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Edited version of private ruling
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Ruling
Subject: Legal expenses
1. Are you entitled to a deduction for legal expenses under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
No.
2. Are you entitled to claim a capital loss for legal expenses?
No.
This ruling applies for the following period
Year ended 30 June 2010
Year ended 30 June 2011
The scheme commenced on
1 July 2009
Relevant facts
You were an employee.
Your employment agreement had a restraint of trade clause.
You left your employer and started a new company in the same industry with some others. You are a director and shareholder of the new company.
Your former employer took you to court to enforce the restraint of trade clause in your employment agreement.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 102-10
Income Tax Assessment Act 1997 Section 102-20
Income Tax Assessment Act 1997 Section 108-5
Reasons for decision
1. Are you entitled to a deduction for legal expenses?
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, private or domestic nature.
For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of your assessable income (Ronpibon Tin N.L.Tongkah Compound N.L. v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236).
The expenditure must therefore be related to the production of assessable income and not incurred at a point too soon to be deductible (FC of T v. Maddalena 71 ATC 4161; (1971) 2 ATR 541).
Also, in determining whether a deduction for legal expenses is allowable 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). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses.
In your situation, you were defending action taken by your previous employer to prevent you from working for a competitor.
The action by your former employer was to enforce a restraint of trade clause in your employment agreement. The action was not prompted or caused as a consequence of the performance of your then current duties.
It is considered your legal expenses were incurred to enable you to continue working in your new business. They did not relate to the duties of your previous employment or your new business and therefore, not incurred in earning your assessable income from either.
Defending a right to practice a profession or employment is capital in nature, as the right to practice is considered a structural asset and the expenses were incurred to protect this right (Case 140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859 and Case X84 90 ATC 609; AAT Case 6528 (1990) 21 ATR 3721). As the nature of the expense follows the nature of the advantage sought, the expense is also capital in nature.
You are therefore not entitled to a deduction for legal expenses incurred to defend an application for restraint of trade.
2. Are you entitled to a capital loss for legal expenses under section 102-20 of the ITAA 1997?
Under section 102-20 of the ITAA 1997 you make a capital gain or capital loss as a result of a capital gains tax (CGT) event.
CGT events are the different types of transactions or events involving a CGT asset.
A CGT asset is:
· any kind of property; or
· a legal or equitable right that is not property.
In your case, you are defending a right to practice a profession or employment which is considered a structural asset and capital in nature. However, not all things often referred to as rights will be assets for CGT purposes. To be an asset, a right must be recognised and protected by law. Personal liberties and freedoms, such as the freedom to work or trade or to play amateur sport, are not legal or equitable rights and accordingly will not be assets for CGT purposes.
Therefore as your right to practice is not considered a CGT asset a CGT event does not occur and as a result you are not entitled to a capital loss for the legal expenses.