Edited version of your private ruling

Authorisation Number: 1012592293919

Ruling

Subject: Income tax - deductions - strata levies, interest and legal fees

Issue 1

Question 1

Am I entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for purported strata levies, even though those levies have not been paid?

Answer

Decline to rule

Question 2

If yes, at what point in time am I entitled to claim a deduction for those levies under section 8-1 of the ITAA 1997?

Answer

Decline to rule

Question 3

Am I entitled to a deduction under section 8-1 of the ITAA 1997 for interest on unpaid levies?

Answer

Yes, when it is incurred.

Issue 2

Question 1

Am I entitled to claim legal fees in relation to the hearings as a deduction under section 8-1 of the ITAA 1997?

Answer

Decline to rule

Question 2

Am I entitled to claim legal fees in relation to the Appeals as a deduction under section 8-1 of the ITAA 1997?

Answer

Decline to rule

Question 3

Am I entitled to claim legal fees in relation to the counter claims as a deduction under section 8-1 of the ITAA 1997?

Answer

Decline to rule

Question 4

If the answer to questions 3, 4, or 5 is 'No', are the amounts spent on legal fees able to be deducted under any other provision of the ITAA 1997?

Answer

Decline to rule

This ruling applies for the following period

1 July 20XX to 30 June 20YY

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

You are the owner of strata lots in a strata plan. These units earn assessable income in the form of rent.

During the course of several years the former strata councillors of the strata company held a series of meetings at which they purported to reappoint themselves to the strata council (purported council).

Also during the same period, the strata company under the direction of the purported council attempted, among many other things, to issue levies to you. Together with interest the total due under these purported strata levies is now large. The election of the purported council, and the validity of these levies is disputed by you, and none of the disputed levies have been paid by you.

The purported levies were for the administrative fund of the strata company the budget of which included items for certain works which the purported council contended were repairs and maintenance within the meaning of strata titles legislation. The budgets also contained an amount for legal expenses related to the various legal actions.

Interest on unpaid levies is imposed at a statutory maximum rate of 15% per annum.

You began to seek access to strata company books and records via your solicitors. The purpose of this request was to gain access to books and records to determine whether or not you were legally liable for the purported levies (that is to avoid the expense of the levies).

The strata company refused you access to its books and records and you were forced to take the matter to the Hearing.

Thereafter, the strata company provided access to some but (you contend) not all of its books and records. You were not fully satisfied and you sought leave to appeal the decision.

The appeal has been heard and a decision is pending. You have incurred substantial legal fees in relation to the Hearing and the Appeal

Separately, the strata company filed a statement of claim seeking recovery of outstanding levies. You are strongly defending the claims on a number of grounds, including that the levies are not properly due and owing as no legally effective meetings ever took place, that some of the items of expenditure are not in truth repairs and maintenance and therefore outside of the powers of the strata company, as well as cross claims for breach of statutory duty.

The nature of the levies, and the purposes to which they are applied, are set out in the various notice papers and minutes of resolution.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 section 40-880

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 subsection 110-25(6)

Taxation Administration Act 1953 paragraph 357-110(1)(a) of Schedule 1

Reasons for decision

Where the Commissioner has declined to rule it has been because a private or oral ruling would depend on making an assumption about a future event or other matter. Where the facts are uncertain and the making of an assumption would be inappropriate the Commissioner has the right to decline to rule in accordance with paragraph 357-110(1)(a) of Schedule 1 to the Taxation Administration Act 1953 (TAA) and instead provide general advice.

Issue 1

Question 1

Summary

Decline to rule.

The 'purported' strata levies which are the subject of this ruling are generally not deductible except where it can be established that they have been incurred in the ongoing and day-to-day administration of the strata property and are not in the nature of special purpose sinking funds from which the funds are applied to capital improvements.

In accordance with the 'facts' presented a determination regarding whether the levies are 'legally due and payable at all' is still in progress therefore it is not possible to rule on the deductibility of the purported strata levies at this time.

