Edited version of private advice

Authorisation Number: 1052379044478

Date of advice: 28 March 2025

Ruling

Subject: Deductions - legal fees

Question 1

Are you entitled to a deduction for the legal fees to defend the allegations made against you?

Answer 1

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You were working as a professional a number of years ago.

A couple of years ago you were handed a notice of personal injury claim.

It was alleged that while you were working in your previous position that you committed a crime against an individual.

You were named as Second Respondent in this Personal Injury Notice of Claim.

Your employer during that period was named as First Respondent in the claim.

You contacted lawyers for advice.

You also contacted the relevant union for guidance.

The union advised that they would fund a portion of your cost as you had not been a full‐time member of the union at the time of the alleged incident.

They also advised that they were using the services of Lawyer Z for other cases.

Legal processes were followed by Lawyer Z culminating in a Compulsory Settlement Hearing where Mandatory Final Offers were exchanged.

The Claimant was requesting a payment from you and the first respondents.

You and the first respondents offered Nil.

The claimant did not accept the offer in the time frame, and it expired.

The claimant did not proceed to trial.

During the entire period, you were at risk of losing the certification and registration required to do your job, and having your position placed on hold or terminated.

This would have impacted your capacity to work.

You were employed as a professional in a different position at the time the allegations were made, and you are still employed in that role.

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 that 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.

It is well established that the words 'incurred in gaining or producing assessable income' are to be understood as meaning 'incurred in the course of gaining or producing assessable income', and do not convey the meaning or outgoings incurred 'in connection with' or 'for the purpose of' deriving assessable income (Commissioner of Taxation v Payne [2001] HCA 3 and Commissioner of Taxation v Day [2008] HCA 53). Further, it is both sufficient and necessary that the occasion of the loss or outgoing should be found in whatever is productive of the assessable income or, if none be produced, what would be expected to produce assessable income (Ronpibon Tin NL and Tongkah Compound NL v Federal Commissioner of Taxation)

Essential to the inquiry of whether certain expenses are incurred in gaining or producing assessable income is what it is that is productive of assessable income.

For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income, (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; [1949] HCA 15; (1949) 4 AITR 236; (1949) 8 ATD 431).

Also, 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] HCA 34; (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.

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business. (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; [1932] HCA 56; (1932) 39 ALR 46; (1932) 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; [1980] FCA 150; (1980) 11 ATR 276; 80 ATC 4542).

Similarly, in FC of T v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the way a taxpayer performed their employment duties were allowable. No significance was placed by the court on the taxpayer's status as an employee.

In Case U102 87 ATC 621; AAT Case 72 (1987) 18 ATR 3515 the taxpayer took defamation action against comments made regarding the management of a trust fund of which they were a trustee. It was found that the expenses were not incidental to the proper execution of the office of trustee but rather were to maintain the taxpayer's personal reputation.

In Case W94 89 ATC 792; AAT Case 5376 (1989) 20 ATR 4001 the taxpayer, a public servant incurred legal fees in defending and then appealing against disciplinary charges of improper conduct resulting from their compulsive gambling. It was found that the expenses incurred where not incidental or relevant to the gaining of the taxpayer's assessable income. It was the conduct of the taxpayer through their compulsive gambling which led to the charges which, in turn, led to them incurring legal costs. The expenses incurred were not incidental or relevant to the gaining of the taxpayer's assessable income.

Involuntary expenditure may be deductible when the occasion for the expenditure is the taxpayer's income-producing activities which have commenced and have not ceased.

In the case of FC of T v. Day 2008 ATC 20-064 (Day) the claim for deductions was allowed; however, this case can be distinguished from your case on its facts primarily because the employee in Day still had an ongoing employment relationship with his employer. In his dissenting judgment, Kirby J at [69] stated:

Having regard to the purpose of s 8-1(1), and to the context (including s 8-1(2)(b)) essential to whether a loss or expenditure has been "incurred in [the course of] gaining or producing assessable income" is the determination of what it is that is productive of assessable income. However, the interposition of the words "in the course of" in the legislation places emphasis upon a temporal and functional connection between the gaining or production of the assessable income and the incurring of the propounded deduction. It is not enough that the deduction claimed has some general, even causative, connection with the derivation of income. Nor is it enough that the outgoings were incurred for the purpose of deriving, or continuing to derive, the income. This has not been the discrimen accepted by this Court in decisions going back three-quarters of a century.

Duncan v FC of T [2020] AATA 2540 provides commentary on legal expenses incurred after employment has ceased. The decision states:

46.          The Applicant put the following submission relying on Day. In Day the High Court thought that expenditure incurred by an employee taxpayer to defend a charge which may have resulted in dismissal was sufficient to establish the necessary connection to employment or service which is productive of income. In this case, the factual enquiry fixes on the requirement of directorships as part of the Applicant's employment which establishes connection to the employment which is productive of income.

47.          The argument is flawed. In Day, the employee was seeking to maintain his employment by defending the charges. In this case, the Applicant was not. He incurred the Outgoing after his employment ended. It is implicit in the Applicant's argument that the directorships were required as part of his employment and that the directorships ended when his employment ended. His employment was productive of income. If his directorships continued after his employment ceased, they were not productive of income. The connection found in Day between the expenditure and employment productive of income, is not found in this case.

Your duties as a professional in a different position are not the occasion of the outgoing.

If these expenses were incurred while you were a XX professional, then it could be argued that you were defending the manner in which you were carrying out your duties as a XX professional. However, these expenses have been incurred while you are in your current position as a YY professional and there is not the relevant nexus between the expenses and your income earning activity.

The legal expenses incurred by you in defending the personal injury claim arose from your personal conduct. They did not arise from the performance of your duties from which you derived assessable income as a YY professional.

Therefore, the legal fees incurred by you are not an allowable deduction under section 8-1 of the ITAA 1997.