ATO ID 2004/214: Legal expenses: costs to maintain beneficiary's amount of their entitlement to trust income
Date of decision: 25 February 2004
Year of income: Income year ended 30 June 2004
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 they incurred in defending a legal action that sought to reduce the amount of their entitlement to trust income?

Decision
Yes. The taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses they incurred in defending a legal action that sought to reduce the amount of their entitlement to trust income, as the expenses are revenue in nature and were incidental and relevant to the gaining or producing of their assessable income.

Facts
The taxpayer is a beneficiary of a testamentary trust established in accordance with their parent's will. Under the terms of the will, the taxpayer's other parent is to receive an annuity from the trust income to be increased annually to reflect any increase in the Consumer Price Index. The taxpayer and their sibling are residuary beneficiaries, and are to receive equally the balance of the net annual income of the trust. There is no provision for winding up the trust and distributing corpus/capital during their surviving parent's lifetime. The surviving parent commenced legal action seeking to increase their annuity entitlement, and thereby reduce the amount of the net annual trust income available for equal distribution between the taxpayer and their sibling. The matter was resolved by private settlement, resulting in an increase in the annuity payments to the surviving parent. The taxpayer incurred legal expenses in defending the legal action to maintain the amount of trust income they are to receive annually, under the terms of their parent's will.

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 Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190, the Court established that in determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. Dixon J stated at CLR 647 that: ...legal expenses...take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or purposes of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them. Legal expenses incurred by a taxpayer in maintaining the amount of partnership income to which they were entitled was held to be revenue in nature and incurred in the course of gaining or producing assessable income ( Creer v. Federal Commissioner of Taxation (1994) 28 ATR 442; 94 ATC 4454). Similarly, in this case, the taxpayer incurred legal expenses to maintain the amount of trust income to which they were entitled under the terms of their late parent's will. The surviving parent was not attacking the taxpayer's right to receive income. Rather, they were disputing the amount of income to which the taxpayer was entitled. The object the taxpayer had in view when the legal proceedings were undertaken was to maintain the amount of income to which they were entitled (under the terms of their late parent's will), and the situation which prompted them to undertake the proceedings was the denial of a proportion of their previously accepted share of income from the testamentary trust. Therefore, their legal expenses are revenue in nature. In addition, the occasion of the incurrence of the legal expenses was the legal proceedings to maintain their level of assessable income from the testamentary trust. As such, there is a sufficient connection between taxpayer's legal expenses and the gaining or producing of their assessable income. Therefore, the taxpayer's legal expenses were incurred in the course of gaining or producing their assessable income. Accordingly, the taxpayer is entitled to a deduction under section 8-1 of the ITAA 1997 for your legal expenses.

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) 3 AITR 436 (1946) 8 ATD 190
Subject references: Legal expenses Trust distributions Wills