General advice has however been provided (see below).

Detailed reasoning

To claim a deduction for expenses incurred for strata levies (whether paid or unpaid) the expense must satisfy the tests under section 8-1 of the ITAA 1997.

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, or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed under subsection 8-1(2) of the ITAA 1997 for expenses to the extent that they are of a capital, private or domestic nature.

Subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) is the equivalent of section 8-1 of the ITAA 1997. For guidance on the application of the provisions of section 8-1 decisions and ruling based on subsection 51(1) remain applicable.

Taxation Ruling TR 95/33 Income tax: subsection 51(1) - relevance of subjective purpose, motive or intention in determining the deductibility of losses and outgoings (TR 95/33) at paragraph 11 states:

Where, having regard to the overall objective circumstances, there is an obvious commercial connection between the loss or outgoing and the carrying on of the taxpayers' business, it will not be generally necessary to have regard to the taxpayer's subjective purpose, motive or intention.

The payment of legal expenses to challenge levies imposed in relation to your strata properties which are held for the purpose of producing assessable income falls within these provisions. Even though you are not carrying on a business of renting properties, there is sufficient connection between the derivation of income and the attempt to reduce the cost of deriving that income for the expenditure to be considered incurred in gaining or producing your assessable income. It is therefore necessary to consider the exclusory provisions of subsection 8-1(2) of the ITAA 1997 and in particular whether the expenditure can be considered capital in nature.

The distinction between a revenue and capital expense

The decision of the High Court in Sun Newspapers Ltd & Associated Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337 (1938) 5 ATD 23 ; (1938) 1 AITR 403 (Sun Newspapers) is the leading authority on the distinction between revenue and capital expenditure. The general rule is found at 359 where Dixon J said:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss….

As general conceptions, it may not be difficult to distinguish between the profit yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue.

In the Sun Newspapers case, Dixon J stated three matters to be considered when deciding whether expenditure incurred is revenue or capital in nature. These are:

· the character of the advantage sought by the outgoing;

· the manner in which the advantage is to be used, relied upon or enjoyed by the taxpayer; and

· the means adopted to obtain the advantage, such as by recurring payments.

The character of the advantage sought

The character of the advantage sought provides important direction. It provides the best guidance as to the nature of the expenditure because it says the most about the essential character of the expenditure itself. The decision of the High Court in G P International Pipecoaters Pty Ltd v. Commissioner of Taxation (1990) 170 CLR 124 at 137; (1990) 90 ATC 4413 at 4419; (1990) 21 ATR 1 at 7 emphasised this, stating:

The character of expenditure is ordinarily determined by reference to the nature of the asset acquired or the liability discharged by the making of the expenditure, for the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid: Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation (1938) 61 C.L.R 337, at p.363

In relation to the character of the advantage sought by the expenditure it is necessary to examine whether the expenditure secures an enduring benefit for the business. This test was outlined in British Insulated and Helsby Cables Ltd v. Atherton [1926] AC 205 at 213 - 214 by Viscount Cave where he stated:

But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

As noted above, when the matters stated by Dixon J in the Sun Newspapers Case are considered, the character of the advantage sought by the making of the expenditure is the chief, if not the critical, factor in determining the character of what is paid. The nature or character of the expenditure will therefore follow the advantage that is sought to be gained by incurring the expenditure. If the advantage to be gained is of a capital nature, then the expenditure incurred in gaining the advantage will also be of a capital nature.

The character of the advantage sought by challenging the validity of the strata levies is to reduce your payment of the levies which is the reduction of a tax deductible expense. What must be taken into consideration however is whether the levies are to be paid for the day to day administration and maintenance of a property owned under a strata title.

The body corporate of your rental property complex has levied a special levy to fund repairs to the units and common areas of the complex. The character of an expense follows the purpose for which the expense was incurred. It follows that if the levy is used to fund expenditure which would be deductible then the contribution made is also deductible.

