Edited version of your private ruling

Authorisation Number: 1012387265412

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Ruling

Subject: Legal expenses, court fine and court fees

Question 1

Are you entitled to a deduction for court fees and legal fees in relation to court proceedings?

Answer

Yes, in part.

Question 2

Are you entitled to a deduction for the fine imposed by the court?

Answer

No

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You are in business as a sole trader.

You employed an employee who held an appropriate licence.

You checked periodically on the currency of your employee's licence in order for them to legally perform work for you.

Your employee's licence lapsed and they continued to work as an employee for you.

During the course of conducting your business you were charged with a number of offences in relation to the lapse of your employee's licence.

You pleaded guilty to the offences and were fined an amount of money and ordered to pay court costs. You also incurred legal costs.

The Magistrate granted your application for a "spent conviction" so these offences should not be reported in the industry's newsletter.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 26-5

Reasons for decision

Legal expenses and court costs

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

In determining whether a deduction for legal expenses is allowable, 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.

The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the legal expenses arise out of the day to day activities of the taxpayer's business or employment (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183, (1980) 11 ATR 276; 80 ATC 4542).

Taxation Ruling IT149 examines the situation where legal expenses are incurred by a business for fines or breaches of law. Where you take liberties with the law in the interests of more efficient operation then the legal expenses are considered to be in connection with the imposition of penalties for unlawful acts, rather than in the furtherance of your business.

However where you have acted in good faith and you were exposed to prosecution as a result of your income earning activities, the expense incurred in defending yourself would be attributed to this earning activity.

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties were allowable. The activities which produced the taxpayer's income were what exposed him to the liability against which he was defending himself. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income.

In your case, you incurred legal expenses and court fees in defending the charges which occurred as a result of your employee not renewing their licence and subsequently continuing to perform their work (illegally) for you in your business. You periodically checked the currency of your employee's licence so as to continue to operate you business legally. The lapsing of your employee's licence was an accidental breach of the law. It was not considered that you took any calculated risk or took any liberties with the law in order to operate your business more efficiently and you acted in good faith.

You are therefore entitled to a deduction for the portion of legal expenses you incurred in defending the charges under section 8-1 of the ITAA 1997. It is also considered that the court costs fall within the same reasoning.

However, section 8-1 of the ITAA 1997 denies a deduction where the loss or outgoing is a capital or private nature.

Legal expenses are capital or private in nature where the legal action taken is to protect the taxpayer's personal good name and reputation (Case U102 87 ATC 621; AAT Case72 (1987) 18 ATR 3515).

In case U102 the taxpayer's legal expenses were not sufficiently connected with the income earning activities of the taxpayer and were essentially private or capital in nature and character. The need for them arose out of the taxpayer's reaction to what they saw as damage to their credit and reputation.

In your case your solicitor applied for, and was granted, an application for a "spent conviction" so the offences should not be reported in your industry's newsletter.

The newsletter is a publication which includes prosecutions for breaches of appropriate legislation.

Having a spent conviction order (SCO) means that you may not have to acknowledge that you were charged with, and convicted, of an offence. The aim of spent convictions legislation is to prevent discrimination on the basis of certain previous convictions.

Spent convictions legislation limits the use and disclosure of older, less serious convictions and findings of guilt.

By applying to the Court for a spent conviction you were trying to keep your reputation intact by not having your name and offence details published in the industry's newsletter. Legal expenses are capital or private in nature where the legal action taken is to protect the taxpayer's personal good name and reputation.

The portion of the total legal expenses which were incurred in relation to the spent conviction are capital in nature and are therefore not deductible under section 8-1 of the ITAA 1997.

A reasonable apportionment must be made for the allowable portion of the total expenses and the portion which is associated with the capital amount. Splitting expenses between the times spent on the deductible portion of the expenses and the non-deductible portion (capital) by time spent on each portion would be considered reasonable.

Court fine

Subsection 26-5(1) of the ITAA 1997 states you cannot deduct under this Act:

a) an amount (however described) payable, by way of penalty, under an Australian law or a foreign law; or

b) an amount ordered by a court to be paid on the conviction of an entity for an offence against an Australian law or a foreign law.

In your case the court imposed a fine as a result of you pleading guilty to the charges. You are not entitled to claim a deduction for the fine as it was an amount ordered by a court to be paid on your conviction for an offence against an Australian law.