Private ruling: Legal expenses –banning order – licence
Date of advice: 31 August 2018
Published: October 2018
Ruling period: Financial year ended 2016 | Financial year ended 2017 | Financial year ended 2018
Date scheme commenced: 1 July 2015

Ruling: Q1: Are you entitled to claim a deduction on the legal expenses incurred in relation to the government body’s investigation? | A1: No | Q2: Are you entitled to claim a deduction on the legal expenses incurred in relation to the Board preliminary enquiry and the surrender of your tax (financial) advisor registration? | A2: No | Q3: Are you entitled to claim a deduction on the legal expenses incurred in relation to your re-registration as a tax (financial) advisor with the Board? | A3: No

Relevant facts and circumstances: Employment with Company X You were employed by Company X as a “ABC” in the “Financial Services Group”. Company X held an Australian Financial Services Licence (AFSL). It authorised its advisers to provide financial advice to its clients under its AFSL. During your employment, you were only a representative of the company and not an authorised AFSL representative. You formed an informal business partnership with a work colleague from Company X. You provided strategic /financial planning advice whilst your work colleague provided investment advice (stockbroking and securities advice) to clients. Company X terminated your employment. On cessation of employment, you complied with the six month restraint of trade period as a condition of your employment contract with Company X. Employment with Company Y You commenced employment with Company Y as a XYZ. When you moved to Company Y, a substantial proportion of your client base from Company X continued to use your services with your new employer. Company Y is an Australian Financial Services Licensee. You were an authorised representative of Company Y. The company authorised you to provide clients with ongoing financial advice surrounding their personal situation, including various elements. You were required to provide tax advice in the course of providing financial advice. Legislation was introduced that required all Australian Financial Services Licensees and their representatives that provide tax (financial) advice services for a fee or other reward to be registered with the Board. You registered as a tax (financial) adviser with the Board. The government body Investigation - banning order While being employed by Company Y, the government body commenced an investigation against you based on the following concerns: a) That as a representative of Company X (as opposed to being an authorised representative), you were involved in Company X’s contravention of a financial services law. b) That you may not have complied with a financial services law, that is, you engaged in conduct, in relation to a financial product or a financial service, that was misleading or deceptive or likely to mislead or deceive. The government body found that you were not involved in the contravention by Company X in providing advice and recommended investments to a list of clients. While the investigation was taking place, you decided to take a leave of absence from Company Y. You stopped working in your usual position in compliance with the ban. However, during the leave period, you attended the office at least once a week to assist with client queries that were outside your usual role. You received half commissions during that time. The government body prohibited you from providing any financial services for one year. Consequently, you were unable to work for Company Y as a financial planner during the relevant period. You sought legal representation from a law firm in responding to the enquiry and you incurred legal expenses of a specified amount. The Board’s preliminary enquiry and surrender of registration While being on leave, you received preliminary enquiry correspondences from the Board seeking a written explanation in relation to concerns the Board had in respect to your conduct as a registered tax (financial) advisor. Details relating to the enquiry were provided. You received an invoice from your lawyers of a specified amount for their professional costs and disbursements in relation to the said preliminary enquiry. Re-registration as a tax (financial) adviser When the banning order expired Company Y later issued you a licence as an Authorised Representative (and Financial Advisor). You have re-applied for registration as a tax (financial) adviser with the Board. You submitted that the registration was required under your employment agreement with Company Y in order to continue in your role of providing advice at Company Y. You engaged a law firm to prepare submissions to help you satisfy the ‘fit and proper’ person requirement. You incurred legal expenses in preparing these submissions. You ceased working for Company Y. As a result, you never obtained re-registration from the Board.