To determine if the special levy is deductible for the purposes of claiming an income tax deduction, we would first need to look at what the levy monies will be expended upon and the deductibility of those expenses. Section 25-10 of the ITAA 1997 states expenditure incurred by you for repairs to any premises, or part of premises, plant, machinery, tools or articles held or used by you solely for the purpose of producing assessable income is an allowable deduction. However, a deduction is not allowable if the expenditure is of a capital nature, for example, an improvement.

Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23) provides the Tax Office's view on repairs that are allowable under section 25-10 of the ITAA 1997 and indicates that expenditure for repairs to property is of a capital nature where:

· the extent of the work carried out represents a renewal or reconstruction of the entirety, or

· the work results in a greater efficiency of function in the property, therefore representing an 'improvement' rather than a 'repair', or

· the work is an initial repair.

The core of your dispute with the body corporate is that the expenditure is not in the nature of expenses incurred for repairs and maintenance and is therefore outside the power of the body corporate to impose the levies. If your claim is successful you would have established that the levies imposed are not deductible under section 8-1 of the ITAA 1997.

The manner in which it is to be used, relied upon or enjoyed

Where payments are made in the form of strata levies to a body corporate for administration and general purpose sinking fund the payments are considered to be for the provision of services and a deduction can be claimed at the time you incur them provided there is established a connection between the payment of the levy and gaining or producing assessable income. However, where the body corporate requires you to make a payment to a special purpose fund or imposes (or attempts to impose) special purpose levies, the application of the funds must be carefully considered. Where the funds are applied to capital improvements or capital repairs a deduction is not allowed under section 8-1 of the ITAA 1997. Any successful reduction to the levies payable through the legal action taken would be seen as incurred in producing your assessable income.

The means adopted to obtain it

In Hallstroms Pty Ltd (1946) 72 CLR 634 (Hallstroms) Dixon J referred at 647 to the general consideration that:

the contrast between [expenditure on capital or revenue account] corresponds to the distinction between the acquisition of the means of production and the use of them; between establishing or extending a business organisation and carrying on the business; between the implements employed in work and the regular performance of the work in which they are employed; between an enterprise itself and the sustained effort of those engaged in it.

Where the special purpose levy is utilised to improve the strata premises the levy paid is not considered deductible under section 8-1 of the ITAA 1997.

Recurrent expenditure

Many judgments in relation to the deductibility of expenditure refer to the statement by Viscount Cave in British Insulated and Helsby Cables Ltd v. Atherton (1926) AC 205 at pp 213-214:

But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is a very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

The levies which have been imposed by the body corporate include the regular levies imposed for the day to day administration of the strata premises including costs such as insurance premiums which are considered deductible under section 8-1 of the ITAA 1997. However, other expenses for which levies have been imposed are not recurrent, may be capital in nature and are excluded from a deduction by the exclusory provisions of subsection 8-1(2) of the ITAA 1997.

Conclusion

A deduction is allowable when an expense is incurred for strata levies which are considered to be an ongoing expense incurred in relation to the ownership of rental properties as the funds are applied to administration and general maintenance.

However, levies which are imposed by the body corporate for special purposes such as the payment of extraordinary (read capital) repairs and replacements are not deductible and the share of funds applied to capital repairs and improvements must be treated as capital expenditure. Where the special purpose levy funds are applied to repairs and maintenance a deduction is still allowable when the expenditure is incurred.

It is understood that part of the dispute which you have with the body corporate involves a difference of opinion of the nature of the work to which the levy funds have been applied. Where it is legally determined that the costs are not capital in nature, a deduction will be allowable under section 8-1 of the ITAA 1997 when the expenditure is incurred. The distinction between levies being 'incurred' and 'paid' is discussed below.

Question 2

Summary

An expense is not considered to be 'incurred' until you are definitively committed, or have completely subjected yourself to the expenditure. It is at that point in time that a deduction may be claimed even if the expense has not yet been paid.

