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

Ruling: Q1: Are you entitled to a deduction for legal expenses? | A1: Yes

Relevant facts and circumstances: You are employed by a state government agency. Allegations were made against you that you used information obtained in the course of your duties regarding a matter unrelated to your duties. The state government agency conducted an internal inquiry in relation to your actions. The inquiry resulted in disciplinary action being taken against you by your employer. You were directed to take paid leave and sought legal counsel to review the decision. The review of the tribunal has confirmed the decision made by the state government agency. Your employer has re-assigned you to another role that does not involve matters of confidentiality. You incurred legal fees in defending these claims.

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

Reasons for decision: Summary: Section 8-1 of the ITAA 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 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. 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. It follows also that the character of legal expenses is not determined by the success or failure of the legal action. Further, legal expenses are generally deductible if they arise out of the day-to-day income producing activities of the taxpayer ( Herald and Weekly Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169). The legal action must have 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; (1980) 11 ATR 276; 80 ATC 4542). In Federal Commissioner of Taxation v. Day [2008] HCA 53; (2008) 70 ATR 14; 2008 ATC 20-064 (Days case), a taxpayer was charged with breaching the standards of conduct and failing to fulfil his duty as an officer. It was found that the requisite connection with his assessable income was present and that he was exposed to the charges by reason of his office. The majority approach in Days case was that an expense will satisfy the test outlined in paragraph 8-1(1)(a) of the ITAA 1997 if the occasion of the expense is found in whatever is productive of actual or expected income. It was indicated that a broad approach should be taken in determining what activities produced the actual or expected assessable income, and that it is not only the day to day tasks performed by the employee that gain or produce this income. Furthermore, the High Court determined that the expenses in Days case would not be considered to be private in nature because they were incurred in connection with the taxpayer's employment position and were not unconnected to his service like some fines and penalties would be. The significant factors affecting the decision in this case included the fact that the legal expenses were incurred in responding to disciplinary action internal to the employment relationship and existed for no other purpose. The taxpayer in Days case was exposed to the action by reason of his employment and the consequences of the action only affected his employment. It may be generalised that where employment or service is conducted on terms that standards of conduct may be observed in a taxpayer's personal life on pain of dismissal or reduction in salary, legal expenses incurred in resisting civil disciplinary or legal action will be deductible. Your case is similar to Days case; you incurred legal expenses in disputing your employer's decision as a result of internal disciplinary action. Your employment position required you to act in accordance with certain codes of conduct. Your actions, although outside your normal employment duties, brought about internal action by your employer affecting your employment. In accordance with Days case, your legal expenses are not considered to be private in nature as they were related to your employment position. Accordingly, the legal expenses you incurred have the requisite connection to your income earning activities and you are entitled to a deduction for these expenses under section 8-1 of the ITAA 1997.