Private ruling: Deductibility of legal fees under section 40-880
Date of advice: 25 June 2015
Published: June 2015
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013 | Year ended 30 June 2014
Date scheme commenced: The scheme has commenced

Ruling: Q1: Can you claim one fifth of the legal expenses per year over five years under section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997) incurred in defending an action brought against you personally in relation to the sale of a business owned by a trust? | A1: Yes


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 40-880

Reasons for decision: Summary: You can deduct the capital expenditure you incurred in the form of legal fees over 5 years under section 40-880 of the ITAA 1997. You can deduct 20 percent of the capital expenditure in the year you incurred the expenditure and in each of the following 4 years. | Detailed Reasoning - Detailed reasoning: Subject to the limitations and exceptions contained in subsections 40-880(3) to 40-880(9) of the ITAA 1997, subsection 40-880(2) of the ITAA 1997 provides that you can deduct, in equal proportions over a period of five income years starting in the year in which you incur it, capital expenditure you incur in relation to your business. In First Provincial Building Society Limited v. Commissioner of Taxation (199X) 56 FCR 320; 95 ATC 4145; (199X) 30 ATR 207, Hill J. considered the phrase 'in relation to' within the context of paragraph 26(g) of the Income Tax Assessment Act 1936 . He considered the words 'in relation to' in that context included a relationship that may either be direct or indirect, provided that the relationship consisted of a real connection, but that a merely remote relationship is insufficient. It is necessary to consider the legislative context of subsection 40-880(2) of the ITAA 1997 in order to determine whether there is a sufficient and relevant connection between the expenditure incurred and the taxpayer's business. In discussing the types of business capital expenditure to which subsection 40-880(2) of the ITAA 1997 applies, the EM states: Expenditure on the structure by which an entity carries on (or used to or proposes to carry on) their business and on the profit yielding structure of the business would ordinarily be expected to be of a capital nature. Capital expenditure can also relate to a business's trading operations or the entity that will carry on the business. The structure covers the legal entity (such as a company) or the legal relationship (such as a partnership or trust) that is the entity that carries on the business for a taxable purpose and that holds the business assets. These paragraphs indicate that capital expenditure incurred on the structure by which an entity carries on (or used to or proposes to carry on) their business, on the profit yielding structure of the business, or relating to the business's trading operations, are capable of being described as capital expenditure incurred 'in relation to' that business for the purposes of subsection 40-880(2) of the ITAA 1997. Whether such capital expenditure is incurred 'in relation to' the particular business will depend on whether there is a sufficient and relevant connection between the incurring of the expenditure and that business on the facts of the particular case. In this case, you incurred capital expenditure on legal fees to finalise all of the claims against you regarding misrepresentation in the sale process of the business. You personally incurred these expenses. In these circumstances, there is a sufficient and relevant connection between your incurrence of the capital expenditure on the legal fees and the business carried on. Accordingly, the expenditure you incurred on the legal fees is capital expenditure incurred in relation to the business for the purposes of paragraph 40-880(2)(a) of the ITAA 1997. A deduction allowable under section 40-880 of the ITAA 1997 is however, subject to the limitations and exclusions to deductibility outlined in subsections 40-880(3) to (9) of the ITAA 1997. Subsection 40-880(3) of the ITAA 1997 is not applicable in this case, as the business was carried on by the trust and not by you. Subsection 40-880(4) deals with expenditure incurred for a business that another entity used to carry on and as the business was carried on by the trust wholly for a taxable purpose, subsection 40-880(4) of the ITAA 1997 does not apply to limit the amount you can deduct under section 40-880 for the expenditure. Subsections 40-880(5) to (9) of the ITAA 1997 set out further limitations and exclusions to deductibility under section 40-880 of the ITAA 1997. On the facts of this case only paragraph 40-880(5)(f) of the ITAA 1997 needs to be relevantly considered. Paragraph 40-880(5)(f) of the ITAA 1997 provides that you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that it could, apart from that section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event. In view of the fact that you have incurred the cost of the legal fees personally and not the trustee of the trust the amount cannot form part of the cost base (or reduced cost base) of the CGT asset (the business) and it could not be taken into account in working out the amount of a capital gain or capital loss from the CGT event. Therefore, the exception in paragraph 40-880(5)(f) of the ITAA 1997 will not apply. Accordingly you can deduct the capital expenditure incurred on legal fees over five years under section 40-880 of the ITAA 1997 commencing in the relevant income year and followed by a further 20% of the capital expenditure in each of the following four years.

Relevant facts: The arrangement that is the subject of the private ruling is described below. This description is based on the following document. This document forms part of and is to be read with this description. The relevant document is: | • Private Ruling application | A business which was conducted by a trust of which you were a beneficiary was sold. You made certain representations about the business at the time of sale. | The purchaser issued a writ against you with regards to these representations made at the time the business was sold. | You personally incurred legal expenses in relation to defending yourself in relation to this writ.