ATO ID 2007/136: Legal expenses: shareholder resisting further share issue
Date of decision: 25 June 2007
Year of income: Year ended 30 June 2006
Business line: Small Business/Individual Taxpayers

Issue
Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in opposing a further share issue in a company in which the taxpayer owns shares?

Decision
No. The taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in opposing a further share issue in a company in which the taxpayer owns shares.

Facts
The taxpayer owns shares in a Company A. Company A undertook an expansion of capital by offering shares to the existing membership. The first dividend declared after this share issue resulted in the taxpayer receiving less dividend income than would have been received based on the shareholding prior to the new issue. The taxpayer took legal action against the company and the board of directors in order to void the share issue. The court validated the share issue. The taxpayer incurred legal expenses during the court proceedings.

Reasons for decision
Summary: Section 8-1 of 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, 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 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. 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. Legal expenses may be of a revenue nature and therefore deductible if they arise out of the day to day activities of the taxpayer's business or income producing activity ( Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 2 ATD 169). Where however, expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible ( Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; (1938) 5 ATD 87; (1938) 1 AITR 403). Outgoings incurred in the preservation of an existing capital asset have been held to be capital in nature ( John Fairfax & Sons Pty Limited v. Federal Commissioner of Taxation (1959) 101 CLR 30; (1959) 7 AITR 346; (1959) 11 ATD 510). The taxpayer incurred legal expenses in seeking to stop a further share issue by the company in which the taxpayer owns shares. The advantage sought to be obtained by pursuing the legal action was to preserve the taxpayer's existing equity interest in the company, being the taxpayer's existing proportion of the company's total issued shares, and the enduring benefit that attaches to that equity interest. The legal expenses are accordingly capital in nature. As the legal expenses incurred by the taxpayer are of a capital nature, a deduction is not allowable under section 8-1 of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 8-1
Case references: Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634 (1946) 8 ATD 190 (1946) 3 AITR 436
Related public rulings and determinations: Taxation Determination TD 93/29
Related ATO interpretative decisions: ATO ID 2001/4 | ATO ID 2001/42 | ATO ID 2002/1081 | ATO ID 2003/315 | ATO ID 2004/214
Subject references: Capital expenditure Deductions & expenses Legal expenses Shareholders