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Edited version of your written advice
Authorisation Number: 1012881406168
Date of advice: 28 September 2015
Ruling
Subject: Deductibility of legal expenses
Question and answer
Are you entitled to claim a deduction for the amount you paid to settle the legal proceedings brought against you?
No.
This ruling applies for the following period:
Year ended 30 June 20YY
The scheme commences on:
1 July 20XX
Relevant facts and circumstances
You left your employment with a business and took some information with you.
You began employment with another business and your former employer commenced legal proceedings against you over the information you took.
A deed of settlement was subsequently reached in which you agreed to pay a settlement amount to the solicitor of your former employer.
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 or 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 expenses can be characterised as an outgoing on revenue account or an outgoing of a capital nature depending on the cause or purpose for which the legal expenses were incurred (Hallstroms Pty Ltd v.Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; 8 ATD 190).
In Herald & Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169 (Herald & Weekly Times) it was held that the taxpayer, a newspaper publisher, was allowed a deduction for legal expenses incurred in defending damages claims against it on the basis that the expenses arose as a consequence of the taxpayer's income earning activities. Further, the deductible legal expenses were found to include the expenses incurred by the claimant, expenses incurred by the publisher and the damages payable by the publisher.
Another example of deductible legal expenses is where a landlord incurred expenses in defending a damages claim in respect to injuries suffered by a third party on the landlord's rental property. In this case, there was a clear connection between the legal expenses incurred and the earning of rental income (ATO ID 2003/484).
In your situation, you defended legal proceedings brought by your former employer against you on the basis of an alleged wrongful action you committed against your employer. You subsequently agreed to pay an amount to settle the proceedings against you.
From the information provided, the legal proceedings were brought against you after you had left your former employer and there is not a sufficient connection between the amount you paid and the carrying on of your income earning activities with your former employer. For example, there was no dispute over wages owed under your former employment contract.
The amount you paid was capital in nature and was not incurred in gaining or producing your assessable income. Therefore, the amount is not deductible under section 8-1 of the ITAA 1997.