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Edited version of private ruling
Authorisation Number: 1011864838136
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Ruling
Subject: Deduction- legal expenses
Question:
Are you entitled to a deduction for legal expenses?
Answer:
No
This ruling applies for the following period:
Year ended 30 June 2011
The scheme commenced on:
1 July 2010
Relevant facts
You and your spouse (you) were provided with advice from the defendant regarding the purchase of a number of potential investments.
On advice provided by the defendant you borrowed funds to invest in a number of investments.
You used your home as security for the loans.
Due to the expenses in relation to the investments exceeding the income received, you sold the investments.
You took legal action against the defendant for loss and damage by reason of breach of duty and negligent investment advice.
You were awarded an amount by the court.
It is unlikely that you will ever recover the monies from the defendant.
The defendant has been declared bankrupt.
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 that they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.
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 (Hallstroms case). 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.
Legal expenses may be of a revenue nature and therefore deductible if they arise out of the day to day activities of the taxpayer's income producing activity (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169). Where however, expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible.
The guidelines for distinguishing between capital and revenue outgoings were laid down in the High Court case of Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; 5 ATD 87 (Sun Newspapers Case). It was pointed out that expenditure in establishing, replacing and enlarging the profit-yielding structure itself is capital and is to be contrasted with working or operating expenses. The test laid down in the Sun Newspapers Case involved three elements, although none is in itself decisive:
· the nature of the advantage sought
· the way it is to be used or enjoyed, and
· the means adopted to get it.
In regards to the first two elements, the lasting or recurrent character of the advantage and the expenditure is important. The courts have held, in the absence of special circumstances that expenditure is capital in nature where it is made with a view to bringing into existence an asset or an advantage (tangible or intangible) of enduring benefit (British Insulated & Helsby Cables v. Atherton (1926) AC 205). Legal expenditure is also capital in nature where the action is undertaken to protect a capital asset (Pye v. FC of T (1959) 12 ATD 118).
In your case, you purchased a number of investments as a result of advice provided by the defendant. You took legal action to sue the defendant for breach of duty and negligence as the advice provided was incorrect. The claim was made for damages and relates to the establishment of your profit-yielding structure rather than for the purposes of the operation of the investments.
The expenditure incurred in seeking damages for the breach of duty and negligence is expenditure of a capital nature. This includes those legal expenses associated with the bankruptcy action.
Therefore, the costs you incurred for legal expenses is not deductible under section 8-1 of the ITAA 1997.