Edited version of your written advice

Authorisation Number: 1012873673122

Date of advice: 18 September 2015

Ruling

Subject: Legal expenses

Question 1

Are you entitled to a deduction for legal expenses you paid for the super fund

Answer:

No.

Question 2:

Are you entitled to a deduction for legal expenses you incurred to protect and gain title of the property?

Answer:

No.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

Year ended 30 June 2015

The scheme commenced on:

1 July 2009

Relevant facts

You and your spouse are directors of the corporate trustee company (the Trustee).

The Trustee acts as the trustee to a Superannuation Fund (the Fund)

You and your spouse are members of the fund.

You entered into a contract of sale with a developer to purchase a property.

You sold an asset and deposited the funds to Fund.

There was no loan agreement between you and the Fund.

The Fund entered into a loan agreement and invested the funds in a development.

Under the terms of the loan agreement the interest on the loan was to be paid to the Fund.

The developer became the registered proprietor of the property.

The property is held under mortgage by a financial institution.

The developer went into liquidation.

The property is your place of residence.

You and the Trustee sought legal advice in relation to acquiring the title of the property and to recover the funds lent by the Fund to the developer.

The loan to the Fund was repaid.

You took legal action against the developer seeking to gain the title of property upon the discharging of the mortgage over the property.

You paid the legal expenses in relation to the advice sought in relation to acquiring the title of the property and to recover the funds lent by the Fund to the developer.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

The legal expenses you paid for the Fund are not deductible as there is an insufficient nexus between the legal expenses you paid and the earning of your assessable income.

The legal expenses you incurred in relation to seeking to acquire and protect the title of the property are not deductible as they are capital in nature and also not incurred in earning your assessable income.

Detailed reasoning

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, relate to the earning of exempt income or are excluded by another provision of the taxation legislation.

The courts have considered the meaning of 'incurred in gaining or producing assessable income'. In Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 56 ALR 785; (1949) 8 ATD 431 the High Court stated that:

For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words "incurred in gaining or producing the assessable income" mean in the course of gaining or producing such income.

The reference to your assessable income in section 8-1 of the ITAA 1997 means that the expenditure must be incurred in producing the assessable income of the person who incurs the expenditure. 

Generally, a taxpayer cannot claim a deduction unless it is incurred in gaining or producing their assessable income. Only the person who incurs the expense can claim the deduction, but it has to relate to assessable income that they have derived.

As stated in Case M36 80 ATC 280 (Case M36): 

It is a condition of deductibility under section [8-1 of the ITAA 1997] that any loss or outgoing must have a nexus with the gaining or producing of assessable income in the hands of the claimant, or be necessarily incurred in carrying on a business (by the claimant) for the purpose of producing such income. 

All losses and outgoings of a taxpayer incurred in gaining or producing assessable income of the same taxpayer are allowable deductions to that taxpayer and only that taxpayer: Marshall Richards Machine Co Ltd v Jewitt (1956) 36 TC 511.

In practice, taxpayers often have to deal with groups of related companies or entities and with payments which are non-arm's length in the sense that payments are made either to or (wholly or partly) for the benefit of an associated person or entity.

Taxpayers must bear in mind that each entity is a separate taxpayer, and that generally a loss or outgoing will not be deductible under 8-1 unless it is incurred in gaining or producing assessable income (or in carrying on a business for the purpose of gaining or producing such income) for the taxpayer who incurred that loss or outgoing: see Federal Commissioner of Taxation v Munro (1926) 38 CLR 153 at 170 per Knox CJ.

Capital expenses

An expense will usually be capital in nature where it is incurred with the intention to create an asset or advantage of a lasting and enduring nature (British Insulated & Helsby Cables Ltd v. Atherton (1926) AC 205; (1926) 10 TC 155).

Legal expenses

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.

Expenditure made in order to preserve an asset is generally considered to be of a capital nature and therefore is not deductible, whereas working or operating expenses are considered of a revenue nature and deductible. 

The following guidelines for determining whether a loss or outgoing is of a capital nature have been set down by the High Court in Sun Newspapers Ltd. and Associated Newspapers Ltd. v. Federal Commissioner of Taxation
(1938) 5 ATD 23; 5 ATD 87; 61 CLR 337: 

• the expenditure is related to the business structure itself, that is, the establishment, replacement or enlargement of the profit yielding structure rather than the money earning process, or

• the nature of the advantage has lasting and enduring benefit, or

• the payment is 'once and for all' for the future use of the asset or advantage rather than being recurrent and ongoing.

Legal expenses to recover funds lent by The Juldic Pty Ltd Superannuation Fund

In your case, you are seeking to deduct legal expenses you paid in relation to legal advice provided to the Trustee for the recovery of funds lent by the Fund. As noted in Case M36 any loss or outgoing must have a nexus with the gaining or producing of assessable income in the hands of the claimant, or be necessarily incurred in carrying on a business (by the claimant) for the purpose of producing such income.

The legal expenses you have paid are in relation to an investment made by the Fund. The expenses relate to the activities of the super fund rather than your income earning activities and therefore although you are a member of the super fund, there is an insufficient connection with your assessable income. In any case, as super benefits paid from a taxed super fund to people over 60 years are tax-free and not included as assessable income, you would not even receive any assessable income from the super fund.

Legal expenses in relation to the property

As noted above, expenditure made in order to preserve an asset is generally considered to be of a capital nature and therefore not deductible. In your case you incurred legal expenses in acquiring and defending the title of your current private residence. The legal expenses were incurred in connection with securing an enduring (lasting) benefit which is to retain ownership of the property.

The legal expenses in question did not arise out of the day to day activities of an investment property you held or from a business activity you carried on as an individual. The character of the legal expense you incurred is such that it was incurred in acquiring and defending your title to a capital asset and accordingly capital in nature.

Also, the property is not used to produce assessable income.

Your legal expenses incurred in this action are therefore not deductible under section 8-1 of the ITAA 1997.