CASE 61/96

Members:
BM Forrest DP

Tribunal:
Administrative Appeals Tribunal

Decision date: 4 October 1996

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BM Forrest (Deputy President)

This is an application for review of an objection decision disallowing a deduction claimed by the taxpayer of $60,000 for legal expenses in defending criminal proceedings during the income year ended 30 June 1993. The claim was made under s. 51(1) Income Tax Assessment Act 1936 (``the Act'') on the basis they were necessarily incurred in carrying on the business of a medical practitioner for the purpose of gaining or producing assessable income and that they were not outgoings of capital or of a capital private or domestic nature.

The Commissioner disallowed the deduction on the basis that the legal expenses were outgoings of a capital nature.

Substantiation of the quantum of the claim which was also in issue was put to one side pending determination of the deductibility issue.

At the hearing the taxpayer was represented by her husband, and by her accountant, Ms Galgani. Mr Moshinsky of counsel appeared for the Commissioner. The Tribunal had before it the documents lodged with the Tribunal pursuant to s. 37 of the Administrative Appeals Tribunal Act 1975, together with materials provided by the taxpayer as part of her statement of Facts and Contentions.

The taxpayer is a general medical practitioner in private practice. At the time the taxpayer was also a part-time medical officer employed by the State of Victoria at a centre for the intellectually disabled (``the Centre'') a position she had held for a number of years.

In 1991 a taskforce established by the State government investigated the affairs of the staff

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at the centre, including the taxpayer. These investigations led to the taxpayer being charged with 54 counts of dishonestly obtaining property by deception contrary to s. 81 of the Crimes Act 1958 (Vic.). The charges covered the period from 26 July 1990 to 11 July 1991 and in substance alleged that the taxpayer obtained property by deception by holding herself out to be present on duty at the centre and obtaining payment when she was deriving income from her private practice. The offences were indictable. The prosecution and the taxpayer had apparently agreed to have the charges dealt with summarily in the Magistrates' Court but the Magistrate decided to remit the matters for committal. During the second day of the committal proceedings the prosecution offered to withdraw, the committal was converted into a summary hearing and all charges were dismissed.

The taxpayer claimed she expended a total of $102,800 in legal costs defending the charges, $42,800 in the income year ending 30 June 1992 and $60,000 in the income year ending 30 June 1993. For 1992 year, the taxpayer sought a ruling on the deductibility of the $42,800 legal expenses claimed in that year. The ruling denied deductibility and the taxpayer then objected to her assessment. The objection was allowed and the taxpayer received an amended assessment on 27 March 1995 allowing the deduction. For 1993 year, the taxpayer requested a Private Ruling on the deductibility of $60,000 legal expenses. The background facts recited in the application for the ruling were said to be:

``Because of the financial pressures facing the centre, the taxpayer was approached in October, November 1990 to resign her position. After that date, there were a number of discussions between representatives of Community Services Victoria and the taxpayer. These discussions were never fruitful and were developing to the stage where the representatives from Community Services Victoria were pressuring the taxpayer to resign by using threats to withdraw her right to private practice. This matter further developed when a taskforce appointed by the State Government began investigations into the affairs of the staff and in the taxpayers case, with the intent of obtaining information which might force the taxpayer to resign. This culminated with the charge of obtaining property by deception.''

On 30 May 1995, the respondent issued a Private Ruling as follows:

``The legal expenses are not an allowable deduction. The $60000 in legal expenses incurred represent the protection of a structural asset and the right to practise a profession (as a medical practitioner). As such the amount is viewed as a capital item and therefore not an allowable deduction under Section 51(1) of the Income Tax Assessment Act (1936).''

The taxpayer objected to her assessment which the Commissioner subsequently disallowed. The taxpayer then applied to this Tribunal for review.

The fact the Commissioner made inconsistent assessments does not give rise to any issue of estoppel:
FC of T v Rowe 95 ATC 4691 at 4699; (1995) 131 ALR 622 at 630.

