Private ruling: Legal expenses
Published: September 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Are you entitled to a deduction for legal expenses you incurred to fund a class action where you are seeking compensation for your losses attributed to your investment in a managed investment scheme (MIS)? | A1: No.

Relevant facts and circumstances: An entity offered a MIS. You took out two loans to invest in a scheme and these loans have been repaid. The MIS collapsed and a class action was commenced in the court against the MIS. The class action is asking for damages in the nature of recovering the loss of your investment which was the cost of each woodlot. You have no other MIS investments.

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. In determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, 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 sought is a new asset or right or an advantage with an enduring benefit, then the expenses take on the character of capital expenditure. The courts have established guidelines for distinguishing between capital and revenue outgoings. In Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1936) 61 CLR 337; (1938) 45 ALR 10; (1983) 1 AITR 403; 5 ATD 87, three elements were identified as being relevant: • the nature of the advantage sought • the way it is to be used or enjoyed • the means adopted to get it. In your case you have incurred legal expenses as part of a class action against the MIS. The legal action seeks to repay to you the losses you incurred in taking out and repaying loans to buy into the scheme. Although you may have derived assessable income from your investments, the legal action taken to reimburse your losses does not have the necessary connection with your income earning activities. This advantage would be considered to be capital in nature. By incurring legal expenses in seeking such a reimbursement, the legal expenses take on the character of the benefit you are seeking. As the benefit is considered to be capital in nature, the legal expenses are also considered to be capital in nature. Therefore the legal expenses are not deductible under section 8-1 of the ITAA 1997.