Edited version of your written advice

Authorisation Number: 1012989574030

Date of advice: 29 March 2016

Ruling

Subject: Legal and other expenses

Question 1

Are you entitled to a deduction for legal expenses and financial analyst fees that relate to determining your assessable income?

Answer

Yes.

Question 2

Are you entitled to a deduction for legal expenses and financial analyst fees that relate to the separation and Family Court matters?

Answer

No.

Question 3

Are you entitled to a deduction for the services of a professional in managing your tax affairs?

Answer

Yes.

Question 4

Are you entitled to a deduction for fees paid to your business consultant?

Answer

No.

Question 5

Are you entitled to a deduction for a portion of your home office expenses?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 20xx

Year ended 30 June 20xx

Year ended 30 June 20xx

Year ended 30 June 20xx

The scheme commenced on

1 July 20xx

Relevant facts

You ran a business with your spouse for several years.

Your spouse and business partner, decided to leave the marriage.

After your separation, your ex-spouse ran the business without reference to you. You were deprived of all the business records and your spouse used the business funds for personal matters. Business leases were executed in your ex-spouse's name.

Your ex-spouse also began to bank and hold significant stock and income belonging to the partnership in their own name. None of this stock and income was declared by the partnership.

Partnership funds were previously deposited into a joint partnership bank account. Deposits of income into the joint bank account ceased after separation.

Your ex-spouse set up a new trading entity and transferred all partnership assets, including cash and income into that entity.

Your ex-spouse changed banks so that you had no access or authority to bank accounts or records. Business related money was not made available to you. Stock numbers were under-estimated.

After separation, partnership funds were deposited in your ex-spouse's personal bank accounts and their new business bank accounts. Partnership stock and income were moved into their name. They traded under other business names.

Your ex-spouse withdrew funds from your bank account to cover partnership expenses. These funds were never returned to you. It was at this time that you became aware of your ex-spouse's actions.

In the 20xx year the court ordered the return of all partnership funds to the partnership account and ordered that all future partnership income be paid into the partnership account.

Your ex-spouse had their accountant prepare the partnership tax returns and your tax returns despite not having the authority to do so. You did not authorise your XXXX-XX tax returns. You became aware of the unauthorised tax return when your accountant went to lodge your return.

The agreement and decision to wind up the partnership was made and entered into as part of a family court consent order.

You started seeking legal advice in relation to the above and incurred legal expenses.

You have incurred outgoings in relation to partnership matters and income from previous years.

You have spent money on professional fees and ran a home office to identify, locate and return the income, assets and stock to the partnership and therefore help calculate the correct partnership income for tax purposes.

You incurred financial analyst fees.

You employed an accountant to help liaise with the partnership accountant and provide you with advice on your personal income tax matters and returns. You incurred accountant fees.

You engaged a business consultant to stabilise the partnership and ensure its future following the marital separation, to determine a management structure and improve the profitability of the partnership. You attended some sessions together and other individually depending on the recommendation of the consultant.

You incurred business consultant costs.

The invoices for the above costs are made out to you and not the partnership.

You spent substantial hours in your home office to help recover the partnership assets and income. You do not have a diary or record of the time spent in your home office. You are planning to claim a percentage of the relevant costs of your home.

You were paid out part of your share of partnership income in 20xx and will receive the remainder as annual instalments each year for the following XX years as part of the family court settlement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

Allowable deduction

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 or are necessarily incurred in carrying on a business for the purpose of 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:

• 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), 

• 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

• 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).

Legal expenses

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. 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 activities of the taxpayer's business (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169 (Herald and Weekly Times)) 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 (1980) 11 ATR 276; 80 ATC 4542).

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).

Legal expenses incurred in recovering salary or wages are considered to be of a revenue nature and therefore deductible under section 8-1 of the ITAA 1997.

Similarly, legal expenses incurred in recovering business income are generally allowable as they directly relate to gaining or producing assessable income.

In your case you incurred legal expenses in relation to determining the correct assessable income of the business including the trading stock and the amount of business funds. It is considered these legal expenses are sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

The fact that some of your expenses were incurred in the 20xx-xx financial year after the business ended is not detrimental as it is considered that the expenses sufficiently relate to your previously derived assessable income. The allowable expenses are deductible in the year they were incurred.