It was contended on behalf of the taxpayer that her right to practice was not under threat if convicted as charged, and therefore the purpose of her incurring legal expenses to defend the charges was not to protect the capital asset (her right to practice as a medical practitioner) but her reputation, and an income source (her employment at the centre) as well as avoiding a conviction and penalty for the offences.

It was also contended on behalf of the taxpayer that the offences for which she was charged were not related to her practice as a medical practitioner and misconduct in that role, but revolved around alleged conduct as part of her employment by the centre and in the function of her daily activities as an employee.

In submissions on behalf of the Commissioner, Mr Moshinsky sought to rely on a letter dated 10 February 1994 from the taxpayer's former accountants to the taxation office in support of his contention that the expenditure for legal expenses was of a capital nature. The letter read in part:

``If the taxpayer had have been convicted of this charge the taxpayer's right to practice would have been withdrawn and the taxpayer would not have been able to derive assessable income.''

This comment was also contained in the information supplied by the accountants with the application for a private ruling.

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In her evidence the taxpayer sought to distance herself from her accountants letter. When questioned about it she stated that if convicted of the offences, she would not have to face automatic deregistration, as the offences did not involve her patient responsibilities. She was unaware that her former accountants had sent the letter as she tried to be involved in the process as little as possible. It had been brought to her attention that she could face a gaol sentence if convicted, and it was this possibility as well as her professional reputation that she was trying to protect in defending the charges. The possibility of deregistration was not considered, she said.

The taxpayer's stated belief that if convicted, she would not be deregistered received some support from Mr Smith, Registrar of the Medical Practitioners Board of Victoria (``the Board'') who was called by the Commissioner. Possible courses of action under the now repealed Medical Practitioners Act 1970, in operation at the time the offences were said to have taken place, were reprimand, imposition of conditions, limitations or restrictions, suspension, deregistration and/or imposition of a fine (s. 17). Mr Smith indicated that based on his 13 years experience with the Board, there would be little likelihood of deregistration, with the more probable outcome being reprimand or a short suspension from practice in the event of the taxpayer being convicted of the charges she faced.

In submissions reference was made to a number of cases which discussed the criteria to be applied in endeavouring to distinguish whether the outgoings are of a revenue or capital nature.

In
Associated Newspapers Ltd v FC of T; Sun Newspapers Ltd v FC of T (1938) 5 ATD 87 at 96; (1938) 61 CLR 337 Dixon J. (at 363) in the oft quoted passage discussed various tests and added:

``There are, I think, three matters to be considered, (1) the character of the advantage sought, and in this its lasting qualities may play a part, (2) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (3) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future loss or enjoyment.''

The taxpayer relied on a number of cases which held that legal expenses which are incurred in proceedings which do not imperil ``the existence of the business or the capital assets'' (
FC of T v Snowden & Willson Pty Ltd (1958) 11 ATD 463 at 465; [1958] 99 CLR 431 at 437) and thus the ``profit-yielding subject'', are appropriately classified as revenue expenses. One such case was the Full Federal Court decision in
Magna Alloys & Research Pty Ltd v FC of T 80 ATC 4542; (1980) 49 FLR 183. In that case, criminal proceedings were brought against three directors of the taxpayer company in relation to the payment of secret commissions in the course of the company's business. The taxpayer expended money in defending the charges. It was held this expenditure was deductible. Brennan J. (at ATC 4554; FLR 201):

``... 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).''

In a joint judgment Deane and Fisher JJ. said (at ATC 4562; FLR 213):

``Except in the most indirect way, the criminal proceedings imperilled neither the business nor the capital assets of the taxpayer... The criminal proceedings in respect of which the outgoings were incurred arose out of the day to day business activities of the taxpayer. The outgoings did not involve the acquisition of any enduring or tangible asset.''

