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Edited version of your written advice
Authorisation Number: 1051425349467
Date of advice: 5 September 2018
Ruling
Subject: Deductibility of legal expenses and compensation payment relating to your rental property
Question 1
Are you entitled to a deduction for legal expenses incurred that relate to your rental property?
Answer
Yes
Question 2
Are you entitled to claim the compensation settlement payment as a deduction?
Answer
Yes
This ruling applies for the following periods:
Year ended 30 June 20XX
Year ended 30 June 20XX
The scheme commenced on:
1 July 20XX
Relevant facts and circumstances
You own a rental property which you rent out and derive income from.
You have used the services of a company (the company) to manage your rental property.
You have taken out a Land Lord’s insurance policy with an insurance company (the insurance company).
You rented the property out to a tenant in 20XX.
Soon after the tenant moved into your property they lodged a request with the company to complete some internal repairs.
The company failed to complete the internal repairs, and the tenant suffered injuries as a result.
The tenant commenced legal proceedings and lodged a claim for compensation.
You have supplied a Deed of Release which details the legal proceedings.
In the process of defending the legal proceedings you engaged your own legal team, which was a requirement of your Land Lord’s insurance policy.
You have incurred substantial costs in legal expenses during the 20XX-XX financial year that directly relate to the abovementioned legal proceedings.
You have also incurred substantial costs in legal expenses during the 20XX-XX financial year that directly relate to the abovementioned legal proceedings.
You also paid a further amount as compensation to the tenant in 20XX in respect to their claim, which is confirmed in the supplied Deed of Release.
The Deed of Release also confirms that in respect to the tenants claim, the Insurance Company paid a large amount of money as compensation to the tenant, and the Company also paid a large amount of money as compensation to the tenant.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 8-1
Reasons for decision
Summary
You are able to claim both the legal expenses and compensation settlement payment 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 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).
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.
In your case, your tenant suffered injuries whilst they were living in your property which was rented out for the purposes of producing assessable income. Therefore there is a clear connection between the legal expenses, compensation settlement payment 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 legal expenses and compensation settlement payment that you incurred for the settlement.