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Edited version of private advice
Authorisation Number: 1051527618785
Date of advice: 15 August 2019
Ruling
Subject: Legal expenses
Question
Are you entitled to a deduction for the legal fees incurred in defending against litigation taken out against you in the Supreme Court of your state?
Answer
No.
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
For over 30 years you have been the sole registered owner of a property which has been rented for over 6 years.
Over 6 years ago another person attempted to get you to cancel an existing rental agreement on the property. Their legal action commenced when you refused. They were attempting to deny you receiving rental income from the property, and you were defending your right to the rental income.
Five years ago you were issued with a writ claiming ownership of a portion of the property by others.
From that time, you have been denied the rental income from the property. Because of this, you engaged a lawyer and barrister to defend against the legal action taken against you, and protect your income from the rental property.
The other party refused to contribute any money towards the property, and you were struggling with costs at that time, and needed the income to pay for the bills you were incurring.
The other party maintained that they were a part owner of the property.
You intended to keep the house until the zoning was changed such that the property could be subdivided.
You have incurred legal fees for over X years.
Your beneficial interest in the property was established through the Supreme Court of your state.
Judgement in this case was delivered in 20XX.
You had withdrawn funds from the rental income account in order to maintain the property.
Until the final judgement was handed down, you had to repay any monies you had withdrawn from the rental income account.
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 except where the outgoings are of a capital, private or domestic nature.
Where an outgoing is of a capital nature in relation to the acquisition of a CGT asset, it will be accounted for under section 110-25 of the ITAA 1997, which includes subsection 110-25(6) for capital expenditure incurred to establish title to an asset or a right over an asset.
In determining whether a deduction 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; 8 ATD 190; 3 AITR 436 per Dixon J). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses.
Where legal expenses arise as a consequence of the day to day activities of a business or income earning activity, the object of the expenditure is devoted towards a revenue end and the legal expenses are deductible (Herald & Weekly Times v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169).
However, where the expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible (Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337; 5 ATD 87; (1938) 1 AITR 403).
In your case, you incurred legal expenses to defend a challenge to the title of your property. While we acknowledge that until this issue was judged upon, you were unable to retain the rental income from the property, it is considered that the legal expenses were incurred in protecting the underlying profit yielding structure of an asset. That is, they were incurred defending your title to the asset. Consequently, the expenses are capital in nature and are not deductible under section 8-1 of the ITAA 1997.