Edited version of private ruling

Authorisation Number: 1011664460116

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Ruling

Subject : Deductions - legal expenses

Question and Answer

Are you entitled to a deduction for legal expenses in relation to protecting your reputation?

Yes.

This ruling applies for the following period

1 July 2009 to 30 June 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

A complaint at work was made after you undertook activity in the recent year that constituted a normal part of your employment duties.

The employer instituted disciplinary proceedings alleging serious misconduct or misconduct.

You were suspended without pay pending the outcome of the investigation into the allegations.

The complainant also contacted a third party and that third party wrote to you threatening to contact the employer and lend its voice to the complaint.

As a member of your profession, your reputation with those of a class to which the third party belongs is important and the third party's actions would contribute to your employer's assessment of whether you had committed serious misconduct or misconduct.

In order to defend your employment and your reputation you instructed a lawyer to write to the third party and dissuade them from taking action.

You incurred legal expenses for the issuing of the letter.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reason for decision

Section 8-1 of the Income Tax Assessment Act 1997 provides that a loss or an outgoing is an allowable deduction if it is incurred in producing assessable income or in carrying on a business for the production of assessable income unless that loss or outgoing is capital or of a private or domestic nature.

The courts on a number of occasions have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer's business. The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business and the expense may arise out of litigation concerning the taxpayer's professional conduct.

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, an employee incurred legal expenses in defending the manner in which he performed his employment duties. The court accepted that such expenses were allowable and no significance was placed on the taxpayer's status as an employee.

In Elberg v. F C of T (1998) 82 FCR 440; (1998) 98 ATC 4454; (1998) 38 ATR 623, a doctor incurred legal expenses defending charges of fraud arising from the billing of work she performed for a Government department.

In that case, the Federal Court considered whether the revenue aspect of the expenditure was over-ridden by a consideration that the legal defence costs were incurred to protect the taxpayer's reputation and future income-earning capacity (and could be characterised as 'capital').

Merkel J, at 4463, said that;

In most instances where serious criminal charges arise out of the conduct of a taxpayer's professional practice, an object in defending such charges will almost inevitably be the necessity to do so because of the effect of possible professional disciplinary consequences that would follow upon a conviction. The consequences usually will range from a reprimand to the potential risk to the taxpayer's right to professional practice. However, that is merely one of the indirect objects in defending such charges. Other objects include the direct object of securing an acquittal, and to avoid any penalty, as well as to protect one's personal and professional reputation.

He said that these other objects did not detract from the conclusion that the cost of defending her business activities was an allowable deduction.

Conclusion

You incurred legal expenses in preventing the third party from taking a course of action which would prejudice disciplinary procedures and your suitability to continue in your position in your employment. The charges arose from an activity that constituted a normal part of your employment duties. The legal expenses incurred are an allowable deduction.