Private ruling: Non-commercial losses and the deductibility of legal expenses
Date of advice: 16 February 2018
Published: June 2018
Ruling period: Year ending 30 June 2012 | Year ending 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2004

Ruling: Q1: Are the managed investment schemes that you entered into business activities of a similar kind under subsection 35-10(3) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Are legal expenses incurred in relation to class action suits against the liquidators deductible under section 8-1 of the ITAA 1997? | A2: No.

Relevant facts and circumstances: You invested in a number of managed investment schemes (MIS). Each of these schemes was carried out: ● in different geographical locations of Australia, often in different and multiple States; ● producing different goods; ● with an intent to sell to different market places; and ● using different assets. Each of the MIS went into voluntary liquidation at different times. You incurred expenses to join several class action suits against the liquidators of each MIS. The benefit sought from each of the class action suits was to protect the business structure of that particular MIS.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 35-10

Reasons for decision: Summary: For the purposes of applying Division 35 of the ITAA 1997 subsection 35-10(3) of the ITAA 1997 allows you to group business activities 'of a similar kind'. Subsection 35-10(3) of the ITAA 1997 states in applying Division 35 you may group together business activities of a similar kind. In certain situations the taxpayer’s business activities may be so discrete in character and in the manner they are conducted that the question arises whether they are carrying on separate and distinct business activities for Division 35 purposes. Whether this is so is a question of fact and degree. As discussed in paragraph 51 of Taxation Ruling TR 2001/14: Income tax: Division 35 - non-commercial business losses (TR 2001/14) determining whether business activities are of a similar kind to one another will involve comparing and contrasting them in relation to characteristics such as: ● the location(s) where they are carried on; ● the type(s) of goods and/or services provided; ● the market condition(s) in which those goods and/or services are traded; ● the type(s) of assets employed in each; and ● any other features affecting the manner in which the activities are conducted. Some of these characteristics may be the same for the business activities being compared however some difference must always be expected. The presence or absence of similarity in respect of a single characteristic will rarely be determinative ( Goodfellow v. FC of T 77 ATC 4086 at 4094; (1977) 7 ATR 265 at 274). An overall comparison of the separate business activities will be called for, weighing up the extent of the characteristics which are the same or similar against those where there are significant differences. In your circumstances, each MIS that you entered into: ● was operated in a different geographical location of Australia, often in different and multiple States; ● produced different goods; ● was destined to be sold to different marketplaces; and ● the same assets were not used in each of the MIS. Therefore it is not appropriate to group the different MIS that you entered into for the purposes of Division 35 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. In distinguishing between capital and revenue outgoings, Sun Newspapers Ltd and Associated Newspapers Ltd v. FC of T (1936) 61 CLR 337; (1938) 45 ALR 10; (1983) 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; and ● the means adopted to get it. In your case you have incurred legal expenses as part of class action suits. The expenses incurred were to protect the business structures of each individual MIS. By incurring these legal expenses to protect the business structure, they take on the character of the benefit you are seeking. As the benefits are considered to be capital in nature, the legal expenses are also considered to be capital in nature. As such, they are not deductible under section 8-1 of the ITAA 1997.