ATO ID 2003/145: Legal expenses: defending a writ served on a director of a trustee company.
Date of decision: 29 January 2003
Business line: Private Groups and High Wealth Individuals

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
Summary: 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.

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
Subject references: Deductions & expenses Legal expenses