Detailed reasoning

Incurred

There is no statutory definition of the term 'incurred' however Taxation Ruling TR 97/7: Income tax: section 8-1 - meaning of 'incurred' - timing of deductions (TR 97/7) sets out the Commissioner's view as to the meaning of 'incurred' for the purposes of section 8-1 of the ITAA 1997. Paragraphs 5 and 6 of TR 97/7 state:

5. As a broad guide, you incur an outgoing at the time you owe a present money debt that you cannot escape. But this broad guide must be read subject to the propositions developed by the courts, which are set out immediately below.

6. The courts have been reluctant to attempt an exhaustive definition of a term such as 'incurred'. The following propositions do not purport to do this, they help to outline the scope of the definition. The following general rules, settled by case law, assist in most cases in defining whether and when a loss or outgoing has been incurred:

a) a taxpayer need not actually have paid any money to have incurred an outgoing provided the taxpayer is definitively committed in the year of income. Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing. That is, subject to the principles set out below, it is not sufficient if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum;

b) a taxpayer may have a presently existing liability, even though the liability may be defeasible by others;

c) a taxpayer may have a presently existing liability, even though the amount of the liability cannot be precisely ascertained, provided it is capable of reasonable estimation (based on probabilities);

d) whether there is a presently existing liability is a legal question in each case, having regard to the circumstances under which the liability is claimed to arise;

e) in the case of a payment made in the absence of a presently existing liability (where the money ceases to be the taxpayer's funds) the expense is incurred when the money is paid.

The application of this treatment is described in example 7 of TR 97/7 which states:

46. Dianna is an employee working for Dial-A-Label Manufacturing Company Pty Ltd and is a member of a work union. She has gone through hard times and currently her union fees are in arrears in the amount of $244 as at 30 June 1997. She does not pay the union fees until the commencement of August 1997 on a half yearly instalment basis. On the basis that Dianna is definitively committed to paying the fees, she has incurred them in the 1996/97 income year. However, if she is not definitively committed to paying the fees, for example, she disputed the liability, she will not have incurred the outgoing until it is actually paid - (refer, for example, Softwood Pulp & Paper Ltd v. FC of T 76 ATC 4439; (1976) 7 ATR 101).

Relevant case law

The Commissioner's view that a taxpayer was not 'definitively committed' to nor was 'completely subjected' to an amount under dispute, and therefore has not incurred the amount, reflects case law including the following part of the judgment of Menhennit J of the Supreme Court of Victoria in Softwood Pulp and Paper Limited v Federal Commissioner of Taxation 76 ATC 4439 at 4456:

The circumstances in which a loss or outgoing is to be regarded as being incurred were dealt with by the High Court in F.C. of T. v. James Flood Pty. Ltd. (1953) 88 CLR 492 at pp. 506-7, and in the course of the reasons of the joint judgment of Dixon C.J. and Webb, Fullagar, Kitto and Taylor JJ., their Honours said at pp. 506-7:

For under our law the facts must satisfy the expression `losses and outgoings incurred'. These words perhaps are but little more precise than the word `established' or the expression used above `definitively committed'. But they do not admit of the deduction of charges unless, in the course of gaining or producing the assessable income or carrying on the business, the taxpayer has completely subjected himself to them.

And later at p. 507:

To repeat what has been said before in relation to an analogous provision in the Act of 1922-1934: `To come within that provision there must be a loss or outgoing actually incurred. `Incurred' does not mean only defrayed, discharged, or borne, but rather it includes encountered, run into, or fallen upon. It is unsafe to attempt exhaustive definitions of a conception intended to have such a various or multifarious application. But it does not include a loss or expenditure which is no more than impending, threatened, or expected.': New Zealand Flax Investments Ltd. v. F.C. of T. (1938) 61 CLR 179, at p. 207.

