Private ruling: Deductions
Date of advice: 11 December 2018
Published: April 2019
Ruling period: Year ending 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Are you entitled to a deduction for payment of an invoice for legal expenses for a client of your former employer? | A1: No

Relevant facts and circumstances: You were employed by employer 1. You sold a product to a client of employer 1. The client of employer 1 sought legal advice in relation to the product. The advice was provided to the client in relation to the product an invoice was made out to the client for the services provided to the client. You left the employment of employer 1 and got a job with another employer (employer 2). The client left employer 1 when you ceased your employment with employer 1 and took their business to employer 2 your new employer. You paid the invoice on behalf of the client as employer 1 refused to pay the invoice.

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

Reasons for decision: Summary: 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 (Hallstroms Pty Ltd v. FC 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. The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day income producing activities of the taxpayer (The Herald and Weekly Times Ltd v. FC of T (1932) 48 CLR 113). The action out of which the legal expense arises has to have more than a peripheral connection to the taxpayer's business or income earning activities. The expense 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). It is irrelevant if the taxpayer is successful in the proceedings when determining if the legal expenses are an allowable deduction. In your case you were an employee with employer 1. The client was a client of your employer, employer 1. The client sought legal advice in dispute of the product. The provision of services by the lawyers was provided to the client and they were invoiced for the services provided. You paid the invoice after you left work with employer 1 and commenced work with employer 2. Employer 1 refused to pay the invoice. Just because you paid the expense does not mean you incurred the expense for the purpose of generating your assessable income. The legal expense was incurred by the client and not you. The legal expenses were not incurred by you in the derivation of your employment income as you were an employee of employer 1 when the costs were incurred. You are not entitled to a deduction for legal expenses under section 8-1 of the ITAA 1997.