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Edited version of your private ruling
Authorisation Number: 1012590193976
Ruling
Subject: Legal costs in defending civil proceedings
Question
Are you entitled to a deduction for legal expenses?
Answer
Yes.
This ruling applies for the following periods
Year ended 30 June 2011
Year ended 30 June 2012
Year ended 30 June 2013
Year ending 30 June 2014
The scheme commences on
1 July 2010
Relevant facts and circumstances
You were employed under an employment contract.
You undertook various duties for your employer.
You resigned from your position with the company.
Subsequently the company commenced legal action against you alleging that you had breached your duties in several respects including being in breach of section 182 of the Corporations Act 2001 and section 183 of the Corporations Act 2001(which are about improperly using your position or information to gain an advantage for yourself or someone else or to cause detriment to the company).
The employer is claiming for damages, an account of profits, equitable compensation and compensation under the Corporations Act 2001.
You have incurred legal expenses.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Reasons for decision
Section 8-1 of the Income Tax Assessment Act 1997 (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.
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 income earning activities. The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business and the expense may arise out of litigation concerning the taxpayer's professional conduct.
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 cleared him 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, in order to defend the threat of dismissal, were allowable. 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 FC of T v. Day, 2008 ATC 20-064; 70 ATR 14, the taxpayer incurred legal expenses in defending charges in respect of conduct which was alleged to have occurred outside the course of his normal day-to-day duties. The Court found the legal expenses incurred by the taxpayer in relation to the disciplinary action taken by his employer were not outgoings of a private or domestic nature. Crucial to this view was the fact that the terms of employment, namely the various codes of conduct, standards, and policies and procedures imposed on public servants, exposed the taxpayer as an employee to the employer action, and therefore to the need to incur the expenses. Of significance was the fact that the legal expenses were incurred in responding to disciplinary action internal to the employment relationship and existing for no other purpose. The taxpayer was exposed to the action by reason of his employment as a public servant, and the consequences of the action only affected his employment. The occasion of the legal expenses was to be found in his position as an officer and it followed that the expenses were properly allowable as deductions.
In your case, you incurred legal fees in order to defend your conduct in relation to the conditions imposed upon you as an employee under several sections of the Corporations Act 2001. Therefore, as your expenses relate to the performance of the duties from which you derived your assessable income you are entitled to a deduction under 8-1 of the ITAA 1997 for the legal expense you incurred relating to this defence.