Edited version of private advice

Authorisation Number: 1051688716004

Date of advice: 3 June 2020

Ruling

Subject: Legal expenses

Question

Is the Superannuation Fund able to claim legal fees as a deduction under section 8-1 of the Income Tax Assessment Act 1997 for defending a right to an easement?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The commercial property is held by the Superannuation Fund.

The property was originally purchased approximately XX years ago by the parent of the trustee who ran a business on the site.

At the time of purchase, access through the Servient Tenement allowed separate access to the rear of the Dominant Tenement for increased security, property maintenance and rubbish removal.

The property was moved into the superannuation fund at a later date.

The trustee has managed the property since 2007 when he became the registered proprietor of the Dominant Tenement and continued use of the Servient Tenement.

The property is now leased by a tenant who runs a business onsite.

An adverse possession claim was made by the owner of the neighbouring property relating to the carriageway at the rear of the neighbouring property which is used for rear access.

The case was unsuccessful and thrown out of court.

Legal fees equating to $xxx,xxx were payable by the superannuation fund.

Had the case been successful, the property may have suffered a loss of tenant as the rear of the property is 'land locked' and without access to the carriageway, the only entry to the property would be via the front door which is unhygienic and harming to the business clientele when removing rubbish from the property.

The title for the property does not include the carriageway however it does stipulate unvetted access.

This property and neighbour both have the right to use the carriageway, easement documents confirm this fact.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 110-25(6)

Income Tax Assessment Act 1997 section 110-35(1)

Summary

As the owner of a property used to produce assessable income, legal fees incurred in taking action to defend your right over an asset are not an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) as the expense is of a capital nature. The expense will form part of the cost base of your asset for the purpose of determining any capital gains or losses when the asset is sold pursuant to subsection 110-25(6) ITAA 1997.

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.

In determining whether a deduction is allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v FC of T (1946) 72 CLR 634; 8 ATD 190 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 the legal expenses arise as a consequence of the day to day activities of a business, the object of the expenditure is devoted towards a revenue end and the legal expenses are deductible (Herald & Weekly Times v FC of T 48 CLR 113; 2 ATD 169). Where, however, the expenditure is devoted towards a structural rather than 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).

Under section 110-35(1) of the ITAA 1997 there are a number of incidental costs you may have incurred that are eligible to reduce your cost base. They are costs you may have incurred:

(a) to acquire a CGT asset; or

(b) that relate to a CGT event.

Capital expenditure incurred by a taxpayer to establish, preserve or defend their title to an asset, or a right over an asset forms the fifth element of the cost base of the asset under subsection 110-25(6) of the ITAA 1997.

As stated in Cooper, GS 1992, Capital gains tax, 2nd edn, Butterworths, Sydney, p. 87:

Defending the taxpayer's title or right seems to refer to action taken when the title or right is put in dispute. The most obvious example of this is where someone else lays a claim to the asset in whole or in part and institutes legal proceedings to establish that claim. Costs of the taxpayer in defending those proceedings would be costs in defending the taxpayer's title.

An easement is a right over someone else's land or property. It is an asset which is created at the time it is granted.

In your case, the Easement in Instrument of Transfer document states that the property is sold together with the right of the carriageway specified on the Certificate of Title.

The unsuccessful claim by the neighbour to have the right removed has caused you legal expenses incurred in protecting your right to access the carriageway. The Commissioner understands that although you may have suffered loss of income if the amendments to the easement had been successful in court, it remains that these cost were incurred in protecting a right connected to a CGT asset and are not deductable under section 8-1 of the ITAA 1997.

As this expense was incurred by you to preserve your right over an asset, it forms part of the cost base of your asset when the asset is sold pursuant to subsection 110-25(6) of the ITAA 1997.