Edited version of your written advice

Authorisation Number: 1051222525309

Date of advice: 8 May 2017

Ruling

Subject: Deductibility of legal and settlement expenses

Question 1 

Are the legal fees incurred in taking action against the alleged Wills deductible against the income of the estate for tax purposes?

Answer

No

Question 2

Is the $XX paid from the Estate due to the court settlement a deduction for tax purposes?

Answer

No.

Question 3

Is there any statutory provision under the Australian Taxation Law pursuant to which all or any the legal costs paid can be claimed or are claimable by the Estate as a deduction or offset against any taxation amount assessed or assessable from the monies that the Estate has received?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commences on:

1 July 2015

Relevant facts and circumstances

The deceased died in 20AA.

The deceased's family all lived in outside of Australia.

Not long after the deceased's passing two Wills dated Early 20AA and Later 20AA were put forward for probate.

The deceased's family questioned the validity of both Wills and two legal proceedings were initiated on their behalf by Lawyer A.

The Early 20AA Will named Lawyer's B and C as the executors and the deceased's sibling and M as beneficiaries.

The Later 20AA will named Lawyer's B and C as the executors and P, who alleged to be the deceased's de facto at the time of death, as the sole beneficiary.

During the legal proceedings a case was put forth from both sides as to their case for each Will.

The Court found multiple circumstances of suspicion in regards to both Wills and decided that neither would be into probate as they were deemed unsafe.

During the legal proceedings Lawyer's B and C applied to have the superannuation and death benefit held by AB paid to P as the deceased's dependant.

When you found out about this application you added AB to the legal proceedings to stop this application from proceeding.

Just prior to early 20BB a settlement was reached between P and the deceased's parent.

P agreed to receive a payment of $XX from the Estate in return for giving up his/her claim on any of the monies in the Estate.

This settlement received court approval in early 20BB.

The outcome of the both legal proceedings that were finalised in early 20BB were that:

● Both Wills put forward for probate were rejected

● Letters of administration were granted as it was deemed that the deceased died intestate

● Lawyer A was named as administrator

● The deceased's parent as sole beneficiary of the Estate

The death benefit and superannuation amounts were paid during the 20BB financial year.

The $XX settlement amount was paid to P in 20BB from the estate.

In late 20BB the Administrator's and Administrator's Counsel's legal fees were paid form the estate amounting to $XXX and $XXX respectively.

These legal fees were incurred as a result of the legal proceedings mentioned above.

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 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.

Question 1

For legal expenses to constitute an allowable deduction under section 8-1 of the ITAA 1997, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations (Ronpibon Tin NL and Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431). Also, in determining whether a deduction for legal expenses is allowable, 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.

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 are incurred.

In this case, the legal action relates to action against the validity of the two Wills put forward for probate.

The result of the legal action will not affect the amount of net income earned by the estate, apart from the legal expenses themselves, if it is decided that they are allowable deductions. You have stated that you believe if not for the legal expenses being incurred the superannuation and death benefit would not have been paid to the Estate. You have also put forward that had you not been successful in your challenge the money would have gone to P as the deceased's dependant.

However, there is no guarantee that the money would not have been paid to the estate regardless of the legal proceedings. Typically, where there is no beneficiary stated with the superannuation fund, and sometimes even when there is, any superannuation or death benefit amounts paid by the superannuation fund will be paid directly to the Estate, to then be distributed to any beneficiaries of the deceased's will.

Expenses must be related to the production of assessable income in order to be deductible. The legal expenses incurred were not for the purpose of producing assessable income of the estate but for determining the beneficiaries of the estate. The estate is therefore not entitled to a deduction under section 8-1 of the ITAA 1997 for the legal expenses incurred in the above legal proceedings, as these legal expenses are considered to be capital, or capital in nature.

Question 2

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 and 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 settlement amount was paid so that P would give up his/her claim on the rest of the estate. There is no clear connection between the reason for this payment and the Estate producing assessable income and, as stated above, the legal expenses are deemed to not be deductible. Therefore, the Estate is not entitled to a deduction for the settlement amount paid to P.

Question 3

The only relevant provision that the legal expenses could be deducted under would be section 8-1 of the ITAA 1997. No other statutory provisions would apply in these circumstances.

As stated above the legal expenses incurred and the settlement payment is not an allowable deduction under section 8-1 of the ITAA 1997.