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Edited version of private ruling
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Ruling
Subject: Legal expenses
Question 1
Are you entitled to a deduction for the legal expenses incurred in defending yourself against the criminal charges?
Answer
No.
Question 2
Are the additional legal expenses incurred as a result of the employer's involvement in the legal process deductible?
Answer
Yes.
This ruling applies for the following periods:
Year ended 30 June 2010
Year ended 30 June 2011
The scheme commences on:
1 July 2009
Relevant facts and circumstances
You are a professional sportsperson.
Your employment contract stipulates behavioural expectations and a code of conduct that you must uphold at all times.
You were allegedly involved in an incident that involved charges from the police.
Your alleged involvement was also considered a breach of your employment contract which entails further disciplinary action.
You incurred legal fees in relation to defending yourself against these charges.
Your legal fees contained an amount solely due to the role your employer played in the legal process.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasons for decision
Summary
The expenses incurred in defending yourself against the criminal charges are not deductible as they lack the connection to your income producing activities. However, the additional expenses incurred as a direct result of the role your employer played in the process are deductible as they are incidental or relevant to the production of your assessable income.
Detailed reasoning
Section 8-1 of the Income Tax Assessment Act 1997 (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 NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431). Also, in determining whether a deduction for legal expenses is allowable, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (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. For example, if the advantage to be gained is of a capital nature, then the legal expenses incurred in gaining the advantage will also be of a capital nature and are not deductible.
In the case of Commissioner of Taxation v. Shane Day [2008] HCA 53 an employee was able to deduct the legal expenses incurred as a result of disciplinary action brought on by the employer. The disciplinary action was a result of incidents that occurred outside the day to day duties of the employee but were a breach of their code of conduct. Your case differs to that case in that your charges were brought by the police instead of your employer.
You incurred the expenses in relation to defending yourself against the charges. However due to the involvement your employer had in the legal process these expenses were increased. Because of the involvement of your employer it is deemed that the increased expenses incurred are related to dealing with a potential disciplinary action that could be brought by the employer rather than with the criminal charges. Therefore it is deemed that there is a sufficient connection between the increased legal expenses and your income producing activities. The amount incurred due to your employer's involvement is therefore deductible.
The expenses incurred in defending yourself against the criminal charges are not considered to be incidental or relevant to the production of your assessable income and are therefore not deductible.