Private ruling: Legal expenses
Date of advice: 14 December 2016
Published: May 2017
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: 1 July 2014

Ruling: Q1: Are you entitled to a deduction for the legal fees incurred from the date of the appeal of the court decision? | A1: No.

Relevant facts and circumstances: You are the owner of a rental property. Legal action was commenced against you. The court ruled that you were to transfer the property to another entity. You subsequently lodged an appeal shortly after the decision however an out of court settlement was reached via a deed of settlement and release that was finalised resulting in the ownership of the property not being transferred to the other entity as previously ruled.

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. Where an outgoing is of a capital nature in relation to the acquisition of a CGT asset, it will be accounted for under section 110-25 of the ITAA 1997, which includes subsection 110-25(6) for capital expenditure incurred to establish title to an asset or a right over an asset. In determining whether a deduction 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; 8 ATD 190; 3 AITR 436 per Dixon J). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. Where legal expenses arise as a consequence of the day to day activities of a business or income earning activity, the object of the expenditure is devoted towards a revenue end and the legal expenses are deductible ( Herald and Weekly Times v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169). However, where the expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible ( Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337; 5 ATD 87; (1938) 1 AITR 403). In your case, you incurred legal expenses to appeal a court decision that required you to transfer ownership of your rental property to another entity. While we acknowledge that you were able to retain the income stream from the property, it is considered that the legal expenses were incurred in protecting the underlying profit yielding structure of an asset. That is, they were incurred defending your title to the asset. Consequently, the expenses are capital in nature and are not deductible under section 8-1 of the ITAA 1997.