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

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income. However, where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income they will not be deductible. In determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expense must be considered. An expense will satisfy the test outlined in paragraph 8-1(1)(a) of the ITAA 1997 if the occasion of the expense is found in whatever is productive of actual or expected income. The expenditure must be incurred in gaining or producing the assessable income which is different from an outgoing that is incurred ‘in connection with’ or ‘for the purpose of’ gaining the relevant assessable income. Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064. While there are some legal expenses that are made deductible through the application of a specific section of the act, most legal expenses fall for consideration under the general deduction provisions. In cases where an accused incurs legal costs in defending themselves, the courts have held that such costs will be deductible if the conduct or activity giving rise to the charges is transparently and intrinsically part of the day to day activities by which the individual earned their assessable income. Putnin V FC of T (1991)[91 ATC 4097]; Elberg v FC of T (1998)[98 ATC 4454] and FC of T v Rowe (1995) [95 ATC 4691]. It is necessary to consider the reason for which legal expenses are incurred, that is the object in view when the legal proceedings were undertaken or the situation which impelled the taxpayer to undertake them. The nature of the alleged misconduct, the scope of a taxpayer's income earning activities and other existing circumstances, will determine whether the legal expenses are deductible, ( Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 8 ATD 190; (1946) 3 AITR 436) and ( Putnin v. Federal Commission of Taxation (1991) 27 FCR 508; 21 ATR 1245; 91 ATC 4097 ( Putnin's Case ). In cases where the expenditure is related to income of past year- this can be deducted in a later assessment year where it is of such a character that, in a continuing business, it must be met from time to time as a part of the process of gaining assessable income, ( Herald and Weekly Times Ltd v Federal Commissioner of Taxation cited in Amalgamated Zinc (De Bavay’s) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295. In Ward & Co v Commissioner of Taxation , the expenditure may be allowed as a deduction though it produces and is possibly designed to produce results in a way of income in a future year and not in the year in relation to which is being assessed, cited in Amalgamated Zinc (De Bavay’s) Ltd v Federal Commissioner of Taxation (1935) 54 CLR 295 In the High Court’s decision in Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064 ( Days case), Mr Day was charged with breaching the standards of conduct and failing to fulfil his duty as an 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. The majority approach in this case was that an expense will satisfy the test outlined in paragraph 8-1(1)(a) of the ITAA 1997 if the occasion of the expense is found in whatever is productive of actual or expected income. They indicated that a broad approach should be taken in determining what activities produced the actual or expected assessable income, and that it is not only the day to day tasks performed by the employee that gain or produce this income. In Case N9 81 ATC 56; 24 CTBR (NS) Case 81 the Board of Review disallowed a claim for legal expenses by a director of a number of companies. He was defending himself on charges under the Companies Act that would affect his future appointment as a director. The deduction was disallowed as it was of a private and capital nature. The action did not occur as a matter of course in the gaining or producing of his assessable income. The ‘profit yielding structure’ or ‘business entity’ test in Sun Newspapers Ltd & Associated Newspapers Ltd v FC of T (1938) 5 ATD 87; (1938) 61 CLR 337 is the leading Australian test in determining whether a loss or outgoing is of a capital nature. The test requires an enquiry as to whether the expenditure relates to the structure within which the profits are earned or whether it relates to part of the money-earning process. | Detailed Reasoning - Application to your circumstances: 1. Legal Expenses- the government body investigation In your submission, you contended that the investigation expenses were deductible for the following reasons: ● The activities that produced your assessable income were what exposed you to the expenses in responding to the government body investigation on those same activities. The investigation was in relation to your employment at Company X. You were defending the way you earned your assessable income by performing your duties as an employee. ● The expenses were not capital in nature. The legal expenses were not incurred for the purpose of obtaining an advantage for your enduring benefit. You incurred the expenses to defend your actions in carrying out your past employment duties and therefore continue with your current employment duties as a financial planner with Company Y. The circumstances and reasons which impelled you to incur the amount were not in the contemplation of section 8-1 of ITAA Act 1997. | Detailed Reasoning - Issue 1: Involvement in Company X’s contravention of a financial services law: The government body