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Edited version of your private ruling
Authorisation Number: 1012615591529
Ruling
Subject: Legal expenses
Question 1
Are you entitled to a deduction for legal expenses incurred?
Answer
No.
This ruling applies for the following periods:
Year ended 30 June 2014
Year ended 30 June 2015
The scheme commenced on:
1 July 2013
Relevant facts
You are the owner of a rental property.
The rental property was built by the previous owner.
You were previously told by the council that the building approval for the property had gone missing.
The council previously gave you written confirmation that you can lease the dwelling and no further approvals are required.
You have since been advised by another section of the same council that they are to issue an order requiring you to cease use of the dwelling and have the tenant vacate the property. The council is asking you to reapply for the building approval for the property.
The tenant has recently moved in and has a six month lease agreement.
The property is being rented at a commercial rate through a real estate agent.
You are seeking legal advice in relation to stopping the council's order from going ahead.
You will incur legal expenses in relation to the above.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1.
Reasons for decision
Legal expenses
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.
A number of significant court decisions have determined that for an expense to be an allowable deduction:
n it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478),
n there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and
n it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).
For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, in determining whether a deduction for legal expenses is allowable 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.
Legal expenses are generally deductible if they arise out of the day to day income earning activities (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).
However, where the expenditure is incurred for the purpose of securing an enduring benefit, rather than a revenue purpose, the expenditure is capital in nature and is not deductible (Sun Newspapers Ltd v. FC of T (1938) 61CLR 337; 5 ATD 87; (1938) 1 AITR 403).
Taxation Ruling TR 95/33 considers the decision of the Full High Court of Australia in Fletcher & Ors v. FC of T 91 ATC 4950; (1991) 22 ATR 613 and in particular, considers situations in which a taxpayer's subjective purpose, intention or motive is relevant in determining the availability of an income tax deduction.
In order to determine whether your legal fees are deductible under section 8-1 of the ITAA 1997, we first need to look at the reason for the legal fees and why they will be incurred.
The legal expenses relate to your rights in relation to your rental property. The expenses did not arise as a consequence of your day to day activities as a landlord and do not sufficiently relate to your assessable rental income.
It is acknowledged that the council order may stop you from deriving assessable income from your property. However, legal expenses incurred in preserving an asset or defending your rights are not deductible as they are considered to provide an enduring advantage and are therefore capital in nature. As such, the expenses are not deductible under section 8-1 of the ITAA 1997.