In my view it is clear in this case that the claim by MacMillan against the taxpayer for $178,170.04, of which the taxpayer has claimed as a deduction $134,137.91, was not a loss or outgoing incurred by the taxpayer. At no stage did the taxpayer subject itself to that claim, either completely or at all, except to the extent of the ultimate settlement for $24,000. At the most it falls within the language of the High Court as being a loss or expenditure which was no more than impending, threatened or expected. At all stages the taxpayer denied liability for the amount and that denial was not only asserted in correspondence and its annual balance sheets, it was also continued as its attitude at the time of the deed of the release, which was dated 29th day of September 1967 and executed by the taxpayer later that year, because there in the taxpayer denied the validity of the claims by MacMillan.

The Commissioner's view also reflects the decision of Newton J of the Supreme Court of Victoria in Commonwealth Aluminium Corporation Limited v Federal Commissioner of Taxation 77 ATC 4151 where a loss or outgoing is or may be defeasible. A deduction that is defeasible is incurred where the taxpayer is completely subjected to the loss or outgoing. Newton J stated at 4163:

…as earlier stated, an existing liability may be a loss or outgoing, which has been ``incurred'' within the meaning of sec. 51, notwithstanding that it is defeasible, provided that the taxpayer has otherwise completely subjected itself to the liability.

Your situation

You are the owner of lots in a strata plan. These units earn assessable income in the form of rent. An extraordinary general meeting (EGM) was held where it was agreed by the majority of owners to pay for maintenance works. You were a financial member of the strata group at that time and you voted by proxy against the renovation works.

Another EGM was held and it was determined that a quorum of proprietors was in attendance at the meeting and a chairperson was appointed as well as a Council of Management (COM). Even though you were a financial member you had given your proxy vote to another member who was unexpectedly detained and could not attend the meeting.

You were not considered to be a financial member of the strata group subsequent to missing levy payments.

You commenced legal action to gain access to books and records to determine whether or not you were legally liable for the purported levies (ie, to avoid the expense of the levies). Subsequent to the initial action you have submitted the matter to a Hearing and appealed that decision.

The information provided by you indicates that you have never been 'definitively committed' or 'completely subjected' to the levies which are being imposed upon you. You have therefore not incurred the expenses. You will have incurred the expenses when you have definitively committed to paying them. In accordance with section 8-1 of the ITAA 1997 you will then be able to claim a deduction for expenses you have incurred in gaining or producing assessable income to the extent that they are not of a capital nature.

Question 3

Summary

A deduction for interest incurred on unpaid levies is allowable when the expense is incurred.

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a deduction for expenses necessarily incurred for the purpose of gaining or producing assessable income. However, no deduction is allowable if the expense is of a private, domestic or capital nature.

In general the character of interest is determined with reference to the use to which the borrowed funds are put as discussed in the Commissioner of Taxation v. Roberts; Commissioner of Taxation v. Smith (1992) 37 FCR 246; 92 ATC 4380; (1992) 23 ATR 494. The interest will not be deductible, to the extent to which it is private or domestic in nature, or is incurred in relation to the gaining or production of exempt income.

Taxation Ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities (TR 2004/4) outlines deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities.

Outgoings of interest are a recurrent expense. The fact that borrowed funds may be used to purchase a capital asset does not mean the interest outgoings are on capital account as established in Steele 99 ATC 4242 at 4249; (1999) 41 ATR 139 at 148.

You are accumulating charges at the rate of 15% on unpaid levies (which are discussed in Question 1). The interest is being accrued because levies have been imposed by the strata fund which represents the strata units which you hold for income producing purposes and they remain due.

The levies include ongoing quarterly levies as well as 'special levies'. Those levies are currently the issue of a dispute regarding the legality of the imposition of the levies and their application to costs described as repairs and maintenance or whether they should be described as capital improvement or repairs. All the levies imposed remain unpaid and interest has accrued on the quarterly levies as well as the special levies.

In your case the interest has been accrued on levies which are on revenue and capital account and the imposition of interest does not differentiate between the nature of asset (in this case the nature of the payments for which the levies are being imposed).

As discussed in TR 2004/4 it has been established that interest is ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but rather the use of borrowed money during the term of the loan. It is ordinarily a revenue item.

