Edited version of your written advice

Authorisation Number: 1013058753875

Date of advice: 25 July 2016

Ruling

Subject: Legal expenses

Question

Is a deduction allowed for the legal expenses incurred?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

Entity A operates a business.

A former employee passed on confidential information to a business competitor.

As a result, the competitor later took legal action against entity A. The legal action was dismissed, however not all of the legal costs were recovered from the competitor. The competitor is now de-registered.

Later, via a solicitor, entity A issued a writ against the former employee. Further legal expenses were incurred by entity A.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Reasons for decision

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, or relate to the earning of exempt income, or a provision of the ITAA 1997 prevents it.

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 activities of the taxpayer's business (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).

Taxation Ruling TR 2000/5 Income tax and fringe benefits tax: costs incurred in preparing and administering employment agreements states that the costs incurred in the settling of disputes out of existing employment agreements are deductible.

In this case, the former employee's breach of contract and passing on confidential information to a third party led to the legal action being taken against entity A and the associated legal expenses.

Although the employee is no longer working for entity A, it was the actions of that employee while employed that led to the legal action and associated costs which in turn impacted on the income earning activities of entity A.

It is accepted that the legal expenses now being incurred against your former employee are sufficiently connected to entity A's income earning activities and are not capital or private in nature. Therefore, the associated legal expenses incurred are an allowable deduction under section 8-1 of the ITAA 1997.