Edited version of private ruling

Authorisation Number: 1011786152802

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Ruling

Subject: Legal expenses

Question

Are you entitled to a deduction for legal expenses and damages in relation to your defamation action?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2009

The scheme commences on:

1 July 2008

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.

You are an Australian resident.

You are a member of a political party and were a Member of Parliament.

As part of your occupation, you:

· attended public occasions

· spoke at public occasions

· promoted the cause and ideals of your political party for and on behalf of the members of the public

· spoke out against persons who offend the cause and ideals of your political party

· publicly supported and promoted other members of your political party who stood for election at any political level.

Court proceedings for defamation were commenced against you.

The alleged instances of defamation arose from speeches you made at public gatherings as a Member of Parliament on issues that were relevant to the policies of your political party.

In the first instance, the court found for you. Defences included substantial truth, public interest and qualified privilege.

On appeal, the court found against you and awarded damages plus costs.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

You incurred legal expenses in defending yourself against defamation proceedings that arose from you speaking at public gatherings as a Member of Parliament. The legal expenses and damages payment are directly related to the performance of your duties from which you earned your assessable income. Therefore the legal fees and damages payment are deductible.

Detailed reasoning

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 losses or 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 nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Generally, the treatment of a settlement sum or damages payment will follow the treatment of the other legal costs incurred in relation to a particular matter.

The leading case on the deductibility of legal expenses is Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169. In this case the taxpayer was the proprietor and publisher of an evening newspaper who 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 FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. The activities which produced his income were what exposed him to the liability against which he was defending himself.

In Case V116, AAT Case 4502 (1988) 88 ATC 737; 19 ATR 3703 the Administrative Appeals Tribunal allowed a deduction for legal expenses by a solicitor employed as a director of a company to defend defamation proceedings. Senior Member Roach stated that the duties of the solicitor's position created the risk of defamation proceedings and the legal expenses were:

as directly related to the performance of his duties as a director, and thereby his incoming earning activities, as are the expenses incurred by divisions of the media which incur expense in dealing with allegations that they have defamed others.

In Case U102 87 ATC 621; AAT Case72 (1987) 18 ATR 3515 a secretary-manager of a sporting club initiated defamation proceedings in the Supreme Court to obtain an apology, recovery of expenses and damages. The legal action was undertaken to protect the taxpayer's reputation, not his continued employment with the club. The events which gave rise to the expenses incurred were not regarded as what is normally expected of a secretary-manager of a club in the course of producing assessable income. The expenses were considered private in nature as the need for them arose out of the taxpayer's reaction to what he saw as a slur upon his personal good name and reputation.

Accordingly, for legal expenses to be deductible, you have to be able to show that it was the very act of performing the prescribed or authorised activities of your employment that exposed you to the legal expenses. If it is something other than employment duties that exposed you to the legal expenses, the necessary nexus with the earning of assessable income cannot be established and the expenses are not allowable.

You incurred legal expenses in defending yourself against defamation proceedings that arose from you speaking at public gatherings as a Member of Parliament. The legal expenses and damages payment are directly related to the performance of your duties from which you earned your assessable income. Therefore the legal fees and damages payment are deductible under section 8-1 of the ITAA 1997.