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Edited version of your private ruling
Authorisation Number: 1012585305480
Ruling
Subject: Expenses - legal
Question
Are you entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in taking legal action?
Answer
No
This ruling applies for the following periods
Year ending 30 June xxxx
Year ending 30 June xxxx
Year ending 30 June xxxx
The scheme commenced on
A certain date
Relevant facts and circumstances
You have commenced legal action against an individual who made certain allegations against you.
You claim the allegations have created a serious impediment to your prospects for any future employment.
A proposed statement of claim has been structured to reflect the outcome sought to include compensation for loss of earnings, recovery of your legal expenses and general and aggravated damages.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.
Legal costs take their quality as an outgoing of capital or revenue nature from the cause or purpose of incurring the expenditure. If the advantage to be gained is of a revenue nature, then the costs incurred in gaining the advantage will also be of a revenue 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. The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business or income earning activities.
Where the legal costs are incurred in recovering unpaid wages or other contractual entitlements relating to a right to income, the taxpayer will be entitled to a deduction: Romanin v. Federal Commissioner of Taxation [2008] FCA 1532; (2008) 73 ATR 760.
However, 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 Case 72 (1987) 18 ATR 3515.
Legal expenses incurred in seeking compensation for loss of employment, such as in an action for wrongful dismissal or loss of office, are capital in nature even if the amount awarded is calculated by reference to unpaid salary or lost income: Scott v. Commissioner of Taxation (1935) 35 SR (NSW) 215.
It is relevant to note that the Full Federal Court held that an award of damages for defamation received by a company for defamation was not held to be assessable income in Federal Commissioner of Taxation v. Sydney Refractive Surgery Centre Pty Ltd [2008] FCAFC 190; 2008 ATC 20-081; (2008) 73 ATR 28. This was because the damages were awarded for the harm caused to its business reputation, and not for lost profits (even though they were calculated by reference to lost profits) because an award of damages for injury to reputation is not assessable income.
In that case, the Court held that the damage was to the corporation's reputation which is part of what enables it to earn money. An injury to that reputation diminishes its capacity to earn because it reduces the corporation's ability to induce others to do business with it. The Court said that an award of damages for that injury is therefore no different from an award for the loss of an arm or any other injury impairing earning capacity, which is capital in nature.
Similarly, in your case the alleged damage was to your reputation which is part of what enables you to earn money. The legal expenses are more connected to your income earning ability than any actual income earning activities.
The legal expenses you have incurred (and expect to incur) in taking legal action are therefore not deductible under section 8-1 of the ITAA 1997 as they are considered to be insufficiently connected with your income earning activities and are essentially private or capital in nature and character.