found that you were not involved in the contravention by Company X in providing advice in contravention of section 945A of the Corporations Act 2001. This finding allows a foundation to argue that you had to incur the legal expenses in defending the manner in which you performed your employment duties from Company X. The activities in providing strategic financial planning advice were what exposed you to the liability. However, when you incurred the legal expense, you were employed as a XYZ with a different employer, Company Y. You were only a representative and not an ‘Authorised Representative’ at Company X. There are differences between these roles within the context of the Australian Financial Services industry. In contrast with Day , the taxpayer had an ongoing employment relationship with his employer which justified the deduction. In your case, your job with Company X was ‘terminated’ two years before the financial year ended 20xx to 20xx from when the legal expenses were even incurred. The connection between the expense and the production of assessable income is a mere ‘causal connection’ which does not meet the required relevant connection for section 8-1. The direct object of the expenditure is another important consideration in determining deductibility. Since you were no longer a representative of Company X, having to defend your conduct from an alleged involvement in Company X’s contravention of financial services law was done to protect your professional reputation and future employment in the financial services industry. The advantage you sought was a lasting one; therefore, the expense is capital in nature. | Detailed Reasoning - Issue 2: Misleading or deceptive conduct: You defended yourself against allegations of misleading and deceptive conduct. The government body found that the breach happened in relation to executing a trade for your clients. The relevant activities were certainly what you undertake to produce your assessable income. However, what needs to be considered in this case is the nature of the conduct which gave rise to the investigation. The conduct that was investigated was not transparently and intrinsically part of the day to day activities of a financial advisors role. The employment termination letter from Company X and the decision letter from the government body clearly condoned the said conduct. Therefore, the occasion of the expense, that is defending a breach of a provision of the Corporations Act, is not productive of your actual income. 2. Legal Expenses- the Board Initial Enquiry and Surrender of License You argued that the legal expenses were necessary in order to continue with your current work at Company Y. Nevertheless, while you were officially on leave during the banning period, you were still able to work one day a week with the employer. You gained an assessable income by being paid commissions, albeit in a different role. You incurred the legal expenses in giving notice to the Board of your intention to voluntarily surrender your license. The effect of non-registration was, you will not be able to legally provide tax (financial) advice services for a fee or other reward after your registration has ceased. The legal expenses you incurred in responding to the Board’s initial enquiry and subsequent surrender of your license are private in nature. The expenses have essentially terminated your income earning activities; hence, are not deductible under section 8-1. 3. Legal Expenses- Tax (Financial) Advisor Re-registration In Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859, a solicitor was suspended from practice for one year and ordered to pay the costs of the Law Society. The Tribunal applied the tests described in Sun Newspapers by Dixon J, namely, that the advantage sought (the right to practise as a solicitor) was a lasting one; the manner in which that right was to be used was to derive recurring income; and the means adopted to obtain (in this case retain) that right was a 'once and for all' payment. A deduction is not allowable under subsection 8(1) of the Act for expenses incurred by an employee lawyer in defending his or her right to practise. The expenses are considered to be capital or of a capital nature. Your decision to cancel your registration had in effect suspended your license to practice as a tax financial advisor. You sought legal assistance in preparing your submissions to prove that you are a ‘fit and proper’ person. You required legal assistance because of your concerns brought about mainly by the government body investigation and also by the Board initial enquiry. Similar to Case V140 , the occasion of the legal expense was incurred to defend your right to practice as a tax financial advisor and to enable you to re-enter the regulated financial services industry. The essential character of the advantage sought relates to an enduring advantage of being able to practice your profession. The expenses were related to a profit yielding structure and capital in nature. Hence, the legal costs would not be deductible. | Detailed Reasoning - Conclusion: The legal expenses you incurred to defend yourself against the government body investigation, and to surrender and then re-apply for your registration were not incurred in gaining or producing your assessable income. The expenses are also private and capital in nature. Hence, under section 8-1 of the ITAA the legal expenses are not allowable deductions.