Private ruling: Deductibility of legal fees
Published: June 2012
Ruling period: Year ended 30 June 2011 | Year ended 30 June 2012
Date scheme commenced: Year ended 30 June 2008

Ruling: Q1: Are you entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses you incurred in relation to investment X? | A1: No. | Q2: Are you entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses you incurred in relation to investment Y? | A2: No.

Relevant facts and circumstances: This description is based on the application for private ruling. You have two investments. Investment X and Investment Y . You borrowed money to finance your investments from relevant financial institutions. You are seeking to relinquish your legal obligations to the relevant financial institutions in relation to the loans entered for the funding of the investments. To fund this action you are required to pay an upfront fee with further fees to be paid in the future as the cases become ready for court. This fee is the payment for representation.

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

Reasons for decision: Detailed Reasoning - Issue 1: Investment X | Detailed Reasoning - Question 1: Are you entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses you incurred in relation to investment X? | Detailed Reasoning - Answer: No. You are not entitled to a deduction for legal expenses you incur to fund an action where you are seeking to be released from an outstanding loan. The advantage you are seeking is capital in nature. Therefore the legal expenses are also considered to be capital in nature and are not deductible under section 8-1 of the ITAA 1997. Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income except where the outgoings are of a capital, private or domestic nature. 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. The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage sought is a new asset or right or an advantage with an enduring benefit, then the expenses take on the character of capital expenditure. The courts have established guidelines for distinguishing between capital and revenue outgoings. In Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1936) 61 CLR 337; (1938) 45 ALR 10; (1938) 1 AITR 403; 5 ATD 87, three elements were identified as being relevant: · the nature of the advantage sought · the way it is to be used or enjoyed · the means adopted to get it. In your case you have incurred legal expenses. The legal action seeks to excuse you from your outstanding loan liability owing to the relevant financial institutions. Although your borrowings enabled you to derive assessable income from your investments, the legal action taken to extinguish your loan liability does not have the necessary connection with your income earning activities. A release from your outstanding loan would create an advantage that has an enduring benefit, that being the reduction of your existing liabilities. This advantage would be considered to be capital in nature. By incurring legal expenses in seeking such a release, the legal expenses take on the character of the benefit you are seeking. As the benefit is considered to be capital in nature, the legal expenses are also considered to be capital in nature. Therefore the legal expenses are not deductible under section 8-1 of the ITAA 1997 as they are capital in nature. | Detailed Reasoning - Issue 2: Investment Y | Detailed Reasoning - Question 1: Are you entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses you incurred in relation to investment Y? | Detailed Reasoning - Answer: No. You are not entitled to a deduction for legal expenses you incur to fund an action where you are seeking to be released from an outstanding loan. The advantage you are seeking is capital in nature. Therefore the legal expenses are also considered to be capital in nature and are not deductible under section 8-1 of the ITAA 1997. Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or are necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income except where the outgoings are of a capital, private or domestic nature. 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. The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage sought is a new asset or right or an advantage with an enduring benefit, then the expenses take on the character of capital expenditure. The courts have established guidelines for distinguishing between capital and revenue outgoings. In Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1936) 61 CLR 337; (1938) 45 ALR 10; (1938) 1 AITR 403; 5 ATD 87, three elements were identified as being relevant: · the nature of the advantage sought · the way it is to be used or enjoyed · the means adopted to get it. In your case you have incurred legal expenses. The legal action seeks to excuse you from your outstanding loan liability owing to the relevant financial institutions. Although your borrowings enabled you to derive assessable income from your investments, the legal action taken to extinguish your loan liability does not have the necessary connection with your income earning activities. A release from your outstanding loan would create an advantage that has an enduring benefit, that being the reduction of your existing liabilities. This advantage would be considered to be capital in nature. By incurring legal expenses in seeking such a release, the legal expenses take on the character of the benefit you are seeking. As the benefit is considered to be capital in nature, the legal expenses are also considered to be capital in nature. Therefore the legal expenses are not deductible under section 8-1 of the ITAA 1997 as they are capital in nature. | Detailed Reasoning - Section 40-880- of the ITAA 1997: The following is general Australian Taxation Office guidance to help you understand your obligations and entitlements under the laws administered by the Commissioner. This guidance does not address your specific circumstances and does not form part of the private ruling under Division 359 of the Tax Administration Act 1953 . A deduction may be available under section 40-880 of the ITAA 1997. Capital expenditure that is not otherwise deductible and that relates to a business that is, was or is proposed to be carried on for a taxable purpose is deductible over five years provided the deduction is not denied by some other provision. The deduction is available at the rate of 20%, starting in the year in which the expenditure is incurred and in the next four years. For expenditure to be related to a business, there must be a sufficient and relevant connection between expenditure and the business. Taxation Ruling TR 2011/6 Income Tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues, provides the Commissioner's views about the way in which section 40-880 applies or would apply. As investors in investment X were considered to be carrying on a business section 40-800 of the ITAA 1997 may have application. As investors in investment Y were considered to not be carrying on a business section 40-800 of the ITAA 1997 would have no application.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.