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Ruling

Subject: Legal expenses

Questions:

1. Are you entitled to claim a deduction for legal expenses incurred in reviewing an administrative decision to prevent you from working in a particular industry for a period of time?

Answer: No.

2. Are you entitled to claim a deduction for legal expenses incurred in defending criminal charges laid in relation to alleged prohibited activities?

Answer: No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2008

Relevant facts

You have worked in a particular industry for over ten years.

You did not hold a licence to work in this industry yourself, but worked as an authorised representative of a licence holder.

A Government authority claimed that you contravened one condition required of an authorised representative.

There is no suggestion that you profited personally from any of the alleged breaches.

Following an investigation and a hearing, the Government authority issued an order prohibiting you from working in the particular industry for a period of time. This was a reviewable decision.

You applied to the Administrative Appeals Tribunal (AAT) for a stay of the decision pending a review. On review, the AAT upheld the Government authority's decision.

You then appealed the AAT's decision in the Federal Court. The Federal Court dismissed your appeal, upholding the AAT decision.

You then appealed the decision in the Full Federal Court. The Full Federal Court also dismissed your appeal.

In the 2010-11 financial year, criminal charges were also laid against you in relation to the same matter.

You continue to incur legal expenses.

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 or outgoings to the extent to which they are incurred in gaining or producing assessable income. However, where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income they will not be deductible.

In determining whether a deduction for legal expenses is allowed 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) 8 ATD 190). Legal expenses take the nature of an outgoing of a capital nature or an outgoing of a revenue nature from the purpose of incurring the expenditure. It is necessary to consider the reason for which legal expenses are incurred, that is the object in view when the legal proceedings were undertaken or the situation which impelled the taxpayer to undertake them.

Full Federal Court action

In your case, once the order was imposed and the initial review process upheld the decision, your purpose for initiating continued legal action was to have the order lifted, which would allow you to return to employment.

Your ability to undertake employment in this industry is considered a profit yielding structure.

Where expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible (Sun Newspapers Ltd and Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87; (1938) 1 AITR 403). Outgoings incurred in the preservation of an existing capital asset have been held to be capital in nature (John Fairfax & Sons Pty Ltd v. FC of T (1959) 101 CLR 30; (1959) 7 AITR 346; (1959) 11 ATD 510).

In Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859, a solicitor was denied a deduction for legal expenses incurred in defending certain allegations before the Statutory Committee of the Law Society of New South Wales, concerning the solicitor's trust account. The Committee ordered the taxpayer be suspended from practice for a period of twelve months, and to pay the costs of the Law Society. The Administrative Appeals Tribunal (AAT) held that the payments made by the taxpayer were not deductible under subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as the payments were characterised as capital expenditure.  

Further, in Case X84 90 ATC 609; AAT Case 6528 (1990) 21 ATR 3721, the AAT held that legal expenses incurred by a medical practitioner in defending charges brought against him at a Medical Disciplinary Tribunal inquiry, were not deductible under subsection 51(1) of the ITAA 1936 because the expenditure was incurred to protect a structural asset, that is, their registration as a medical practitioner, and was of a capital nature.

In your case, the advantage you were seeking in your continued legal action was to allow you to return to work in the industry, a profit yielding structure. This is considered to be an advantage of a capital nature. As discussed above, the nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expenses. Therefore, the expenses you have incurred are considered to be of a capital nature and are not deductible under section 8-1 of the ITAA 1997. 

Criminal charges

In the recent High Court decision in Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064 (Days case), Mr Day was charged with breaching the standards of conduct and failing to fulfil his duty as an officer.

The Court found, on the facts of this case, that the legal expenses incurred by the taxpayer in relation to the disciplinary action taken by his employer are not outgoings of a private or domestic nature. Crucial to this view was the fact that the terms of employment exposed the taxpayer as an employee to the employer action, and therefore to the need to incur the legal expenses. The employer brought the action and the legal expenses were incurred in respect of proceedings internal to the employment relationship. The consequences of the disciplinary action, for the taxpayer, if proven, principally affected the terms or existence of his employment as a customs officer.

However, the criminal law applies regardless of any employment obligation, and the duty to obey it and to respond to criminal proceedings is owed by every man or woman to the Crown as a subject of the law. Costs incurred in defending criminal proceedings, in the Commissioner's opinion, are private expenses even if an employee is liable to be dismissed from employment on conviction

In your case, you are now facing criminal charges. As discussed above, in the Commissioner's opinion, costs incurred in defending criminal proceedings, are a private expenses and, therefore, not deductible under section 8-1 of the ITAA.