Edited version of your written advice

Authorisation Number: 1051482573681

Date of advice: 11 April 2019

Ruling

Subject: Legal fees

Question

Are the legal expenses you incurred in respect of ‘the Relevant Court Proceedings’ and ‘the Relevant Proceeding’ deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, the legal expenses are deductible under section 8-1. This is because they were incurred in gaining or producing your assessable income, and are neither capital nor private in nature.

This ruling applies for the following periods:

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commences on:

1 July 2014

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are an Australian resident individual taxpayer.

Between 1 July 20XX and 30 June 20XX, you incurred legal fees with a Law Firm in relation to court proceedings arising out of the operation of certain schemes by companies of which you were a director. The period of operation of the schemes was from 1 July 19XX through to 30 July 20XX.

The legal work was undertaken by your Solicitors pursuant to a costs disclosure letter provided to you in 20XX.

You also incurred legal fees with your Law firm in the 20XX and 20XX income years in relation to other areas of work, but those fees are not the subject of, and have been excluded from, this application.

The work carried out falls into three broad categories. Legal expenses incurred in the first and second categories only are the subject of this private ruling.

In 20XX proceedings were commenced against you in the Relevant Court of Australia seeking certain declarations. Orders were made by the Court appointing receivers and managers to the companies. In a subsequent year, receivers of some of the companies applied to the Relevant Court for directions regarding whether certain funds could be used in further legal proceedings against you. This direction was made.

The legal fees incurred by you related mainly to your opposition to the application by the receivers.

In 20XX you were charged with certain offences arising out of the operation of the companies. The charges were subsequently reduced and you agreed to plead guilty.

You incurred legal fees in relation to a sentencing and plea hearing.

Prior to 20XX, you returned amounts in your tax returns as distributions from ‘Various Joint Ventures’. No amounts were included in your assessable income from salary and wages or personal services income.

The distributions in the years ended 30 June 20XX to 30 June 20XX arose from your role in the operation of the schemes.

Broadly, the schemes involved commercial property development and recruiting investors for the schemes. Your role involved managing and operating the schemes.

You received and recorded distributions from the scheme companies as assessable income in your tax returns.

You did not receive any payments from any of the companies in the group from the year ended 30 June 20XX to the year ended 30 June 20XX inclusive.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

The legal expenses were incurred for the purpose of defending the manner in which you carried out your role as a director from which you derived assessable income. The expenses were not of a capital or private nature. Therefore the legal expenses are deductible under section 8-1.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

Therefore, in determining whether a deduction is allowable under section 8-1, the nature of the expense must be considered.

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, (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

Further, legal expenses are generally deductible if the expenses 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), 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) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542).

The Relevant Court proceedings

In your case, proceedings were commenced against you in the Relevant Court of Australia seeking certain declarations. Orders were made by the Court appointing receivers and managers to the companies. In a subsequent year, receivers of some of the companies applied to the Relevant Court for directions regarding whether certain funds could be used in further legal proceedings against you. This direction was made.

The legal fees incurred by you related mainly to your opposition to the application by the receivers.

We agree that these expenses were part of an ongoing series of proceedings in which you were an involuntary participant. You were thus obliged to incur the legal expenses, unlike the taxpayer company in Magna Alloys which had a choice as to whether to incur the expenses or not.

When all your legal expenses are viewed together, the Relevant Court expenses can be seen as expenses incurred in order to mitigate future deductible legal expenses that might be incurred to defend your actions in the Relevant Court, if that ever became necessary.

As an involuntary participant in the Relevant Court proceedings, you were required to defend the manner in which you had carried out your role as director.

The various legal expenses were intermingled to such an extent that it would be artificial to characterise them differently. Accordingly, we consider that the Relevant Court proceeding expenses have the necessary nexus to your assessable income and are deductible under section 8-1.

The legal expenses of the Relevant Court proceedings are not capital in nature. They arose out of your day to day business activities and conduct as a company director. They do not relate to the acquisition or preservation of any structural asset. The expenses are not of a private or domestic nature.

The Relevant proceeding

In 20XX you were charged with certain offences arising out of the operation of the companies. The charges were subsequently reduced and you agreed to plead guilty.

You incurred legal fees in relation to a sentencing and plea hearing.

The legal expenses you incurred in relation to the Relevant proceeding were involuntary in the relevant sense. That is, you were obliged to incur these expenses in order to defend the manner in which you carried out your duties as a director. In doing so you were attempting to reduce the severity of any penalties that might be imposed on you.

In the Commissioner’s view, as set out in the Decision Impact Statement for FCT v Day [2008] HCA 53, legal expenses incurred by employees in defending Relevant charges brought against them are generally not deductible under section 8-1, unless the charges are brought under a provision of a statute that the person is subject to only by virtue of their employment. The exception would apply similarly to directors of companies, who are subject to certain statutory provisions only by virtue of their being a director.

In your case, the charges were specific to your position as a director. The charges were brought under legislation that is specific to these activities, and are not generic charges that could be encountered by ordinary civilians going about their ordinary lives.

In the plea and sentencing hearing you had to defend yourself against the charges. We consider it would be reasonable to accept that the occasion of the losses or outgoings (being the incurrence of legal fees) was your position as a director, and accordingly the claim is directly connected with the derivation of your income as a director.

The legal expenses of the Relevant proceedings are not capital in nature. They arose out of your day to day business activities and conduct as a director. They do not relate to the acquisition or preservation of any structural asset.

We also consider that the legal expenses are not private in nature. While the Commissioner states in the Decision Impact Statement for Day that ‘costs of defending Relevant charges will rarely, if ever, be deductible under section 8-1’, we consider that the exception to this general rule is where the charge is brought under a provision of a statute that the taxpayer is subject to only by virtue of their employment or income earning activities. In your case, defending charges brought under the Corporations Act qualify as being charges arising under legislation specific to your income earning activities as a company director. As such, the expenses cannot be characterised as being of a private nature.