Private ruling: Legal expenses
Published: April 2013
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you entitled to a deduction for legal expenses incurred? | A1: Yes

Relevant facts and circumstances: You commenced employment with the employer in a particular year. Part of your employment involved regularly liaising with X. You were suspended from your duties following a review concerning allegations of certain conduct in dealing with X which was a necessary part of your employment. You were later charged with certain offences in relation to your dealings with X. The charges were filed in the Magistrates Court resolving into a guilty plea with some charges being withdrawn. You pleaded guilty to non-indictable summary offences relating to certain actions contrary to your office. These charges arose as a result of you dealing with X which was a day-to-day aspect of your employment. The decision was handed down in the magistrate's court without a conviction being recorded. You incurred legal expenses in defending the charges. You resigned from your employment even though you were under no obligation to do so. Your employer was open to have you remain serving in your position, although you would have been subjected to some internal disciplinary proceedings. You have provided copies of the charges originally filed in the magistrates court. The legal expenses you incurred were in responding to the charges brought against you, which if not defended could have led to your employer taking one or more disciplinary actions against you such as potential sanctions that include demotion, suspension of promotion, a reduction in pay and potentially, dismissal.

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 (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, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. 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) 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 ( 1980) 49 FLR 183; (1980) 11 ATR 276;80 ATC 4542). In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry cleared him of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties, in order to defend the threat of dismissal, were allowable. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income. Where an expense is incurred involuntarily, your motives in pursuing action will be irrelevant to the determination of its deductibility. It is the objective circumstances which compel you to incur the expense which determine its deductibility ( Shokker v. FC of T 99 ATC 4504; 42 ATR 257). In Putnin v. FC of T 91 ATC 4097; (1991) 27 FCR 508 an accountant was trustee under a particular deed of arrangement. They administered the estate without obtaining an assignment of the debtor's share in a company and the share was subsequently dealt with by the debtor. They were later charged with conspiring with the debtor to defraud the Commonwealth and incurred legal expenses in defending this action. The court found the expenditure arose out of his prosecution, in which they were defending their activities by which income had been earned and they were allowed a deduction for this legal expenditure. Their Honours stated: It may be a natural incident of the conduct of the operations of a particular kind of business that claims of the commission of torts, or even crimes, may arise, although it is to be hoped not often, and have to be repelled. In Elberg v FC of T 38 ATR 623; a doctor was charged with dishonestly obtaining property by deception. The charges alleged they falsely held themselves to be on duty with their employment when they actually deriving income from their private practice. Merkel J said In my view, as in Putnin, the present case is one which concerns expenditure which may relevantly be described as involuntary. Also, as in Putnin, and I would add Rowe, Magna Alloys…and Herald and Weekly Times, the expenditure arose out of proceedings in which the taxpayer was defending her activities in a particular operation of her business, in the present case, as a doctor, by which she earned her income. In your case, you were suspended from your employment duties over allegations of certain actions in relation to your conduct in dealing with X, which was a necessary part of your employment. You were later charged withcertain non-indictable offences. You resigned from your employment prior to the court hearing and pleaded guilty to certain non-indictable offences relating to disclosure of information. All other charges were withdrawn. It is accepted that the action was initiated by your previous employer and the expenses you incurred in defending the action were involuntary. You were consequently required to defend the way in which you performed your duties. It is considered that your legal expenses are sufficiently connected to your income earning activities and are not capital or private in nature. Therefore, the legal expenses you have incurred are deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Charge of misconduct in public office: Section 26-54 of the ITAA 1997 denies deductions for losses and outgoings to the extent that they are incurred in furtherance of, or directly in relation to, a physical element of an offence against Australian law in respect of which the taxpayer has been convicted if the offence was, or could have been, prosecuted on indictment. As you were not convicted of an indictable offence a deduction for legal expenses would not be denied under section 26-54 of the ITAA 1997.`