Private ruling: Deductibility of legal expenses - Section 40-880
Published: August 2014
Ruling period: Year ended 30 June 2009 | Year ended 30 June 2010 | Year ended 30 June 2011 | Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: The scheme has commenced

Ruling: Q1: Are you able to claim a deduction for legal expenses incurred in relation to a new business line that was to be carried on, under section 40-880 of the Income Tax Assessment Act 1997 ? | A1: Yes


Relevant legislative provisions: Income Tax Assessment Act 1997 Paragraph 35-10(2B) | Income Tax Assessment Act 1997 Section 40-880 | Income Tax Assessment Act 1997 Section 110-35

Reasons for decision: Summary: Subsection 40-880(1) states that the object of section 40-880 is to make certain business capital expenditure deductible over 5 years if: (a) the expenditure is not otherwise taken into account; and (b) the deduction is not denied by some other provision; and (c) the business is, was or is proposed to be carried on for a taxable purpose. The term, "business" is defined in section 995-1 as including any profession, trade, employment, vocation or calling, but does not include occupation as an employee. You have been conducting the activity for a number of years. The activity, thus, is included in the definition of business. Since the expenditure is incurred to make the future expansion of the business possible by trying to get the ban lifted. The expenditure is not necessarily incurred in carrying on the current business for the purpose of producing or gaining the assessable income. Therefore the expenditure is not taken into account under section 8-1 or in any other provision of the income tax legislation relating to deductions. The expenditure is capital in nature as it has been incurred to obtain an enduring benefit. You have been running the business for a taxable purpose within the meaning of paragraph 40-25(7)(a), namely for the purpose of producing assessable income. Since all the requirements of subsection 40-880(1) are satisfied, you can claim the expenditure over 5 year period subject to certain conditions and limitations as stated under subsections 40-880(3) to (9). Subsection 40-880(3) limits the deduction that can be claimed to the extent the business is, was or proposed to be carried on for a taxable purpose. As discussed before, the expenditure of the taxpayer relates to business activities that are carried on for taxable purposes. It is not a proposed new business it will be integrated into your current overall business. Subsection 40-880(4) relates to business expenditure that is, was or proposed to be carried on by another entity. This is not relevant to you. Subsection 40-880(5) states as follows: You cannot deduct anything under this section for an amount to the extent that: (a) it forms part of the cost of a depreciating asset that you hold, used to hold or will hold; or (b) you can deduct an amount for it under a provision of this Act other than this section; or (c) it forms part of the cost of the land; or (d) it is in relation to a lease or other legal or equitable right; or (e) it would, apart from this section, be taken into account in working out; (i) a profit that is included in your assessable income (for example, under section 6-5 or 15-15); or (ii) a loss that you can deduct (for example, under section 8-1 or 25-40); or (a) it could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event; or (b) a provision of this Act other than this section would expressly make the expenditure non-deductible if it were not of capital nature; or (c) a provision of this Act other than this section expressly prevents the expenditure being taken into account as described in paragraph (a) to (f) for a reason other than the expenditure being capital in nature; or (d) it is expenditure of a private or domestic nature; or (e) it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income. You have argued in the courts that there was a common law restraint of trade. The payment of the legal expenses is made once and for all to try to obtain an enduring advantage, therefore has the character of a capital payment. If you had been successful in having the ban lifted you would not have obtained any asset as a result of the legal proceedings, rather you would have secured a freedom from the restraint. The capital expenditure cannot be included in the cost base of an asset for CGT purposes. The expenditure incurred by you on legal expenses does not form part of a depreciating asset. The expenditure cannot be deducted under any other provision of this Act. It does not form part of the cost of the land. It is not in relation to a lease or other legal or equitable right. The expenditure is not taken into account in working out the profit or loss for you. The amount is not taken into account in working out the capital gain or loss from a CGT event. The capital expenditure is in relation to getting the restraint removed. There is no provision of this Act that would make the expenditure non-deductible if it were not of capital nature. The expenditure is not of private or domestic nature, rather in relation to a business that you are carrying on. It is not incurred in gaining or producing exempt or non-assessable non-exempt income. Therefore, none of the provisions of subsection 40-880(5) prevents the expenditure from being deductible under section 40-880. Subsection 40-880(6) is further explanation of paragraph 40-880(5)(d) and (f) and does not apply to you. Subsection 40-880(7) does not apply in this case and if it did, it has been stated that if the legal argument had been successful you would have commenced using the new activity as soon as possible. You have provided information that the issue has been debated in the relevant circles and is used in other similar industries. Subsection 40-880(8) limits deduction of an amount which because of the market value substitution rule was excluded from the cost of a depreciating asset. This does not apply to your situation. Subsection 40-880(9) deals with an equity or a debt interest and is not relevant to the present situation. Considering the above, you are eligible to claim a deduction under section 40-880 for the capital expenditure incurred in paying the legal fees to try and get the ban overturned. You can claim the deduction for the expenditure in equal amounts over the five year period starting from the year in which it was first incurred. | Detailed Reasoning - Application of non-commercial losses rules: You cannot deduct an amount under s 40-880 for pre-business expenditure in relation to a business activity that you propose to carry on (either alone or in partnership) in an income year before the one in which the business activity starts to be carried on. In the income year a business activity starts to be carried on, you can only offset a loss from the business activity carried on against other income if one of the exceptions in subsection 35-10(2A) applies. If the loss cannot be offset against other income in the income year in which it arises, it is deferred and offset in a future year when there is a profit from the same activity, or a like activity, or against other income when you satisfy one of the tests for that activity.

Relevant facts: You currently conduct a business and proposed to add a new business line activity. | You were unable to immediately commence the new business line as there was a common law restraint of trade prohibiting the activity. | You commenced legal action to attempt to overturn the exclusion of the activity. You were ultimately unsuccessful in arguing your case and the new business line and the anticipated increase in income has not come to fruition. | The expenditure incurred is directly related to increasing your current revenue streams. | The application of this activity would change the economics of your current activity and open up new income streams. | You haven't done formal profit and loss projections, however you strongly believe the profit potential is substantial otherwise, you would not be committing significant personal resources in fighting for the legal case.