where, however, the expenditure is devoted towards the business entity, structure or organisation rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible. In Sun Newspapers Ltd v FC of T [1938] HCA 73; (1938) 61 CLR 337; (1938) 5 ATD 87), the High Court set down the following guidelines for determining whether a loss or outgoing is of capital nature:

•                the expenditure is related to the business structure itself, that is, the establishment, replacement or enlargement of the profit-yielding structure rather than the money earning process, or

•                the nature of the advantage has lasting and enduring benefit, or

•                the payment is 'once and for all' for the future use of the asset or advantage rather than being recurrent and ongoing.

Capital expenditure incurred by a taxpayer to establish, preserve or defend their title to an asset, or a right over an asset forms the fifth element of the cost base of the asset under subsection 110-25(6) of the ITAA 1997.

An easement is a right over someone else's land or property. It is an asset which is created at the time it is granted.

Application to the taxpayers' circumstances

At the time the legal expenses were incurred, the Partnership's ABN has already been cancelled. Nonetheless, we consider that the legal expenses did not arise as a consequence of the day to day rental activities of the Partnership. Individual A and Individual B incurred legal expenses to gain statutory easement on the Defendant's land. The easement granted by the court allowed Individual A and Individual B to enter and navigate their Property through the Defendant's land. The easement provides lasting and enduring benefit over the Property. Therefore, the legal fees incurred are capital in nature.

The Commissioner understands that, although Individual A and Individual B may have suffered a loss of rental income due to being unable to access the Property, these costs were incurred to protect a right connected to a CGT asset and are not deductible under section 8-1 of the ITAA 1997. Since these expenses were incurred to preserve Individual A and Individual B's right of access over an asset, it forms part of the cost base of the asset when it is sold, pursuant to subsection 110-25(6) of the ITAA 1997.

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