Edited version of your private ruling

Authorisation Number: 1012465787580

Ruling

Subject: CGT

Question

Are the legal costs that you incurred in recovering your mother's property for use in your business an allowable deduction?

Answer

No

This ruling applies for the following periods

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

Your parent owns a property which is used by both your parent and yourself for primary production.

You maintain the property because you are the predominant primary producer and user of the property.

In year ended 30 June 20XX your parent gifted the property to your sibling.

Following the gift of the property to your sibling, both your parent and yourself continued to primary produce on the property and continued to pay the maintenance and holding costs of the property.

You rely on the use of the property for your primary production operations.

In year ended 30 June 20YY, your parent realised that she had transferred the property to your sibling without considering the impact that transfer may have on your primary production operations.

In year ended 30 June 20ZZ you were advised by your solicitors that in order to rectify the situation, either your parent could sue your sibling for financial loss or for recovery of the property.

The priority for yourself and your parent was recovery of the property in order to continue your primary production operations.

From year ended 30 June 20YY to year ended 30 June 20ZZ you and your parent made repeated unsuccessful attempts to encourage your sibling to transfer the property back.

In year ended 30 June 20X1, your sibling advised that they intended to sell the property.

In year ended 30 June 20YY solicitors acting on your parent's behalf and funded by you, brought legal proceedings against your sibling for the recovery of the property.

You paid a total amount of $XX in legal fees in the year ended 30 June 20YY. You have paid further legal fees following that date.

You needed to recover the property for the continuity and stability of your ongoing primary production activities. You would have suffered extreme financial hardship if you had lost use of the property due to the financial impact.

In year ended 30 June 20X1 you and your sibling had an agreement in principal that you would pay $XX to acquire the property.

In year ended 30 June 20X1, you and your sibling settled the dispute, and you acquired the property.

Your parent has a lifetime agistment agreement with you.

You and your sibling settled the dispute because it had always been your legal action and not your parent's.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for expenses incurred in earning assessable income unless those expenses are capital or capital in nature.

Paragraph 13 of TR 93/7 states the following:

13. The critical factor in determining the essential character of an outgoing is the character of the advantage sought by the making of the expenditure ( Sun Newspapers Ltd. v. FC of T (1938) 61 CLR 337 at 363 per Dixon J). Whether an outgoing is capital or revenue in nature "depends on what the expenditure is calculated to effect from a practical and business point of view" (Hallstroms Pty. Ltd. v. FC of T (1946) 72 CLR 634 at 648 per Dixon J).

Therefore, 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) 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 expenses arise out of the day to day activities of the taxpayer's business (Magna Alloys & Research Pty Ltd v. Federal Commissioner of Taxation 80 ATC 4542; (1980) 11 ATR 276). The action out of which the legal expenses arise has to have more than a peripheral connection to the taxpayer's business or income earning activities.

However if the expenses were incurred in protecting the underlying profit yielding structure or assets of the business they are considered to be capital in nature and will not be deductible.

In your case, you incurred legal costs in relation to an action taken against your sibling in relation to your parent's transfer of the property, and your sibling's subsequent intention to sell the property upon which both you and your parent conduct your primary production operations. The legal costs relate to your eventual capital acquisition of the property. Therefore, the legal costs are also capital in nature and not deductible under section 8-1 of the ITAA 1997.