In
Putnin v FC of T 91 ATC 4097, the taxpayer, an accountant acting as trustee under a deed of arrangement, was charged with conspiring to defraud the Commonwealth. He claimed a deduction for legal expenses incurred in defending the charge. The Full Federal Court (Burchett, French and Lee JJ.) said (at 4,102):

``In the argument presented to this Court, great emphasis was laid on the possibility that the taxpayer might, if he had been convicted, have incurred professional

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censure and cancellation of his registration as a trustee in bankruptcy or as an official liquidator. As a result, his partnership might have been dissolved. But these were all indirect consequences that might or might not have happened. They were neither the object of the prosecution, nor could it be said they would inevitably have followed upon its success. As in Magna Alloys & Research, the criminal proceedings arose from the activities by which the taxpayer earned his income, the mode of his performance of a particular task carried out in the course of business operations. Something of that kind is quite remote from capital, and the outgoings secured for the applicant no enduring or tangible asset.''

In FC of T v Rowe, the respondent, a shire engineer was suspended from his employment and was required by the council to show cause why he should not be dismissed. At the instigation of the Director of Local Government an inquiry was conducted into the matters the subject of the suspension. The members of the Full Federal Court found that the respondent's legal costs at the inquiry were an outgoing incurred in gaining assessable income under the first limb of s. 51(1). Burchett J. said (at ATC 4702; ALR 634):

``... I think these expenses should be recognized as incurred by the respondent in defending the manner of his performance of his duties.''

In Case V116,
88 ATC 737 the Tribunal held that expenses incurred by a director in defending a defamation action were incurred (at 740):

``... as directly related to the performance of his duties as a director, and thereby his income-earning activities,...''

Case U4,
87 ATC 122 concerned a medical practitioner who incurred costs in defending charges for an offence under the Health Insurance Act. If he had been convicted and gaoled, he would have been automatically deregistered. The Tribunal held that legal costs in defending the charges were deductible (at 124):

``... Notice was taken of the fact that if convicted, this taxpayer could have been fined or gaoled, and, if gaoled, the outcome would be automatic deregistration. It is not for us to speculate on the likely and, indeed, hypothetical outcome had the taxpayer been convicted. The outgoings were, in a real sense, directed towards preserving his earning capacity,...''

Other cases have found that if the proceedings did imperil the ``profit-yielding subject'' or capital asset, then legal expenses incurred in defending or participating in the proceedings will normally be held to be capital expenditure and thereby not deductible. In arriving at a decision, it is:

``... absolutely necessary to view the nature of the proceedings in respect of which the expenses were incurred, to determine whether the likely outcome threatened the existence of a structural asset....

...

An objective consideration of the nature of the facts involved will give an indication of whether the structural asset is at risk.''

(Case X84,
90 ATC 609, at 614)

The Tribunal in Case X84 casts doubt upon the correctness of Case U4. Case X84 concerned a taxpayer who was a medical practitioner, registered to practice in New South Wales and South Australia. He incurred legal expenses in defending criminal charges relating to his practice, which subsequently led to deregistration proceedings before a medical disciplinary tribunal in New South Wales. He was deregistered and failed in an appeal to the Supreme Court. He moved to South Australia, and further legal expenses were incurred in proceedings before the disciplinary tribunal there, but he was successful in retaining registration in South Australia. He incurred further legal expenses in defending criminal charges relating to his practice in South Australia. He claimed deductions for the legal expenses incurred.

The Tribunal observed (at 613):

``... In all cases, the applicant has said in his returns, in his objections and in his evidence that it was necessary to defend the proceedings brought against him because failure would have resulted in his deregistration as a medical practitioner thereby depriving him of his sole source of income. In each of the proceedings referred to, he had a real fear of this result. In New South Wales, as it transpired, that fear was justified.''

and (at 614) that the taxpayer:

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``... was risking his continuing right to derive his principal source of income through the practice of his profession.... the charges brought were of such seriousness that any observer must have viewed them as a serious risk to the fundamental right to practise. That being so, expenses incurred in defending that right must be regarded as capital expenses.''

