ATO Interpretative Decision

ATO ID 2004/367

Income Tax

Deductions: legal expenses - defending right to practise
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.

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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you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed.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 the taxpayer, who is carrying on a business of providing professional services, entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in defending their right to practise in that profession?

Decision

No. The taxpayer, who is carrying on a business of providing professional services, is not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in defending their right to practice in that profession.

Facts

The taxpayer, a member of a professional association, is carrying on a business of providing professional services.

The taxpayer was convicted of criminal offences. The offences did not arise from the day to day conduct of the taxpayer's business activities.

Following the taxpayer's conviction, disciplinary proceedings were commenced against them by the professional association.

As a result of the disciplinary proceedings the taxpayer was suspended from practising for an indefinite period.

The taxpayer incurred legal expenses and costs in relation to their defence to the disciplinary proceedings.

Reasons for Decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income, or are necessarily incurred in carrying on a business for that purpose. However, where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income they will not be deductible (subsection 8-1(2) of the ITAA 1997).

In determining whether a deduction for legal expenses is allowed 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. 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.

The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer's business (Magna Alloys & Research Pty Ltd v. Federal Commissioner of Taxation 80 ATC 4542; (1980) 11 ATR 276). The action out of which the legal expenses arise has to have more than a peripheral connection to the taxpayer's business or income earning activities. The expense may arise out of litigation concerning the taxpayer's professional conduct. (Putnin v. Federal Commissioner of Taxation (1991) 27 FCR 508; 91 ATC 4097; (1991) 21 ATR 1245 and Elberg v. Federal Commissioner of Taxation (1998) 82 FCR 440; 98 ATC 4454; (1998) 38 ATR 623).

However if the expenses were incurred in protecting the underlying profit yielding structure or assets of the business they are considered to be capital in nature and will not be deductible.

In Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859 (Case V140), a solicitor was denied a deduction for legal expenses incurred in defending certain allegations before the Statutory Committee of the Law Society of New South Wales, concerning the solicitor's trust account. The Committee ordered the taxpayer be suspended from practice for a period of twelve months, and to pay the costs of the Law Society. The Administrative Appeals Tribunal (AAT) held that the payments made by the taxpayer were not deductible under subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as the payments were characterised as capital expenditure.

Further, in Case X84 90 ATC 609; AAT Case 6528 (1990) 21 ATR 3721 (Case X84), the AAT held that legal expenses incurred by a medical practitioner in defending charges brought against him at a Medical Disciplinary Tribunal inquiry, were not deductible under subsection 51(1) of the ITAA 1936 because the expenditure was incurred to protect a structural asset, that is, their registration as a medical practitioner, and was of a capital nature.

In the circumstances here, the criminal offences did not arise out of the day to day carrying on of the taxpayer's business. The expenses were incurred in defending disciplinary proceedings held to review the taxpayer's right to continue practising in their profession. The taxpayer's right to practise is part of the profit yielding structure of their business, and legal expenses incurred in protecting that structure are of a capital nature.

Therefore, the taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for the costs incurred in defending their right to practice.

Date of decision:  5 December 2003

Year of income:  Year ended 30 June 2000 Year ended 30 June 2001 Year ended 30 June 2002

Legislative References:
Income Tax Assessment Act 1936
   subsection 51(1)

Income Tax Assessment Act 1997
   section 8-1
   subsection 8-1(2)

Case References:
Elberg v. Federal Commissioner of Taxation
   (1988) 82 FCR 440
   98 ATC 4454
   (1998) 38 ATR 623

Magna Alloys & Research Pty Ltd v. Federal Commissioner of Taxation
   80 ATC 4542
   (1980) 11 ATR 276

Putnin v. Federal Commissioner of Taxation
   (1991) 27 FCR 508
   91 ATC 4097
   (1991) 21 ATR 1245

Case V140
   88 ATC 875

AAT Case 4896
   (1988) 19 ATR 3859

Case X84
   90 ATC 609

AAT Case 6528
   (1990) 21 ATR 3721

Related Public Rulings (including Determinations)
Taxation Ruling TR 95/9

Keywords
Capital expenditure
Deductions & expenses
Legal expenses

Business Line:  Small Business/Individual Taxpayers

Date of publication:  7 May 2004

ISSN: 1445-2782