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Ruling
Subject: Deductibility of legal expenses
Question
Are you entitled to a deduction for legal expenses you incurred to fund a class action where you are seeking to be released from outstanding loans?
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 and circumstances
You hold investments in a project.
You borrowed money from Company X or a connected lender to finance your investment.
Company X was placed into voluntary administration.
You joined a class action against Company X. You are seeking an outcome that will formally excuse you from having to pay all or some of your outstanding Company X related loan.
You have contributed towards legal bills associated with the class action and anticipate further legal costs.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasons for decision
Summary
You are not entitled to a deduction for legal expenses you incur to fund a class action where you are seeking to be released from an outstanding loan. The advantage you are seeking is capital in nature. Therefore the legal expenses are also considered to be capital in nature and are not deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).
Detailed reasoning
Section 8-1 of the 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 outgoings are of a capital, private or domestic nature.
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. The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses.
If the advantage sought is a new asset or right or an advantage with an enduring benefit, then the expenses take on the character of capital expenditure.
The courts have established guidelines for distinguishing between capital and revenue outgoings. In Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1936) 61 CLR 337; (1938) 45 ALR 10; (1983) 1 AITR 403; 5 ATD 87, three elements were identified as being relevant:
o the nature of the advantage sought
o the way it is to be used or enjoyed
o the means adopted to get it.
In your case you have incurred legal expenses as part of a class action against Company X. The legal action seeks to excuse you from your outstanding loan liability owing to Company X.
Although your borrowings enabled you to derive assessable income from your investments, the legal action taken to extinguish your loan liability does not have the necessary connection with your income earning activities.
A release from your outstanding loan would create an advantage that has an enduring benefit, that being, the reduction of your existing liabilities. This advantage would be considered to be capital in nature.
By incurring legal expenses in seeking such a release, the legal expenses take on the character of the benefit you are seeking. As the benefit is considered to be capital in nature, the legal expenses are also considered to be capital in nature.
Therefore the legal expenses are not deductible under section 8-1 of the ITAA 1997.