Edited version of private advice

Authorisation Number: 1052120868642

Date of advice: 7 June 2023

Ruling

Subject: Deductions - legal expenses - deceased estate issues

Question 1

Will the whole of the legal expenses incurred regarding the recovery of misappropriated funds including interest be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the legal expenses incurred regarding the recovery of misappropriated funds including interest be deductible under section 8-1 of the ITAA 1997 to the extent it relates to the interest component?

Answer

Yes.

This ruling applies for the following periods:

20XX-XX income year

20XX-XX income year

20XX-XX income year

20XX-XX income year

20XX-XX income year

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Deceased died about XX years ago.

The Will appointed two individuals as joint executors and trustees of the Estate.

One individual renounced their position as executor and trustee of the deceased's estate shortly afterward.

Probate of the Will was granted solely to the other named individual (the Individual).

Subsequently, a number of payments were made from the Estate's assets referred to as 'interim distributions'.

By court order, this Individual was removed as the Executor of the deceased's estate and a Substitute individual (the Substitute) was appointed as the Administrator.

The Substitute proceeded to conduct investigations into the Estate and its management which lead to the incurring of legal expenses in order to ascertain assets and liabilities of the Estate, any misappropriated funds from the Estate and the associated recovery of said amounts.

A Deed of Settlement was signed between the Substitute as Administrator of the Estate, the Individual and a related company specifying the recovery of funds paid from the Estate and capital repayments to be made to the Estate with associated interest.

The Individual and the related company agreed to the amounts that had to be repaid and to a repayment schedule.

A couple of payments were made toward this debt. The payment schedule was then varied by operation of the Deed of Variation while awaiting judicial advice and directions.

The Individual separately agreed that an additional sum plus interest was payable by him.

Then, an Event of Default occurred regarding the repayments stipulated under the Deed of Settlement. Accordingly, additional legal expenses were incurred to recover the funds.

As a result of the Event of Default, the interest charged against the outstanding amounts increased significantly.

The outstanding amounts including accruing interest were paid in full by instalments over the following two years after the Event of Default.

Itemised legal expenses were incurred during each of the ruling years until full recovery of the debt was made.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Question 1

Summary

The whole of the legal expenses incurred regarding the recovery of misappropriated funds including interest will not be deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Section 8-1 of the ITAA 1997 allows a deduction from your assessable income for any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income.

However, you cannot deduct a loss or outgoing under this section to the extent it is a loss or outgoing of capital or of a capital, private or domestic nature, if it is incurred in gaining or producing exempt income or another provision prevents you from deducting it.

The character of legal expenses as being revenue or capital in nature is associated with the reason for incurring the legal expenses. Legal expenses that are incurred to gain or produce amounts of ordinary income have a revenue nature while legal expenses that are intended to generate capital receipts have a capital nature.

It is important to note that the character of the legal expenses is not linked to the outcome that is achieved. A deduction will be allowable for legal expenses that are incurred to derive amounts of ordinary income that are assessable even if the attempt is unsuccessful or the amounts actually received are capital in nature.

All of the items in the claim have to be revenue in nature and assessable to you if the whole of the legal expenses are to be deductible.

The claim for or any claim associated with capital repayments is capital in nature. Any legal expenses that relate to this element of the matter are capital in nature and not deductible.

Therefore, the whole of the legal expenses incurred regarding the recovery of misappropriated funds including interest are not deductible because some portions of them relate to a capital claim.

Question 2

Summary

The legal expenses incurred regarding the recovery of misappropriated funds including interest will be deductible under section 8-1 of the ITAA 1997 to the extent it relates to the interest component.

Detailed reasoning

The same principles as described above also apply when working out if any part of the legal expenses are deductible.

Some of the items in the claim have to be revenue in nature and assessable to you if a portion of the legal expenses are to be deductible.

All of the claims associated with the derivation of interest by you are revenue in nature as interest is considered to be ordinary income and interest amounts you receive should be included in your assessable income.

Therefore, the legal expenses incurred regarding the recovery of misappropriated funds including interest will be deductible under section 8-1 of the ITAA 1997 to the extent it relates to the interest component because the interest component is a revenue nature receipt that should be included in your assessable income.

Paragraph 7 of Taxation Determination TD 93/29 makes the following statement about apportioning legal expenses between revenue and capital claims:

Where the solicitor's 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 solicitor's 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.