ATO Interpretative Decision

ATO ID 2003/145

general

Legal expenses: defending a writ served on a director of a trustee company.
FOI status: may be released
Status of this decision: Decision Current
CAUTION: This is an edited and summarised record of a Tax Office decision. This record is not published as a form of advice. It is being made available for your inspection to meet FOI requirements, because it may be used by an officer in making another decision.

This ATOID provides you with the following level of protection:

If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.

Issue

Is a trustee company, entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in defence of a writ served on a director of the trustee company?

Decision

Yes. A trustee company is entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in defence of a writ served on a director of the trustee company.

Facts

The trustee company was a share trader and acquired a substantial number of shares in Company A. One of the directors of the trustee company was appointed a director of Company A due to the substantial number of shares held by the trustee company. The trustee company sold its shares in Company A to a third party, Company B, and the trustee company was assessed on the profit.

The share price in Company A declined and Company B subsequently incurred a significant loss. Company B commenced an action to recover damages from the director of the trustee company in relation to the sale of the shares.

Legal fees were incurred by the trustee company in defending the action brought against the director of the trustee company in relation to the sale of the shares.

Reasons for Decision

Section 8-1of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (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) 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) 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 80 ATC 4542; (1980) 11 ATR 276;).

The legal action arose as a direct result of the sale of the shares in Company A, by a director acting on behalf of the taxpayer, in the normal course of the taxpayer's business. The legal action therefore has a direct connection with the taxpayer's income producing activities.

The resulting legal expenses were incurred by the trustee company to defend the actions of the director and were a normal incident of the day to day trading activities undertaken by the trustee company to generate assessable income. As such, the legal expenses were necessarily incurred in carrying on the trustee company's business and are deductible under section 8-1 of the ITAA 1997.

Date of decision:  29 January 2003

Legislative References:
Income Tax Assessment Act 1997
   section 8-1

Case References:
Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation
   (1949) 78 CLR 47
   (1949) 4 AITR 236
   (1949) 8 ATD 431

Hallstroms Pty Ltd v. Federal Commissioner of Taxation
   (1946) 72 CLR 634
   (1946) 3 AITR 436
   (1946) 8 ATD 190

Herald & Weekly Times Ltd v. Federal Commissioner of Taxation
   (1932) 48 CLR 113
   (1932) 2 ATD 169
   (1932) 39 ALR 46

Magna Alloys & Research Pty Ltd v. FC of T
   80 ATC 4542
   (1980) 11 ATR 276

Keywords
Deductions & expenses
Legal expenses

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  15 March 2003
Date reviewed:  4 August 2014

ISSN: 1445-2782