Private ruling: Legal expenses
Published: December 2013
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: 1 July 2011

Ruling: Q1: Are you entitled to a deduction for legal expenses? | A1: No.


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 allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature. For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, in determining whether a deduction for legal expenses is allowable, 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. 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. Expenses incurred in protecting the underlying profit yielding structure or assets of the business are considered to be capital in nature and will not be deductible. In Smithkline Beecham Laboratories (Australia) Ltd v. FCT (1993) 26 ATR 260 at 265 - 266, Hill J stated that expenditure incurred to preserve or protect a business as such will ordinarily be expenditure of capital. Here, the investigation and legal expenses were incurred to preserve the firm's reputation with existing and potential clients. The expenditure was incurred for the purpose of securing an enduring benefit to the firm, namely its client base, and is therefore capital in nature. In your situation, you sought to prevent the other director from winding up the company. That is, to preserve the business. The expenses were not incurred in gaining your assessable income. While we appreciate your motives for incurring the legal expenses, they are considered to be capital in nature. As such, you are not entitled to a deduction for the legal expenses.

Relevant facts: Your late spouse was a director and 50% shareholder in a company. | After their death, you became a director with 50% shareholding in the company. | The other director put the company into voluntary liquidation. | You did not want the company to be liquidated as you had small children and wanted the company to continue to provide an income for you and your children. | You took legal action to protect the company from being wound up.