Private ruling: Legal expenses
Date of advice: 4 August 2016
Published: September 2016
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are the legal fees you incurred deductible under section 8-1 of the Income Tax Assessment Act 1997 ('ITAA 1997')? | A1: Yes.

Relevant facts and circumstances: You were employed by X Pty Ltd and later Y Pty Ltd. You remained an employee of Y Pty Ltd until the end of the relevant financial year. You derived income in your capacity as an employee of Y Pty Ltd comprising a base salary as well as commissions from sales that you were attributed as earning for your employer. You were carrying out your normal employment duties. As a result of your employment activities you became the subject of legal proceedings. A party alleged that you breached contractual, equitable and statutory duties owing to them. The legal action taken against you has continued and court proceedings have now commenced on appeal. Due to the legal action, you have incurred legal costs over several financial years and there will also likely be further expenses incurred in future financial years.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1

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 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. 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 a taxpayer's business or employment ( Magna Alloys and Research Pty Ltd v. FC of T (1980) 49 FLR 183; (1980) 11 ATR 276; 80 ATC 4542). 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). In the High Court decision in Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064 ( Day's case), the taxpayer was charged with breaching the standards of conduct and failing to fulfil his duty as a Customs Officer. It was found that the requisite connection with his assessable income was present and that he was exposed to the charges by reason of his office, including the obligation to observe standards of conduct, breach of which might entail disciplinary charges. It held that the legal expenses were allowable deductions and could not be viewed as private or domestic in nature. Similar to Day's case , the legal expenses you incurred arose because of your employment and were directly related to income derived, or expected to be derived, from your employment position. Therefore, as the connection between the legal expenses you have incurred (and will incur) and the gaining or producing of your assessable income is evident, you are entitled to a deduction for the legal expenses you have incurred and will incur in relation to this matter under section 8-1 of the ITAA 1997.