Private ruling: legal expenses
Published: September 2011
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you entitled to a deduction for legal fees? | A1: No | Q2: Are you entitled to a deduction for the settlement amount? | A2: No

Relevant facts and circumstances: You were employed by employer X. You ceased employment with employer X during 2010. You began employment with employer Y soon after in 2010. Your remuneration with employer Y was based on the revenue you were able to generate though new clients. You contacted clients of employer X and these clients came across to be clients of employer Y. These clients paid fees to employer Y which impacted your remuneration. During 2010 employer X sued you for damages related to lost income and attempted to get an injunction preventing you from contacting any more clients of employer X. You incurred legal fees in defending the claim. The matter settled out of court. You paid employer X a settlement amount representing the legal fees they had incurred, you did not pay any settlement amount for loss of revenue. The clients you contacted remain as clients of employer Y and continued to have an impact on your remuneration from employer Y.

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

Reasons for decision: Detailed Reasoning - Detailed reasoning: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business ( Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113). For legal expenses to constitute an allowable deduction, it must be shown that they were incidental or relevant to the production of the taxpayer's assessable income, ( Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47). 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. Defending a right to practice a profession or employment is capital in nature, as the right to practice is considered a structural asset and the associated expenses are incurred to protect this right ( Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859 and Case X84 90 ATC 609; AAT Case 6258 (1990) 21 ATR 3721). As the nature of the expense follows the nature of the advantage sought, the expense is also capital in nature. In your case, you were subject to legal action in relation to activities you had undertaken which resulted in your former employer attempting to restrict your ability to contact former clients thereby restricting your ability to carry out your current employment duties. The out of court payment settled any claims made by your former employer in relation to the clients. It thereby allowed you to continue to derive assessable income in the course of your employment from the clients at issue. The out of court settlement brought into existence an asset or an advantage (tangible or intangible) for the enduring benefit of your employment. The out of court settlement payment was therefore capital in nature ( British Insulated & Helsby Cables v. Atherton (1926) AC 205). Accordingly, the legal expenses and settlement sum are not deductible under section 8-1 of the ITAA 1997.

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