You have not 'borrowed money' per se however the imposition of interest is for the use of monies which are considered payable to the strata fund for unpaid levies.

In TR 2004/4 and in reference to Steele's case on appeal, a majority of the High Court (Gleeson CJ, Gaudron and Gummow JJ) overturned the original decision and rejected the reasoning of the Full Federal Court. The majority expressed the following view:

As was explained in Australian National Hotels Ltd v. FC of T, interest is ordinarily a recurrent or periodic payment which secures, not an enduring advantage, but, rather, the use of the borrowed money during the term of the loan. According to the criteria noted by Dixon J in Sun Newspapers Ltd v. FC of T it is therefore ordinarily a revenue item. This is not to deny the possibility that there may be particular circumstances where it is proper to regard the purpose of interest payments as something other than the raising or maintenance of the borrowing and thus, potentially, of a capital nature. However, in the usual case, of which the present is an example, where interest is a recurrent payment to secure the use for a limited term of loan funds, then it is proper to regard the interest as a revenue item, and its character is not altered by reason of the fact that the borrowed funds are used to purchase a capital asset.

The imposition of a charge which can be described as interest is seen as an administrative charge recognising the time value of money.

As seen in Federal Commissioner of Taxation v. Jones (2002) 2002 ATC 4135 (2002) 49 ATR 188 case a deduction can be claimed where expenditure is incurred in an effort to reduce deductions related to the derivation of assessable income.

A deduction can be allowable for interest even if the principal (and in this case the unpaid levies) are considered to be for a capital or revenue expense because the calculation and imposition is considered to not be a capital cost.

As discussed in TR 97/7 (and discussed at length in Question two) a deduction is not allowable until an expense is incurred...

Issue 2

Questions 1 and 2

Summary

Your claim for legal fees for the hearing and appeal are dependent upon the outcome of the hearings. As the case is still in progress an outcome is not known therefore at this point in time we have declined to rule. However, general advice has been provided.

Detailed reasoning

As discussed at length in Issue 1 Question 1 under section 8-1 of the ITAA 1997 you can claim deductions for expenses to the extent they are incurred in gaining or producing assessable income or they are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income.

You cannot claim deductions under section 8-1 of the ITAA 1997 for expenses to the extent to which they are of a capital, private or domestic nature or they are incurred in gaining or producing exempt income. A deduction is also not allowed where a provision of the tax law prevents it.

The character of the advantage which you are seeking by challenging the legality of the levies is the reduction of expenses which are considered by the strata body to revenue in nature thereby affecting the income tax payable on your rental income.

Connection with the income of the taxpayer

To be deductible under section 8-1 of the ITAA 1997, a loss or outgoing must have a sufficient connection with the derivation or calculation of the taxpayer's assessable income. The sufficiency of the connection is determined on the facts of the case.

Legal expenses

To determine whether legal expenses are deductible under section 8-1 of the ITAA 1997 it is necessary to consider the essential character of the expenses. It is irrelevant whether the legal action is successful or not. It is the nature and character of the expense and the advantage sought to be gained by incurring the expense that is important.

In Hallstroms case, Dixon J said:

…legal expenses ... take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.

Legal expenses are generally deductible if the legal action:

· arose out of, or concerned the day to day income producing activities of the taxpayer (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169)

· is not undertaken to protect the taxpayer's profit yielding subject

· has more than a peripheral connection to the taxpayer's business (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276; Putnin v. Commissioner of Taxation (1991) 27 FCR 508: 91 ATC 4097; (1991) 21 ATR 1245), and

· may arise out of litigation concerning the taxpayer's professional conduct (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276 and Putnin v. Commissioner of Taxation (1991) 27 FCR 508: 91 ATC 4097; (1991) 21 ATR 1245).

In general, legal expenses have been held to be deductible if the expenses have arisen as a consequence of the day to day activities of a business, providing that the expenses are not of a capital nature.

The Full Federal Court in FCT v. Rowe (1995) 31 ATR 392; 95 ATC 4691 established that the principles in cases concerning business taxpayers may be applied to taxpayers who are not in business.

