Edited version of your private ruling

Authorisation Number: 1012119213662

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: Expenses - other

Question 1

Are legal fees incurred in defending a claim for damages in relation to your former legal practice deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is a compensation settlement amount you were required to pay for a damages claim in relation to your former legal practice deductible under section 8-1 of the ITAA 1997?

Answer

Yes

Question 3

Are you entitled to claim a deduction for rent and associated legal expenses in relation to your former legal practice premises?

Answer

Yes

Question 4

Are you entitled to claim rental on a storage shed used to store your legal files for the statutory period after cessation of your business?

Answer

Yes

Question 5

Are the re-election expenses you can claim limited to $1,000?

Answer

Yes

Question 6

Are you entitled to claim an income tax deduction for the GST paid on your services?

Answer

No

This ruling applies for the following period

Year ended 30 June 2010
Year ended 30 June 2011

The scheme commenced on

1 July 2009

Relevant facts

You formerly operated a legal practice.

You made a decision to cease your practice.

Subsequent to cessation of your practice, you were required to make a damages payment to a former client.

You were also ordered to pay costs of the proceedings.

Subsequent to the cessation of your legal business, you also:

· became liable for rent and associated legal expenses in relation to your former premises; and

· incurred storage expenses to store:

i) bookcases and desks from your legal practice premises; and

ii) your legal files for the statutory period.

You incurred re-election expenses as a local candidate.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 25-65
Income Tax Assessment Act 1997 Section 27-5

Reasons for decision

Summary

We have concluded that the legal expenses, rent and storage are characterised as having the requisite connection with your assessable income as you were exposed to the legal action by reason of your former role in your legal business.

You are also entitled to your election expenses however they are limited to the amount of $1,000.

Detailed reasoning

The general deduction provision, 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 and producing assessable income, except where the outgoings are of a capital, private or domestic nature.

Legal expenses and associated compensation payment

Legal expenses are generally deductible if they arise out of the day to day activities of your 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 your income producing activities (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).

Similarly, in FCT v. Rowe (1995) 60 FCR 9995; 95 ATC 4691; (1995) 31 ATR 392, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. The activities which produced the taxpayer's income were what exposed them to the liability against which they were defending themselves.

In the High Court decision in Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064 (Day's case), Mr Day was charged with breaching the standards of conduct and failing to fulfil his duty as an officer. It was found that the requisite connection with his assessable income was present and that he was exposed to the charges by reason of his office.

The common thread throughout these cases is that the conduct or activity giving rise to the charges was transparently and intrinsically part of the day to day activities by which each party earned their assessable income.

In your case, the issues related to the day to day activities undertaken in the course of carrying out your role in your legal business.

Similar to Day's case, the legal expenses you incurred arose out of your conduct as an operator of the business and any income derived from that office. Therefore, the essential character of the legal expenses, arising from the nature of the allegations defended, is such that the expenses have sufficient connection with the activities that gained or produced assessable income from that office.

The legal expenses you incurred were not directed toward acquiring, preserving or expanding any capital asset, nor resulted in any alteration of business structure. The expenditure was of a defensive nature and not made to provide you with any benefit. Accordingly, the legal expenses are not of a capital nature.

The incurrence of the expenditure after you ceased to operate the business will not deny deductibility, as the occasion of the outgoings is found in your income earning activities before those activities ceased (Taxation Ruling TR 2004/4).

Furthermore, legal expenses incurred in defending conduct in relation to a client's case by a solicitor could be considered a natural or inherent incident of the legal profession and constitute a loss necessarily incurred in carrying on a business for the purpose of gaining or producing its assessable income.

We have concluded on the facts provided that the legal expenses are characterised as having an income nature. Therefore, you are entitled to a deduction for the legal expenses you incurred in defending the action.

We consider the compensation payment deductible for the same reasons.

Rent and associated legal expenses

The essential character of the rent and associated legal expenses, arising from your former business activity, is such that the expenses have sufficient connection with the activities that gained or produced assessable income from that office.

The incurrence of the expenditure after you ceased to operate the business will not deny deductibility, as the occasion of the outgoings is found in your income earning activities before those activities ceased (TR 2004/4).

Therefore, you are entitled to a deduction for the rent and associated legal expenses.

Rental on storage shed

The essential character of the rental of a storage shed to store your legal business documentation, arising from your former business activity, is such that the expenses have sufficient connection with the activities that gained or produced assessable income from that office.

The incurrence of the expenditure after you ceased to operate the business will not deny deductibility, as the occasion of the outgoings is found in your income earning activities before those activities ceased (TR 2004/4).

Therefore, you are entitled to a deduction for the rental on the storage shed that relates to storing your legal files for the statutory period (including furniture to store the files in). However, any furniture not related to file storage will not be deductible.

Election expenses

Section 25-65 of the ITAA 1997 allows a deduction for expenditure incurred by a taxpayer in contesting an election for membership of a "local governing body". The deduction is limited to the amount of $1,000 per election. The expenditure is deductible in the income year in which it is incurred and exclude entertainment expenses, which are not deductible (s 25-70).

GST

A GST registered taxpayer is required, under section 27-5 of the ITAA 1997, to reduce their deduction for expenses claimed under section 8-1 of the ITAA 1997 by the amount of input tax credit to which they are entitled that is included in those expenses.

In your case you were registered for GST.

Therefore you are not entitled to a deduction for the GST amounts paid under section 8-1 of the ITAA 1997.