Edited version of private ruling

Authorisation Number: 1011691321842

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Ruling

Subject: Defamation claim

Question

Are you entitled to a deduction for legal expenses and settlement payment incurred by you stemming from a defamation claim against you in the particular income year?

Answer: Yes

This ruling applies for the following period

Year ended 30 June 2009

The scheme commenced on

1 July 2008

Relevant facts and circumstances

In a particular year you made a statement in a press conference. The press conference was held in relation to your employment.

A comprehensive statement of claim for undisclosed damages was lodged against you by an individual mentioned in the press conference.

An out of court settlement was reached.

You paid this amount out of your personal income in the relevant income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

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) 3 AITR 436; (1946) 8 ATD 190).

The leading case on the deductibility of legal expenses is Herald and Weekly Times v FC of T (1932) 48 CLR 113 (Herald and Weekly Times). In Herald and Weekly Times, the taxpayer, the proprietor and publisher of an evening newspaper, claimed outgoings (for legal advice, defence costs and damages awarded) in connection with libels the newspaper had published. A majority of the Full High Court allowed the deduction as publishing the newspaper was both the source of income and cause of the liability and secondly, the risk of libel was a regular and almost unavoidable incident or inherent risk of publishing.

In Putnin v FC of T 91 ATC 4097 the Federal Court applied the principles established in Herald and Weekly Times to grant a deduction for legal expenses to an accountant being sued for malfeasance. Burchett, French and Lee JJ stated:

It may be a natural incident of the conduct of the operations of a particular kind of business that claims of the commission of torts, or even crimes, may arise, although it is to be hoped not often, and have to be repelled. If the proprietor of such a business is sued for negligence, for example, the cost of defending the suit would arise out of the relevant business operations.

In FC of T v. Rowe (1995) 131 ALR 622; 31 ATR 392; (1995) 60 FCR 99; 95 ATC 4691, the taxpayer was an employee suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. An independent statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The taxpayer incurred legal expenses in defending himself before his statutory inquiry.

In affirming that the legal expenses were allowable, Beaumont J stated at page 4699:

since the inquiry was centrally concerned with the day to day aspects of the respondent's employment, it ought to be concluded that the respondent's costs of representation before the Inquiry was incurred by him in gaining assessable income.

Further, Burchett J commented at page 4702:

The legal expenses of the taxpayer were incurred by the taxpayer in defending the manner of his performance of his duties.  It was only by so justifying himself that he could make a successful defence against dismissal.

A deduction is generally allowable for legal expenses incurred by someone in their day-to-day activities through which he or she gains or produces assessable income (work-related activities), if the losses or outgoings are not capital, private or domestic in nature. Where legal proceedings stem from activities that could not reasonably be regarded as being part of the work-related activities the losses or outgoings are not allowable deductions because they are not incurred in the course of gaining or producing assessable income.

In your case you have incurred legal expenses and settlement costs in defending defamation claim. The suit was settled out of court. The defamation proceedings were brought against you, for comments you made in the media.

The defamation proceeding resulting from comments made could be seen to relate your day to day income producing activities. Consequently, you are entitled to claim a deduction for the above legal expenses and settlement costs.

Taxation Ruling TR 97/7 sets out general rules to assist in defining whether and when a loss or outgoing has been incurred for the purposes of section 8-1 of the ITAA 1997. In general, a loss or outgoing has been incurred where a taxpayer is completely subjected to the loss or outgoing (that is, the liability is not merely contingent, pending or expected), and there is a presently existing liability to pay a pecuniary sum.

In your case, the settlement was reached in the 20XX income year. The date on which the agreement was reached is the date when the liability was created. Therefore, the total of your legal expenses and settlement costs are deductible in the same income year when the agreement was signed and not in the subsequent income year in which it was paid.