In Case N65,
81 ATC 335, a chemist had claimed a deduction for legal expenses incurred in proceedings before a Pharmacy Board which had cancelled his registration. The Tribunal held (at 339, 340) in applying the Sun Newspapers test:

``... we are of the opinion that the outgoings, being incurred... in an endeavour to preserve intact the business structure that the taxpayer had set up... represent outgoings of capital or of a capital nature....

...

... We are satisfied that the principal object of the expenditure in issue was to preserve the taxpayer's existing business organisation from dislocation and impairment....

...

... what was at stake was the continued existence of the business and the retention of the taxpayer's right to carry on business as a pharmaceutical chemist.''

In Case V140,
88 ATC 875, the taxpayer, a solicitor had claimed a deduction for the costs of the Law Society he was required to pay in proceedings resulting in a suspension from practice. The Tribunal found (at 878):

``... the obligation to pay the Law Society's costs was fundamental to the applicant's continuing right to derive his principal source of income through the practise of his profession. It was not a peripheral or incidental obligation of his practice. That right or privilege to earn money through certain activities, prohibited to those not similarly licensed, can be regarded as a profit-yielding subject or as a structural asset. Expenses of defending or acquiring structural assets are capital expenses.''

In Case 36/95,
95 ATC 327 the taxpayer, a former state parliamentarian who had resigned to take up a newly created public service position, claimed a deduction of $65,000 for legal representation before the Independent Commission against Corruption which investigated his resignation and appointment. The Tribunal held that the expenditure was of a capital nature. The proceedings threatened the ``very existence of his future enduring advantage'' (at 330):

``... the applicant's expenditure could not be fairly classified as working expense, arising out of his day to day business activities... By preparing for the investigation by the Commission and retaining legal representatives for that purpose, the applicant hoped to resolve the propriety of his actions once and for all so that he would have the benefit of any favourable decision indefinitely. Such expenditure, when viewed in this light, is clearly of a capital nature.''

In examining the character of the advantage sought, (Sun Newspapers) the Tribunal is required to look objectively at the nature of the offence and the surrounding facts to determine if the structural asset is at risk. The offences were of a serious nature, alleging dishonesty. Section 81 of the Crimes Act 1958 (Vic.) provided:

``81(1) A person who by any deception dishonestly obtains property belonging to another, with the intention of permanently depriving the other of it, is guilty of an indictable offence and liable to imprisonment for a term not exceeding ten years.''

There seems little doubt that faced with the charges, the taxpayer was concerned about her reputation, her income source as well as the potential consequences of a conviction. Loss of an income source at the centre was a factor although against the backdrop of financial constraints at the centre and the likelihood she would eventually have to resign her employment indicate that protecting that source of income was a less important consideration.

While the taxpayer asserted at the hearing that the possibility of deregistration was not a consideration in incurring legal costs to defend the charges, looking at the facts of the matter, I think it probable that the taxpayer, faced with serious charges and with a private medical practice from which she derived in excess of fifty per cent of her income, was anxious to protect her right to practise from any impingement. That this was an object in view in defending the charges (including briefing two

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counsel) is I think clear enough from all of the material before the Tribunal.

Cases such as Magna Alloys and Putnin v FC of T are instances where the proceedings giving rise to the claim for a deduction arose out of the day to day activities of the taxpayer but did not imperil the taxpayers ``profit-yielding subject'' nor secure for the taxpayer any enduring or tangible asset. While in the present case the offences arose out of the performance of the taxpayer's duties and activities under her employment contract at the centre, they were at the time perceived to represent a risk to her right to practise and impelled the taxpayer to undertake the expense she did. I do not think the expenses could be classified as purely a working expense arising out of daily business activities. The expenses were in large measure to protect an enduring benefit.

Consequently I do not think that it can be said the legal expenses were peripheral to the taxpayer's right to practise. This conclusion also distinguishes the present case from cases such as FC of T v Rowe where the taxpayer was earning recurrent payments solely as an employee. In the present case more than half the taxpayer's income was derived from her private practice.

For these reasons and given that the burden of proof imposed upon the taxpayer under s. 14ZZK Taxation Administration Act 1953 has not been discharged, the decision under review is affirmed.