Private ruling: legal expenses
Published: January 2012
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you entitled to a deduction for legal expenses? | A1: 

Relevant facts and circumstances: You are employed by a hospital. You commenced employment a number of years ago. During the 2010-11 financial year you were informed that you would be required to obtain a Fellowship as a condition of your contract continuing. The Fellowship was not required when you signed your initial contract. You submit that the granting of the Fellowship would not change the nature of your day to day income earning activities. Your membership of the Fellowship was initially rejected. You appealed and your appeal was successful with membership to the Fellowship granted. You incurred legal expenses in relation to the appeal. You submit that membership of the Fellowship was required to maintain your employment.

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

Reasons for decision: Summary: 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 are incurred in earning exempt income. As stated in Taxation Ruling TR 98/9 a deduction is allowable for self education expenses if a taxpayer's income earning activities are based on the exercise of a skill or some specific knowledge and the subject of self education enables the taxpayer to maintain or improve that skill or knowledge. In your case you incurred legal expenses in order to challenge your initial rejection of admittance to the fellowship. These expenses were not incurred in the course of study of a subject which is relevant to your work. As the expenses were not incurred in studying they are not expenses of self education. In determining the deductibility of legal expenses, 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. 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. Legal expenses are generally an allowable deduction if the expenses 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; 2 ATD 169), or the day to day aspects of the taxpayer's employment ( FC of T v. Rowe 95 ATC 4691; (1995) 31 ATR 392). However, if the legal expenses are incurred in protecting the underlying profit yielding structure or assets of the business or employment, they are considered to be capital in nature and will not be deductible. This principle has been considered in a number of cases, including the following decisions of the Administrative Appeals Tribunal. In Case X84 90 ATC 609; AAT Case 6528 (1990) 21 ATR 3721, legal expenses were incurred by a medical practitioner in defending certain charges relating to his practice, which subsequently led to deregistration proceedings. The taxpayer argued that failure to defend proceedings against him would have resulted in his deregistration as a medical practitioner thereby depriving him of his sole source of income. It was held that his legal expenses were not deductible because the expenditure was incurred to protect a structural asset, that is, his registration as a medical practitioner, and were therefore of a capital nature. The charges brought were considered to be a serious risk to the taxpayer's right to practise, and that being so, the expenses incurred in defending that right were regarded as capital expenses. In Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859, a solicitor was denied a deduction for expenses incurred in defending certain allegations before the Statutory Committee of the Law Society of New South Wales. The Committee ordered the taxpayer be suspended from practice for a certain period, and to pay the costs of the Law Society. Failure to pay these costs would have resulted in the taxpayer being further suspended from practice until they were paid. It was held that the obligation to pay the Law Society's costs was fundamental to the taxpayer's continuing right to derive his principal source of income through the practice of his profession. That right to earn money was regarded as a profit-yielding subject or as a structural asset. It was held that expenses of defending or acquiring a profit-yielding subject or structural asset are of a capital nature, and that the taxpayer's expenses were not deductible. In both cases expenditure was in defence of a structural asset and therefore capital in nature. Additionally, expenses associated with the initial joining of a professional association or union are capital in nature: Taxation Ruling TR 2000/7. In your case, the legal expenses you incurred did not arise as a result of your performance in your day to day activities, or in the course of maintaining the fellowship. Rather, they were incurred to obtain initial membership of the Fellowship and this membership was a prerequisite to maintaining your job. Legal expenses incurred in defending the profit-yielding subject are capital in nature and not deductible. As the nature or character of legal expenses follows the advantage which was sought to be gained by incurring them the legal expenses are also considered to be capital in nature. You are therefore not entitled to a deduction for legal expenses.

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