Edited version of your private ruling

Authorisation Number: 1012012132219

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for the legal expenses incurred to recover the outstanding balance of a loan to your former employer?

Answer

No.

Question 2

Are you entitled to a deduction for the legal expenses incurred to recover the interest relating to a loan to your former employer?

Answer

Yes.

Question 3

Can the legal expenses incurred to recover the outstanding balance of a loan to your former employer form part of the cost base of the loan?

Answer:

Yes.

This ruling applies for the following periods

Year ended 30 June 2010
Year ended 30 June 2011
Year ending 30 June 2012

The scheme commenced on

1 July 2009

Relevant facts and circumstances

You deposited funds into your employer's bank account.

This deposit was treated as a loan. A written loan agreement was not created for the transaction.

You were to be repaid the loan capital plus interest.

You have received a part repayment of loan capital.

You have not received any interest income from the loan arrangement.

You engaged solicitors to arrange a repayment schedule and a formal 'Deed of Repayment" with your employer. Correspondence continued between your solicitors and your employer.

You commenced court proceedings to recover the balance of the funds plus interest from a director and the company.

You brought action against the director directly as you believed the loan arrangement was a personal one between the director and yourself.

The Court determined the loan agreement was between yourself and your employer. Your employer was held to be liable for the capital plus interest.

You have incurred expenses in taking this legal action.

You are not in the business of lending money.

The company has gone into liquidation.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Subsection 110-25(5)

Income Tax Assessment Act 1997 Subsection 110-25(6)

Reasons for decision

Summary

You are entitled to a deduction for that portion of the legal expenses which relate to the recovery of the loan interest as this was expenditure incurred in order to gain assessable income.

No deduction is allowable for the legal expenses which relate to the recovery of the loan balance as this expenditure is capital in nature. These legal expenses are added to the cost base of your loan and will be used in calculating any capital loss in relation to the loan.

Detailed reasoning

Deductibility of legal expenses

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for losses and outgoings which are incurred in the course of gaining or producing assessable income, unless the losses or outgoings are capital, or are of a capital, private or domestic nature.

The deductibility of legal expenses will be dependent upon the reasons the legal expenses were incurred and not the outcome of the action undertaken.

If the outcome sought by the legal action is revenue in nature then the legal expenses will also be revenue in nature. Similarly, if the advantage sought is capital in nature the expenses will also be capital in nature.

There are often occasions where the legal expenses are incurred in relation to proceedings that relate both to amounts that are income in nature as well as amounts which are not. In these situations, the expenses need to be apportioned between the income and non-income claims sought.

Where a solicitor's account is itemised, one reasonable basis for apportionment would be the time spent involving the income claim, relative to the time spent on the non-income claim. If this is not possible, an apportionment on the basis of the monetary value of the income claim relative to the non-income claim can be used.

In your case, you took legal action to obtain the balance of funds loaned to your former employer and interest relating to that loan.

The balance of the loan funds is considered to be a capital amount and the legal expenses associated with recovering this amount are not deductible.

The interest associated with the loan would form part of your assessable income and the legal expenses associated with recovering this amount are deductible.

You will need to apportion your legal expenses, using a reasonable basis, between the recovery of the loan capital and the outstanding loan interest. That portion of the legal expenses relating to the outstanding loan interest will be deductible in the years in which the legal expenses are incurred.

Capital gain tax implications of legal expenses

Your loan to the company is a capital gains tax (CGT) asset.

The cost base of an asset includes capital expenditure incurred to: preserve the asset's value; or to preserve or defend your title to the asset, or a right over the asset.

The portion of the legal expenses incurred that relate to the recovery of the balance of the loan funds is capital expenditure. We consider that this expenditure forms part of the cost base of the loan.

A capital gain or loss only arises when a CGT event occurs. In your case a CGT event will occur if: the liquidator of the company declares the loan to have no, or negligible, value; or the company is deregistered.