Edited version of private advice

Authorisation Number: 1052179188266

Date of advice: 18 October 2023

Ruling

Subject: Deductions - legal expenses

Question

Are you entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 in respect of the legal expenses?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Your late parent's Will did not list you as a beneficiary of their estate.

You engaged a law firm to contest the Will.

In contesting the Will, you sought a payment of money from the estate.

You and the estate mediated, and you were successful in securing a superannuation death benefit as payment which consisted of a taxed element and a tax free component.

You are required to pay income tax on the taxed element.

You incurred legal expenses from the mediation and engagement of the law firm.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Question

Are you entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 in respect to the legal expenses?

Summary

A deduction is not allowable as the legal expenses are capital in nature.

Detailed reasoning

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, or relate to the earning of exempt income.

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenses must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses, that is, whether the legal expenses are incurred for a capital or revenue purpose. The outcome of the legal action does not affect the deductibility of the legal expense, rather 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 2001/667 Income Tax Legal Expenses - to recoup full entitlement to a superannuation lump sum payment explains that if the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. Whether a capital payment is specifically brought to account as assessable income does not change the nature of the payment. An amount that is capital in nature will remain capital notwithstanding that it is specifically included in the assessable income of the taxpayer.

Here, it was decided that the lump sum superannuation benefit, being a payment for the loss of the taxpayer's earning capacity, was a capital receipt. The taxpayer incurred the legal expenses in order to obtain the superannuation benefit. Although the taxable component of the superannuation benefit was included in the taxpayer's assessable income, the superannuation benefit retained its character as a capital receipt. The ATO ID concluded that as the legal expenses were incurred in gaining a capital sum they were also of a capital nature and therefore not deductible under section 8-1 of the ITAA 1997 even though the taxable component of the superannuation benefit was included in the taxpayer's assessable income.

Application to your situation

In your case, you incurred legal expenses to contest your late parent's Will to obtain a payment of money from their estate. You were seeking a share of their estate which is a benefit of a capital nature. As a result of contesting the Will, you received a lump sum superannuation death benefit. As in ATO ID 2001/667, the fact that a portion of the lump sum payment you received is assessable does not change the nature of the payment you sought from being capital in nature. As you sought a capital payment, the legal expenses you incurred in doing so are also capital in nature. Consequently, no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses you incurred as expenditure of a capital nature are expressly excluded.