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Ruling

Subject: Legal expenses

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commenced on

1 July 2009

Relevant facts

When you were employed as a manager, a staff member lodged a complaint about your conduct. This complaint was independently investigated and you were found innocent of the allegations, and consequently had no disciplinary action taken against you.

You subsequently resigned from your employment when you successfully obtained a more senior position with another employer.

Later the same staff member lodged a writ for damages against yourself and the employer, alleging stress related injury brought on by: your conduct; and, a failure by the employer to prevent the conduct,

As you were no longer working for the same employer, you were advised you needed to pay for your own legal defence in relation to the action. The employer was represented by its own solicitors.

The employer's solicitors placed the plaintiff under surveillance and obtained evidence that the personal injury damages being claimed were fictitious.

In the face of the surveillance evidence the plaintiff settled the action and agreed to resign from their employment and to take no further action against the parties.

As part of the settlement, which was on a without prejudice basis, the plaintiff received a sum of money which was intended to cover preliminary medical expenses. You were not required to contribute towards this payment.

You incurred legal expenses in defending yourself.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the Income Taxation Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent they are incurred in gaining or producing assessable income except where the outgoings are 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 the taxpayer's 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 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.

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business. (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).

When the principal reason for incurring the legal expenses is defending the actions of the taxpayer in carrying out their employment duties through which they gain or produce assessable income, such expenses are characterised as being of a revenue nature and are deductible (Inglis v. FC of T 87 ATC 2037; and Case V116 88 ATC 737; AAT Case 4502 (1988) 19 ATR 3703).

Similarly, 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.

In your case, you incurred legal expenses defending yourself against allegations of misconduct by a staff member whom you managed. An internal, independent investigation concluded that the person's initial allegations against you were unfounded and consequently no action was taken by the employer against you. Court action subsequently initiated by the staff member was then dismissed by consent after the plaintiff's claims of personal injury were shown to be untrue. Although monies were paid to the plaintiff to cover medical costs, this was on a without prejudice basis and were paid by the employer, who was also a defendant in the action.

The results of the internal investigation, the evidence that the personal injury claims were untrue, and the cessation of the court action are all consistent with your assertion that the staff member's allegations were unfounded and that there was no personal misconduct on your part.

On the basis of information you have provided, it is accepted that your need to incur legal expenses was directly connected to the carrying out of your duties as a manager, duties that exposed you to the allegations. Therefore, it is accepted that the relevant legal expenses arose from your income earning activities and were not of a private nature (arising in the absence of any personal misconduct). As a result, the expenses are considered to be deductible.