Private ruling: Income Tax: deductibility of legal expense
Published: July 2015
Ruling period: 01 April 20XX - 3 March 20XX
Date scheme commenced: 01 April 20XX

Ruling: Q1: Are the legal costs incurred by the taxpayer to deal with the investigation and defence of court action in relation to a breach of Australian law deductible under section 8-1 of the Income Tax Assessment Act 1997 ( ITAA 1997)? | A1: Yes

Relevant facts and circumstances: The following is a summary of the facts and circumstances that you provided. The taxpayer is incorporated in and is a tax resident of Australia. The taxpayer incurred legal costs for the investigation and defence of court action in relation to a breach of Australian law by an employee during a meeting with other industry representatives. Meeting with other industry representatives was within the ordinary duties of the employee. The taxpayer reported the breach to the relevant authority. The Court recognised the taxpayer's cooperation and imposed a reduced penalty. Other undertakings were ordered by the Court, but no criminal sanctions were imposed.

Relevant legislative provisions: Income tax assessment Act 1997 Section 8-1

Reasons for decision: Summary: Legal expenses that are not specifically made deductible under the tax law fall for consideration under section 8-1 of the ITAA 1997. Section 8-1 of the ITAA 1997 allows a general deduction for a loss or outgoing to the extent that it is incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed 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 allowable under section 8-1 of the ITAA 1997, 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 are generally deductible if they arise out of the day to day activities of the taxpayer's business ( Herald and 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). | Detailed Reasoning - Application to your circumstances: It is considered that the legal expenses have arisen out of the normal day to day activities of the business you operate and are not of a capital nature. The incident which resulted in the breach occurred as a result of your employee carrying out their duties. The conduct which is the subject of the breach relates directly to the methods by which the activities of your employee are undertaken. Further, as the Court's decision will not result in criminal sanctions, the decision does not imperil your business or capital assets and the purpose of the expense does not involve the acquisition of any enduring or tangible asset. Accordingly, it is concluded that the legal expenses are revenue in nature and can be claimed as a deduction under section 8-1 of the ITAA 1997