Private ruling: Income tax deductions - legal expenses
Date of advice: 31 March 2016
Published: May 2016
Ruling period: Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2014

Ruling: Q1: Are the valuation expenses incurred by the estate deductible against the income of the estate? | A1: No. | Q2: Are the legal fees incurred in defending the estate against litigation deductible against the income of the estate? | A2: No.

Relevant facts and circumstances: A beneficiary of the estate commenced litigation against the estate. This legal action pertained to how the estate was to be distributed among the beneficiaries. The estate incurred legal fees in defending itself from this legal action. Valuation fees were also incurred by the estate with regards to this legal action.

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 or 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. For legal expenses to constitute an allowable deduction under section 8-1 of the ITAA 1997, 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, 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 can be characterised as an outgoing on revenue account or an outgoing of a capital nature depending on the cause or purpose for which the legal expenses are incurred. | Detailed Reasoning - Application to your circumstances: In this case, the legal and valuation expenses incurred by the estate relate to legal action taken by one of the beneficiaries. This legal action relates to how the estate is to be distributed among the beneficiaries. The result of the legal action will not affect the amount of net income earned by the estate, apart from the legal expenses themselves, if it is decided that they are allowable deductions. Expenses must be related to the production of assessable income in order to be deductible. The legal expenses incurred were not for the purpose of producing assessable income of the estate but for determining the beneficiaries' entitlement to distributions of the estate. The estate is therefore not entitled to a deduction under section 8-1 of the ITAA 1997 for the legal and valuation expenses incurred in defending an action against the estate, as these legal expenses are considered to be capital, or capital in nature.