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Edited version of your private ruling
Authorisation Number: 1012455044927
Ruling
Subject: Entitlement to a deduction for a fine, costs, penalties and legal expenses
Question 1
Is the entity entitled to a deduction for a fine, costs and penalties imposed by the Court for a breach of an Australian law?
Answer
No
Question 2
Is the entity entitled to a deduction for legal expenses incurred in relation to the contravention of the Australian law?
Answer
No
This ruling applies for the following period
Year ended 30 June 2012
The scheme commenced on
1 July 2011
Relevant facts
The entity operates a business.
It contravened an Australian law and as a result the entity was fined by a Court.
The entity also incurred legal expenses in relation to this matter
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Subsection 26-5(1)
Reasons for decision
Summary
The entity is not entitled to a deduction for a fine, costs and penalties imposed by the Court. The entity is also not entitled to a deduction for legal expenses incurred in relation to this matter.
Detailed reasoning
Fine, costs & penalties
Subsection 26-5(1) of the Income Tax Assessment Act 1997 (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 on the entity. The entity is not entitled to claim a deduction for the fine as it was an amount ordered by a court to be paid by way of penalty for an offence against an Australian law.
Legal Expenses
Section 8-1 of the 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 of 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 IT 149 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 this case, the entity incurred legal expenses directly in relation to the finding of the Court. The entity took liberties with the law in order to operate its business more effectively. As such, all legal expenses are considered to be in connection with the imposition of penalties for unlawful acts, rather than in the furtherance of the entity's business.
The entity is therefore not entitled to a deduction for the legal expenses it incurred in relation to the contravention of the Australian law.