Edited version of private advice

Authorisation Number: 1051939370478

Date of advice: 20 January 2022

Ruling

Subject: Legal expenses

Question 1

Is Applicant one entitled to a deduction in the 20XX-XX income year for the portion of the legal expenses that relate to their claim for income?

Answer

Yes.

Question 2

Is Applicant one entitled to a deduction in the 20XX-XX income year for the portion of the legal expenses that relate to the claim for income for Applicants two and three?

Answer

No.

Question 3

Are Applicants two and three each entitled to a deduction in the 20XX-XX income year for the portion of the legal expenses incurred that relate to their claims for income?

Answer

Yes.

Question 4

Are Applicants one, two and three entitled to a deduction for the legal expenses that relate to the lump sum capital payments?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Applicant one's spouse passed away in 20XX.

Applicant one and the deceased had two minor dependents at the time of the deceased's death (Applicants two and three).

At the time of the deceased's death, all three Applicants were dependent on the deceased.

Applicant one engaged a lawyer who commenced legal action for all three Applicants, seeking compensation pursuant to a relevant Statute for both lump sum capital compensation amounts and income amounts.

In 20XX all three Applicants each received capital and income amounts.

The lawyer issued Applicant one with a tax invoice on DDMMYYYY for the legal expenses.

Applicant one paid legal expenses for their claim and the claims for Applicants two and three during the 20XX-XX income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of Income Tax Assessment Act 1997 (ITAA 1197) 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, or relate to the earning of exempt income.

Generally, legal expenses have been held to be deductible if the expenses are directly related to the earning of income.

In determining whether a deduction for legal expenses 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; (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.

ATO Interpretative Decision (ATO ID) 2010/209 states a taxpayer can claim a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in pursuing a workers compensation payment for lost earnings. A taxpayer is entitled to a deduction for legal expenses if their claim is in relation to income.

When legal action is undertaken to obtain a payment, then the deductibility of the legal expenses depends on whether the payment sought is revenue in nature, or whether the payment sought is capital in nature.

This principle is confirmed in Taxation Determination TD 93/29 which states, that where the legal action involves claims for revenue and capital payments, then a reasonable apportionment is required as the legal expenses that relate to the claim for capital payments is not deductible.

Paragraph 7 in TD 93/29 states:

Where the solicitors account is itemised, one reasonable basis for apportionment would be the time spent involving the revenue claim, relative to the time spent on the capital claim. If the solicitors account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim.

Application to your circumstances

In Applicant's one case, they commenced legal action seeking compensation in relation to income and capital on behalf of themselves, Applicant two and Applicant three.

In 20XX all three Applicants received income and capital amounts.

Where the legal action is in relation to claims for capital amounts and income amounts, then a deduction will only be allowed for the portion of the legal expenses paid, that relate to the claim for income amounts. Therefore, an apportionment will be required to exclude the legal expenses related to the claims for the capital amounts.

A further apportionment is also required because the legal action was not only for Applicant's one claims but also claims for Applicants two and three. Therefore, Applicant one is only entitled to a deduction for their portion of the legal expenses they incurred in relation to the claim for their income amount. Although the legal action took place in both the 20XX-XX and 20XX-XX income years, all the legal expenses were invoiced in the 20XX-XX income year and therefore it is considered that the expenses were incurred during the 20XX-XX income year. Consequently, Applicant one is entitled to a deduction in the 20XX-XX income year for the portion of the legal expenses that relate to the claim for their income amount. Applicant one is not entitled to a deduction for the legal expenses they paid in relation to the claim for capital amounts.

It is accepted Applicant one acted on behalf of Applicants two and three and paid their portion of the legal expenses on their behalf, but that Applicants two and three actually incurred their portion of the legal expenses.

Accordingly, Applicants two and three, are each entitled to a deduction in the 20XX-XX income year for the portion of their legal expenses incurred, that relates to the claim for their income amounts. Applicants two and three are not entitled to a deduction for the legal expenses they incurred in relation to the claim for capital amounts.