Private ruling: Legal expenses
Date of advice: 17 May 2018
Published: July 2018
Ruling period: Year ending 30 June 201X
Date scheme commenced: 1 July 201X

Ruling: Q1: Can you claim the legal costs incurred for allegations against you for negligence and/or misleading and deceptive conduct in relation to your previous employment? | A1: Yes

Relevant facts and circumstances: You were a full-time employee of company X. Company X was engaged by company Y to assist with the construction of a residence. You have now ceased employment with company X. Company X declared bankruptcy and was de-registered. There has been foundation movement of the home and garage that resulted in sustained damage. The home owners commenced Civil and Administrative Tribunal proceedings against company Y seeking compensation for damage and distress to the home. Company Y advised the court that you acted negligently and/or was guilty or misleading and deceptive conduct in preparing the Certificate of Compliance. The matter between the employees and company Y has not been trialed by the courts as all parties were recommended to settle the matter by the mediator outside of Court. You have denied any liabilities or wrong doings in regards to this matter. However to avoid further financial costs and for health reasons, you agreed to a full and final settlement of the company Y’s allegations. You agreed to a full and final settlement of the allegations which includes a contributing payment of $XXX to the resolution of company Y’s court case. You incurred legal expenses paid to your solicitor for defending the claim and negotiations for settlement. You did not have personal Professional Indemnity Insurance. It is expected that company X had an appropriate level of Professional Indemnity Insurance. No run off insurance was available.

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

Reasons for decision: Detailed Reasoning - Deduction of legal expenses: 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 losses or outgoings are of a capital, private or domestic nature. In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered according to the decision in 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. 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 deductible provided the legal action: ● arose out of, or concerns the day to day income producing activities of the taxpayer: The Herald and Weekly Times Ltd v. FC of T (1932) 48 CLR 113 ● is not undertaken to protect the taxpayer's profit-yielding subject ● have more than a peripheral connection to the taxpayer's business: Magna Alloys and Research Pty Ltd v. FC of T (1980) 11 ATR 276; 80 ATC 4542; Putnin v. FC of T (1991) 21 ATR 1245; 91 ATC 4097 ● may arise out of litigation concerning the taxpayer's professional conduct: Magna Alloys and Research Pty Ltd v. FC of T (1980) 11 ATR 276; 80 ATC 4542; Putnin v. FC of T (1991) 21 ATR 1245; 91 ATC 4097 When the principal reason for incurring the legal expenses is defending the actions of the taxpayer in carrying out their employment duties through which they gain or produce assessable income, such expenses are characterised as being of a revenue nature and are generally deductible: Inglis v. FC of T 87 ATC 2037; and Case V116 88 ATC 737; AAT Case 4502 (1988) 19 ATR 3703. | Detailed Reasoning - Defence against prosecutions relating to professional conduct: Legal expenses incurred for fines and/or breaches of the law are generally not allowable deductions. IT 149 Legal expenses incurred for fines and/or breaches of the law in the course of carrying on a business , justifies this principle on the basis that the taxpayer chooses to operate in breach of the law, the expenditure is not incurred in the furtherance of his income producing activity but rather in connection with the imposition of penalties for unlawful acts. However, there are some cases where the taxpayer is carrying on their income producing activities in good faith but is exposed to some risk of occasional prosecution because it is in relation in the day to day conduct of their income producing activity, and there is always a risk that inadvertently you may fall into a breach of the law. In these circumstances the decision was taken that it would be consistent with the decision of the High Court in Herald & Weekly Times Ltd v FCT (1932) 48 CLR 113 to regard the expenditure as normal incident to which the taxpayer had been exposed in the day to day conduct of its business and would be deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Timing of deductions: The High Court decision in AGC (Advances) Ltd v FC of T 75 ATC 4057; (1975) 5 ATR 243 established the principle that where a business expense is incurred in the gaining or producing of assessable income generally, the fact that the expense is incurred in a year subsequent to the derivation of income, and the fact that in the meantime the business may have ceased, will not determine the issue of deductibility. Whilst the case involves taxpayers carrying on a business, it is considered that principles established can apply equally to taxpayers who are employees. Therefore the legal expenses you incurred in relation to your day to day duties of your previous employment, will be an allowable deduction under section 8-1 of the ITAA 1997 in the year in which the expense is incurred.