Edited version of private ruling

Authorisation Number: 1011631227810

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Ruling

Subject: Legal expenses

1. Are you entitled to claim a deduction for legal expenses incurred in reviewing a decision by the Australian Securities and Investment Commission (ASIC) made under the Corporations Act 2001 (CA)?

Yes.

2. Are you entitled to claim a deduction for legal expenses incurred in action taken to have your name withheld in the subsequent proceedings to review ASIC's decision?

No.

This ruling applies for the following period

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commenced on

1 July 2008

Relevant facts

You were employed in an industry regulated by ASIC.

ASIC claimed that you contravened sections of the CA in the course of your day to day activities.

There is no suggestion that you profited personally from any of the alleged breaches.

Following an investigation, ASIC issued a Notice of Hearing giving you an opportunity to give evidence and make submissions in relation to the allegations.

Your legal representatives sought a stay of the proposed hearing until after a determination of possible criminal proceedings against you.

The stay was not granted and at the hearing your legal representatives generally submitted that you had no case to answer and again submitted that any decision should be deferred until a determination was made in relation to possible criminal proceedings.

ASIC made a reviewable decision under the CA in relation to disciplinary action.

You applied to the Administrative Appeals Tribunal (AAT) for a stay of the decision pending a review and a stay was granted along with a non-publication order protecting your identity.

The AAT further stayed the hearing of your application, pending possible criminal proceedings on the same issue.

With no determination being made on possible criminal action the AAT handed down its decision affirming ASIC's decision in relation to the disciplinary action.

You then appealed the AAT's decision in the Federal Court.

The Federal Court stayed the AAT's decision and continued the suppression order protecting your identity until a hearing could be held.

At the hearing, the Federal Court dismissed your appeal with costs.

As a result of these and other related actions, you incurred legal costs.

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income. However, where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income they will not be deductible.

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436). Legal expenses take the nature of an outgoing of a capital nature or an outgoing of a revenue nature from the purpose of incurring the expenditure. It is necessary to consider the reason for which legal expenses are incurred, that is the object in view when the legal proceedings were undertaken or the situation which impelled the taxpayer to undertake them.

It follows also that the character of legal expenses is not determined by the success or failure of the legal action.

Review of decision in relation to the disciplinary action

In Federal Commissioner of Taxation v. Rowe (1995) 60 FCR 99; 95 ATC 4691; (1995) 31 ATR 392 the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties, in order to defend the threat of dismissal, were allowable. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income. 

In the recent High Court decision in Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064 (Days case), Mr Day was charged with breaching the standards of conduct and failing to fulfil his duty as an officer. It was found that the requisite connection with his assessable income was present and that he was exposed to the charges by reason of his office. The majority approach in this case was that an expense will satisfy the test outlined in paragraph 8-1(1)(a) of the ITAA 1997 if the occasion of the expense is found in whatever is productive of actual or expected income. They indicated that a broad approach should be taken in determining what activities produced the actual or expected assessable income, and that it is not only the day to day tasks performed by the employee that gain or produce this income.

In your situation, it is accepted that the initial action, the decision in relation to the disciplinary action, was initiated by ASIC. You necessarily incurred expenses having that decision reviewed. You were required to defend the way in which you performed your day to day duties and it is accepted you incurred the legal expenses with this objective purpose. Accordingly, you are entitled to a deduction for the legal expenses you incurred in having the ASIC decision reviewed under section 8-1 of the ITAA.

Identity suppression orders

Generally, a person's reputation is considered to be a capital or private asset.

In Kratzmann v. FC of T 70 ATC 4043; (1970) 1 ATR 827, the taxpayer incurred legal expenses in court proceedings instituted by him to prevent his public examination in connection with the liquidation of a company of which he had previously been a director. In rejecting the claim, Menzies J said:  

The taxpayer's case that the expenses were necessarily incurred in gaining his assessable income was based upon matters which would discourage possible clients from entrusting him, or any company with which he was concerned, with building contracts and it seems to me that the Board was incontestably right that the facts showed that the expenses were not deductible 

The expenditure was not an outgoing incurred in gaining assessable income and, even upon the basis upon which the taxpayer sought to establish the expenses as deductible, they were clearly enough of a capital, or a private, nature. 

In Smithkline Beecham Laboratories (Australia) Ltd v. FC of T 93 ATC 4629; (1993) 26 ATR 260, Hill J stated that expenditure incurred to preserve or protect a business as such will ordinarily be expenditure of capital. Here, the investigation and legal expenses were incurred to preserve the firm's reputation with existing and potential clients. The expenditure was incurred for the purpose of securing an enduring benefit to the firm, namely its client base, and is therefore capital in nature.  

In your case, a portion of the expenses you incurred was to ensure your name was not published in the proceedings that followed in order to protect your reputation. As discussed above, a person's reputation is considered to be a capital or private asset. Accordingly, the portions of the expenses incurred to protect your reputation are considered capital or private in nature and are not deductible under section 8-1 of the ITAA 1997.