Edited version of your written advice

Authorisation Number: 1013050499932

Date of advice: 13 July 2016

Ruling

Subject: Rental expenses and deductions

Question 1

Can you claim the settlement payment as a deduction?

Answer

Yes.

Question 2

Can you claim the legal expenses incurred for the representation of a lawyer for the settlement?

Answer

Yes.

This ruling applies for the following period:

Year ending June 2015.

The scheme commences on:

1 July 2014.

Relevant facts and circumstances

You are an Australian resident for tax purposes.

You own a rental property which you rent out and declare the rental income as assessable income in your tax returns.

You have owned this property for many years.

You hired a tradesperson to repair a fault on the property and the tradesperson was injured while on the property.

The tradesperson filed for personal injury compensation.

This matter was settled outside of court for a settlement lump sum payment.

At the time of the incident, you did not have insurance on the property. Therefore you incurred the liability of the settlement cost.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Summary

You are able to claim both the settlement sum and legal expenses incurred as a deduction as these expenses have a clear connection to your assessable income and are not private or capital in nature.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (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 when the outgoings are of a capital, private or domestic nature or relate to the earning of exempt income.

For an expense to constitute an allowable deduction, it must be shown that it was incidental or relevant to the production of the taxpayer's assessable income (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

In determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must also be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190).

Legal expenses have been held to be deductible if the expenses have arisen as a consequence of the taxpayer's income earning activities provided that the legal expenses are not of a capital, private or domestic nature (Herald & Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169 (Herald & Weekly Times).

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).

The treatment of a settlement sum or damages payment will generally follow the treatment of the other legal costs incurred in relation to a particular matter.

The principles espoused in Herald & Weekly Times were applied in Case C12 (1952) 3 TBRD 100. That case dealt with the trustees of a deceased estate, who let a city property to a number of tenants. A tenant's injured employee claimed damages against the trustees in respect of injuries she sustained on the rental premises. The Board, in allowing the trustees a deduction for the amount that they paid to settle the claim, stated that:

[the trustees] became liable... because they had let rooms to tenants...It was in the capacity of landlord that the outgoing was incurred...the expense incurred resulted from a risk which, to a landlord, is ever present...the expense claimed as a deduction was one which arose out of the letting of the building to tenants for the purpose of producing assessable income, and that it can properly be regarded as having been incurred 'in the course of' gaining or producing that assessable income...I cannot see that the outgoing produced "an enduring benefit" of any sort. I can see no justification ...for capitalising the expense. It seems to me to be one which should properly be set against revenue account.

In your case, the tradesperson was injured while contracted to repair a fault to a property which was rented out for the purposes of producing assessable income. Therefore there is a clear connection between the settlement sum, legal expenses and your rental income such that the expenses are incidental and relevant to the generation of your assessable rental income. Also, these expenses are not considered to be capital in nature.

Therefore, you are entitled to a deduction under section 8-1 of the ITAA 1997 for the settlement sum and legal expenses that you incurred for the settlement outside of court.