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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 2012

The scheme commenced on

1 July 2011

Relevant facts

You entered into a joint venture with a number of other entities.

You paid a deposit and the bank required that you serve as a guarantor on a bank loan the joint venture entered into to purchase the land and pay development costs.

The joint venture defaulted on the bank loan and you were served with a Notice of Default.

You sought legal advice to prevent the bank from enforcing the guarantee as it was confirmed that there were serious breaches of the project manager's obligations under the joint venture.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478), 

· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, 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 (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Taxation Ruling TR 96/23 provides that the payment of an amount under a guarantee may be deductible when it is incurred in carrying on a business of providing guarantees otherwise, it is inherently capital in nature.

In your situation you sought to prevent the bank from enforcing your personal guarantee when the joint venture defaulted on their repayments and it was not incurred in carrying on a business of providing guarantees. Accordingly the expense is capital or private in nature and you are not entitled to a deduction.