Edited version of private ruling

Authorisation Number: 1011617120343

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Subject: Deduction for legal and other expenses under section 8-1 or 40-880 of the Income Tax Assessment Act 1997.

Issue 1

Question 1

Whether legal expenses incurred by X Pty Ltd in obtaining and subsequently defending a planning permit for the expansion and additions to an existing hotel building are deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

No.

Issue 2

Question 1

If no to question 1, are the legal expenses and other ancillary expenses incurred by X Pty Ltd during the course of action such as architect fees, traffic engineers and expert witnesses deductible under section 40-880 of the ITAA 1997?

Advice/Answers

No.

Relevant facts

X Pty Ltd as trustee of Y Trust operates a business from a multiple storied building.

As part of X Pty Ltd's business expansion plans, it was decided to add further levels and ancillary facilities to its existing building structure.

The relevant council issued a Notice of Decision to Grant a Planning Permit. The Notice was sent to surrounding premises informing them of the Council's decision. A number of objections were lodged with the relevant state tribunal.

X Pty Ltd have engaged a number of consultants in connection with this project and incurred the following expenditures:

§ architect fees;

§ fees for expert witness providing strategic advice on best ways to defend its position at the hearing; and

§ legal fees in respect of legal work in connection with obtaining the Planning Permit and the tribunal appeal process.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 40-880

Income Tax Assessment Act 1997 subsection 40-880(1)

Income Tax Assessment Act 1997 subsection 40-880(2)

Income Tax Assessment Act 1997 paragraph 40-8805(b)

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 subsection 43-10(2)

Income Tax Assessment Act 1997 section 43-20

Income Tax Assessment Act 1997 section 43-30

Income Tax Assessment Act 1997 subsection 43-70(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Issue 1

Question 1

Summary

The legal expenses X Pty Ltd has incurred are not deductible under section 8-1 as they are considered to be outgoings of a capital nature.

Detailed reasoning

Legal expenses that are not deductible under specific provisions of the ITAA fall for consideration under section 8-1.

Section 8-1 allows a general deduction for a loss or outgoing to the extent that it is necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed where the outgoings are 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, 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 the present case, the building is a profit yielding structure of X Pty Ltd's business and X Pty Ltd incurred the legal expenses for the purpose of expanding its business by adding additional levels in that building. The legal expenses, however, do not arise out of X Pty Ltd's day to day activities. Whether or not the buildings permit will be granted ultimately, there is no real threat to X Pty Ltd's current income earning operation. Therefore, the legal expenses are of capital nature.

As the legal expenses are of capital nature, X Pty Ltd would not be entitled to a deduction for these legal expenses under section 8-1.

Issue 2

Question 1

Summary

The legal expenses incurred in obtaining and subsequently defending a planning permit for the expansion and additions to an existing building and other ancillary expenses incurred during the course of action are not deductible under section 40-880 as these expenses are deductible under Division 43.

Detailed reasoning

The provision for determining whether certain capital expenditure is deductible over five years is section 40-880.

Under subsection 40-880(1), capital expenditure that is not otherwise deductible and that relates to a business that was or is proposed to be carried on for a taxable purpose is deductible over five years provided the deduction is not denied by some other provision.

Subsection 40-880(2) provides that:

You can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur:

a) in relation to your business; or

b) in relation to a business that used to be carried on; or

c) in relation to a business proposed to be carried on; or

d) to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary that carried on a business.

Paragraph 40-880(5)(b) states that one cannot deduct anything under this section for an amount of expenditure incurred to the extent that you can deduct an amount for it under a provision of this Act other than this section.

Division 43 allows a taxpayer to deduct certain capital expenditure (qualifying expenditure) on assessable income producing buildings, or an extension, alteration or structural improvement to those income producing buildings. One can only claim deductions for the period during the year that the property is rented or is available for rent.

Section 43-20 recognises three categories of capital works which are entitled to a deduction under Division 43. These categories are:

§ buildings or extensions, alterations or improvements to buildings;

§ structural improvements or extensions, alterations or improvements to structural improvements; and

§ environment protection earthworks.

Subsection 43-70(1) defines construction expenditure as capital expenditure incurred in respect of the construction of capital works.

Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements establishes the ATO view on matters that are relevant in determining entitlement to a deduction under Division 43.

The types of construction expenditure referred to in Taxation Ruling TR 97/25 include all costs incurred in the actual construction of capital works. Paragraph 9 of TR 97/25 considers that construction expenditure which is deductible under Division 3 includes preliminary expenses such as architect fees, engineering fees, foundation excavation expenses and costs of building permits.

ATO Interpretative Decision ATO ID 2006/213 Income tax: Capital Allowances: capital works - construction expenditure - preliminary expenses provides the ATO view on expenses which are considered to be preliminary regarding construction expenditure that are deductible under Division 43.

In ATO ID 2006/213, the expenditure incurred by a builder of a residential unit complex in South Australia on an insurance policy that insures the owner of the residential unit complex against the risk of loss from the building not being completed is included in construction expenditure as defined in subsection 43-70(1). In particular, the insurance policy must be obtained to permit the building work on the capital works to commence and has a direct connection with the construction of the capital works.

In the present case, in order for the extension to the building to commence, X Pty Ltd requires the approval of the planning permit. The costs of the planning permit, and the legal expenses and fees for the expert witness, traffic engineers and architect that X Pty Ltd incurred to obtain and defend the planning permit are capital expenditure in relation to it's business, which satisfies subsection 40-880(2).

However, as mentioned above, paragraph 40-880(5)(b) disallows the deduction under section 40-880 if this deduction is allowed under another provision of the ITAA 1997. In this case, these expenses are deductible under Division 43 and therefore not deductible under section 40-880.

The cost of building permits, as specified in Taxation Ruling TR 97/25, is deductible under Division 43. X Pty Ltd incurred the legal fees for the purpose of obtaining and subsequently defending the planning permit. Likewise to the expenditure on the insurance policy in ATO ID 2006/213, X Pty Ltd's legal fees in obtaining and defending planning permit have a direct connection with the extension of the building. Therefore, these legal expenses are construction expenditure that are deductible under Division 43.

Similar to the legal expenses, the fees incurred for expert witness providing strategic advice on best ways to defend X Pty Ltd's position at the hearing also has a direct connection with the extension of the building as it assists it in defending the planning permit. These fees are therefore construction expenditure. Architect fees and traffic engineers are also categorised as construction expenditure according to TR 97/25.

Since these expenses are construction expenditure and X Pty Ltd is entitled to a deduction under Division 43, it is not entitled to a deduction for theses expenses under section 40-880 as paragraph 40-880(5)(b) specifically states that one may not deduct an expense under section 40-880 if the expense can be deducted under another provision of ITAA 1997.

However, under section 43-30, X Pty Ltd cannot claim an amount of the construction expenditure until the construction is completed.