Application to your circumstances

You are currently disputing the election of a strata council of management and the validity of levies imposed on you by the council. You maintain that the expenditure which the council seeks to carry out is capital in nature and outside the powers of the strata company.

Your legal action arose as a consequence of your income earning activities. You incurred the liability in your capacity as a property owner and landlord. There is a necessary connection between the legal fees incurred and the gaining or producing of your assessable income. Therefore the first limb of subsection 8-1(1) of the ITAA 1997 is satisfied.

The second limb of section 8-1 of the ITAA 1997 states however, that a loss or outgoing is not allowable to the extent that it is of a capital, private or domestic nature, or relates to the earning of exempt income.

In determining whether a deduction for legal expenses is allowable, the nature of the expenditure must be considered. 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.

Where an expense relates to multiple purposes, the expense must be apportioned between the purposes on a fair and reasonable basis: Ronpibon Tin NL & Tongkah Compound NL v. FC of T (1949) 78 CLR 47.

The subject of your dispute is that the strata company is acting outside its authority in carrying out capital improvements to the property where their responsibility is limited to repairs and maintenance. The descriptions of the components of the levies (for example water charges) suggest that at least a portion of the levies are to be attributed to repairs and maintenance whereas other expenses may appear to be capital in nature.

Where the expenses are determined at appeal to be in the nature of repairs and maintenance a deduction for the legal expenses incurred in the referral to the hearing and appeal would be allowable deductions and not excluded by the negative limb under subsection 8-1(2) of the ITAA 1997.

Question 3

Summary

Your claim for legal fees for a statement of claim lodged with the District Court of your state in Australia (where the strata company is seeking the payment of outstanding levies) is still in progress.

As the case is still in progress an outcome is not known therefore at this point in time we have declined to rule. However, general advice has been provided.

Detailed reasoning

Claims and counter claims have been lodged regarding unpaid strata levies and work done to common and personal property without your consent. It would appear from the facts provided that a proportion of the legal expenses would be attributable to points of dispute related to revenue costs and others to capital expenditure.

You have indicated that an application to remit the Court is currently being prepared. Therefore the Commissioner is unable to determine whether the legal fees should be considered of a capital or revenue nature (see detailed reasoning for Issue 2 Questions 1 and 2 above) pending the outcome of the hearing.

Upon determination of the case the legal fees incurred would be expected to be apportioned on an equitable basis.

Question 4

Summary

The Commissioner has declined to rule on Issue 2 Questions 1 to 3 (see above) therefore general advice is provided in relation to this question. Where legal expenses are not incurred in gaining or producing assessable income under section 8-1 of the ITAA 1997 because they are considered to be capital in nature a deduction is not available under any other provisions of the legislation.

Detailed reasoning

Some of your legal expenses may be considered to be incurred in gaining or producing your assessable rental income and deductible under section 8-1 of the ITAA 1997.

However legal expenses which are of a capital nature and therefore not deductible may, however, form part of the cost base of your property for capital gains tax purposes.

The cost base of a capital gains tax asset is made up of five elements. Section 110-25 of the ITAA 1997 states the general rules about cost base and subsection 110-25(6) of the ITAA 1997 states:

The fifth element is capital expenditure that you incurred to establish, preserve or defend your title to the asset, or a right over the asset.

In your case, some of the legal expenses you incurred in relations to the SAT Hearing, SAT Appeal and District Court Claims are related to expenses that may be capital in nature and are not deductible under section 8-1 of the ITAA 1997.

Therefore, any non-deductible legal expenses you incur can form part of the cost base in proportion to your units upon disposal of those units. No deduction is available for legal fees which are capital in nature.

Further issues for you to consider

Where strata funds have been applied by the body corporate to capital repairs and improvements to the premises held under strata title, a deduction may be allowable when it is incurred under the provisions of Division 43 of the ITAA 1997. This matter has not been addressed in this ruling.