Private ruling: Deductions - legal expenses
Date of advice: 20 February 2026
Published: 7 April 2026
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are the legal expenses allowable deductions to the taxpayer under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes

Relevant facts and circumstances: The taxpayer company (The Company) carries on a business. The Company has incurred and continues to incur legal expenses in relation to a statement of claim filed on its behalf for claims against two previous directors of the company (the defendants). In summary, the claim is as follows: • During their directorship, the defendants caused the Company to pay themselves sums of money which were purportedly on account of 'directors fees'. • The defendants also caused The Company to make payments to superannuation funds for the benefit of themselves. • The defendants also caused The Company to pay accounting fees which were not properly incurred by The Company. • All of the payments total $XXXX and were unauthorised by anyone other than the persons who received the benefit from the payment. They were not authorised by The Company in general meeting. • The Company contends that these unauthorised transactions were improper and self-dealing. • It is contended that as a result of the unauthorised payments, and the persons involvement in the making of the unauthorised payments, the persons breached duties owed to the Company under sections 181 and 182 of the Corporations Act 2001 (Cth) . • The Company is seeking the following orders: - An order for compensation to the Company pursuant to section 1317H of the Corporations Act 2001 (Cth) in the amount of $XXXX, or such other amount as the Court sees fit - Further or in the alternative, equitable compensation. - Further or in the alternative, an account of profits. - Interest pursuant to s 100 of the Civil Procedure Act 2005 - Costs Section 1317H of the Corporations Act (Cth) concerns compensation for damage suffered, and states that a court may order a person to compensate a corporation for damage suffered by the corporation if the person has contravened a corporation/scheme civil penalty provision in relation to the corporation and the damage resulted from the contravention.

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

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (all future legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated) states that a loss or outgoing may be deducted from a taxpayer's assessable income to the extent that it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. However, under subsection 8-1(2), a loss or outgoing is not deductible to the extent that it is a loss or outgoing of capital or of a capital nature, private or domestic in nature. Taxation Ruling TR 2019/1 Income Tax: when does a company carry on a business? states that proprietary limited companies are typically formed for the purpose of carrying on a business and are unlike individuals or trusts who may have multiple purposes for undertaking gainful activity other than to make a profit or carry on a business. In determining whether a deduction for legal expenses is allowable under section 8-1, it must be shown that the expense is 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]. Legal expenses are generally deductible if they arise out of the day-to-day activities of the taxpayer's business ( Herald Weekly Times Ltd v Federal Commissioner of Taxation (1932) 39 ALR 46). The case of Herald Weekly Times Ltd concerned a deduction for legal expenses incurred in defending defamation claims against employees of a newspaper. In determining whether the expenses were incurred in gaining or producing assessable income, Gavan Duffy CJ, Dixon J stated: The question whether money is expended in and for the production of assessable income cannot be determined by considering only the immediate reason for making a payment and ignoring the purpose with which the liability was incurred. ... The money was spent to answer the claims, and whether it was expended wholly and exclusively for the production of income, must depend upon the manner in which the claims were incurred. When it appears that the inclusion in the newspaper of matter alleged by claimants to be defamatory is a regular and almost unavoidable incident of publishing it, so that the claims directly flow from acts done for no other purpose than earning revenue, acts forming the essence of the business, no valid reason remains for denying that the money was wholly and exclusively expended for the production of assessable income. Taxation Ruling TR 95/33 Income Tax: subsection 51(1)- relevance of subjective purpose, motive or intention in determining the deductibility of losses or outgoings provides the commissioners view on the application of former subsection 51(1) of the Income Tax Assessment Act 1936 , now section 8-1 of the ITAA 1997. Relevantly, it states that the test as to whether the loss or outgoing is 'necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income' is whether the expenditure has the necessary connection with the operations or activities which more directly gain or produce assessable income (see Hill J in FC of T v. Roberts & Smith 92 ATC 4380 at 4386; (1992) 23 ATR 494 at 502). Paragraph 11 of TR 95/33 states the following: 11. Where, having regard to the overall objective circumstances, there is an obvious commercial connection between the loss or outgoing and the carrying on of the taxpayer's business, it will not generally be necessary to have regard to the taxpayer's subjective purpose, motive or intention. Example 6 in TR 95/33 outlines a situation in which expenditure is incurred in order to increase profitability and efficiency of the conduct of a business, and therefore it is expenditure of a business of an income earning kind. The negative limbs of section 8-1 state that you cannot deduct a loss or outgoing to the extent that it is capital or of a capital nature, of a private or domestic nature, incurred in relation to gaining exempt or non-assessable non-exempt income or a provision of the act prevents you from deducting it. The case of Sun Newspapers v FCT (1938) 61 CLR 337 ( Sun Newspapers ) considered the issue of whether an outgoing is capital or of a capital nature. It stated that the question of whether expenditure is of a capital nature revolves around the character of the advantage sought by the expenditure; whether an enduring benefit is obtained as a result of the outgoing. Where the expenditure is devoted towards a structural rather than operational purpose, the expenditure is of a capital nature and the expenses are not deductible ( Sun Newspapers). ATO Interpretive Decision ATO ID 2001/42 Income Tax Deductions and expenses: Legal expenses in recovery of misappropriated funds did not allow a deduction in the circumstances where the taxpayer was an investor who incurred legal expenses to recover invested capital. The legal expenses were therefore of a capital nature and a deduction was not allowed. Application to your circumstances In this case, the Company carries on a business. The Company is seeking to deduct legal expenses incurred in relation to a claim for damages brought by the Company against the Defendants, who were previously directors of the company. The claim concerns a number of transactions made by the Defendants in their roles as directors, but the Company claims the transactions were not authorised. The Company is seeking to recover damages pursuant to section 1317H of the Corporations Act 2001 (Cth) . The legal expenses are being incurred to recover damages for breach of statutory duty by the defendants. The breach of statutory duty claim is in relation to payments made to the defendants as directors fees, the defendants superannuation funds, and accounting fees to a third party that the Company claims are disproportionate to work undertaken. There is an obvious commercial connection between the outgoing of the legal expenses in recovering damages arising from breach of statutory duty of the defendants, and the carrying on of the Company's business. The Company claims that the relevant transactions were not authorised but were made by the defendants on behalf of the Company in breach of their duty as directors of the Company. The loss of funds from operation of the business has a direct commercial connection to carrying on a business for the purpose of gaining or producing assessable income. The legal expenses are not capital or of a capital nature as they do not relate to the recovery of a capital sum as was the case in ATO ID 2001/42 , and following the principles in Sun Newspapers , the advantage sought by the expenditure was not of a capital nature but rather for the operational purposes of carrying on the business. The allegedly unauthorised transactions were paid out as directors fees, accounting fees and superannuation payments, none of which would be considered to be capital expenditure. Therefore, the legal expenses incurred in seeking compensation from the defendants in relation to their alleged breach of statutory duty by making unauthorised transactions are deductible under section 8-1.