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Ruling
Subject: 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 2009
Year ended 30 June 2010
Year ended 30 June 2011
The scheme commenced on
1 July 2008
Relevant facts
You are currently the director of Company A and other companies.
You have never received assessable income from Company A.
Legal proceedings were brought against you regarding actions and decisions made as director of Company A.
You were required to defend your reputation as it may have had an adverse reaction on the other entities of which you were a director.
You were also employed as CEO of another company until you retired.
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 or are necessarily incurred in carrying on a business for the purpose of 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, or a provision of the ITAA 1997 prevents it.
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).
The fundamental requirement that there must be a sufficient nexus between a particular expense and the assessable income such that the expense is incidental and relevant to the gaining of assessable income was also recognised in Case U134 87 ATC 780; (1987) 18 ATR 3646. That case involved a taxpayer who was a director of and a shareholder in a family company. The taxpayer did not receive any payments from the company for his services as a director of the company. However, the taxpayer did receive a dividend from the company. In disallowing the claim, the Tribunal held that:
...the outgoings were incurred in his capacity as a director and are consequently not sufficiently related to the carrying on the business of being a shareholder. Additionally, as no allowance was paid to him in his capacity as a director, it cannot be said that the expenses were incurred in gaining or producing assessable income in that capacity.
Accordingly, if a taxpayer does not derive any assessable income from their position as a director of a company and they incur expenses in respect of their position as a director, they would not be entitled to a deduction under section 8-1 of the ITAA 1997 as the expenses would not have been incurred in gaining or producing assessable income in their capacity as a director.
You did not gain or produce any income in your capacity as a director of Company A. Therefore, you will not be able to satisfy the basic requirement of section 8-1 of the ITAA 1997 as the legal expenses were not incurred in gaining or producing your assessable income.
Legal expenses are capital or private in nature where the legal action taken is to protect the taxpayer's personal good name and reputation (Case U102 87 ATC 621(Case U102); AAT Case 72 (1987) 18 ATR 3515 (Case 72)).
In your case, you defended yourself to protect your reputation as adverse findings may have affected your other income earning activities. Therefore, the expenses are considered to be capital in nature. As such, a deduction is not allowed for the legal expenses.