However, other legal expenses related to the Family Court matters. Such matters did not arise as a consequence of the business conducting its day to day workings or operations or the performance of business's income earning activities.

Legal fees initiated following the breakdown of the marriage were incurred with respect to a range of matters arising out of their personal relationship. Such expenses incurred in defending Family Court proceedings relate to a private or domestic matter and are not sufficiently connected to the income earning activities of the business. Therefore a deduction is not allowed under section 8-1 of the ITAA 1997.

Financial analyst

The financial analyst was involved in going through various documents to help trace the money and stock of the business and to help determine your assessable income. As outlined above, matters in relation to recovering such unpaid assessable income are revenue in nature and relate sufficiently to the earning of your assessable income. Therefore a deduction is allowed under section 8-1 of the ITAA 1997 for the fees that relate to determining the correct business income.

However, fees that relate to Family Court matters and splitting of assets are not sufficiently related to your assessable income and are more private and domestic in nature. Therefore no deduction is allowed for this portion of fees.

Apportionment of expenses

As your legal expenses and financial analyst expenses are not fully deductible, you will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

Business consultant

The business consultant provided advice on an appropriate management structure and operation of the business following your separation.

Advice on the structure of the business is designed to provide an enduring benefit and is capital in nature. This was highlighted in the judgment of Dixon J in Sun Newspapers Ltd v FCT (1938) 61 CLR 337:

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.

Expenditure that relates to the business structure or `profit yielding structure' of a business is generally capital in nature. Conversely, expenditure that relates to the process of the taxpayer to earn profits will be indicative of expenditure of a revenue nature.

In your case, the business consultant costs related to the structure of the business which is capital in nature and not sufficiently connected to your day to day income earning activities. Furthermore, the need for such services arose following your separation which relates to more personal matters. Therefore no deduction is allowed for the associated costs.

Accountant fees

Section 25-5 of the ITAA 1997 provides that certain tax related expenses are deductible. 

Paragraph 25-5(1)(a) of the ITAA 1997 provides that a taxpayer can deduct expenditure they incur to the extent that the expenditure is for managing tax affairs. 

Expenses for managing tax affairs include expenses relating to preparing and lodging your tax return and the costs associated with lodging your tax return through a registered tax agent. 

Therefore, expenditure for fees paid to a registered tax agent liaising with the business accountant and providing advice on your tax affairs and tax returns is an allowable deduction under paragraph 25-5(1)(a) of the ITAA 1997. 

Home office expenses  

Normally, expenses associated with a person's home are private or domestic in nature, and therefore do not qualify as an allowable deduction (Handley v FC of T 81 ATC 4165; (1981) 11 ATR 644; and FC of T v Forsyth 81 ATC 4157; (1981) 11 ATR 657). However, where part of the home is used in connection with a person's income earning activities, a deduction may be allowable for a portion of the running expenses such as electricity (Taxation Ruling TR 93/30).

In your case you used your home office in relation to the above matters. You are therefore entitled to a deduction for the running costs such as electricity attributable to the income-producing activities in your home office. However if other people in the house also use the room at the same time as you, the expenses retain their private and domestic character and no deduction is allowable.

The amount that you are entitled to claim is the difference between what was actually paid for heating/cooling and lighting and what would have been paid had you not worked from home.

You may calculate your allowable deduction based on actual expenses. The appropriate formula for calculating the additional electricity expenses is set out in TR 93/30 at paragraph 24. Alternatively, the Commissioner accepts a deduction calculated at the rate of 34 cents per hour for the time when you use the room exclusively for work related purposes. The rate increased to 45 cents for the 20xx-xx financial year. This rate covers home office running expenses for electricity and the decline in value of office furniture.

The Commissioner does not consider an apportionment based on floor area as appropriate in calculating your work related running expenses of your home office as different parts of the house have different portion of running costs. Therefore 20% of your electricity costs is not a reasonable basis to calculate any allowable deduction. As stated above it is only the additional costs in using your room at home for work related purposes that is allowed as a deduction.