Private ruling: Legal expenses deduction
Date of advice: 13 December 2017
Published: May 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Are you entitled to a deduction for legal expenses? | A1: No

Relevant facts and circumstances: You were employed by Company A under an employment agreement. The agreement contained a restraint of trade clause. You left Company A. You are employed by Company B. Company A sued for breach of the restraint of trade agreement. You incurred legal expenses in relation to the legal action which eventually resulted in an out of court settlement.

Relevant legislative provisions: Income Tax Assessment Act 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 relate to the earning of exempt income. 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; (1949) 4 AITR 236; (1949) 8 ATD 431). Also, in determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenses 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. 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: (1932) 2 ATD 169). Similarly, in FCT v. Rowe (1995) 60 FCR 99; (1995) 31 ATR 392; 95 ATC 4691, the court accepted that legal expenses incurred in defending the manner in which a taxpayer performed his employment duties were allowable. The activities which produced the taxpayer’s income were what exposed them to the liability against which they were defending themselves. In your case, you incurred legal expenses defending an action taken by your previous employer in trying to enforce a restraint of trade clause in your employment contract. The action was not prompted or caused as a consequence of the performance of your current duties. It is considered that your legal expenses were incurred to enable you to continue working for your new employer. They are not related to the duties of your previous employment and they were incurred at a point too soon in the earning of your assessable income with your new employer. 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. Therefore you are not entitled to a deduction for legal expenses incurred to defend an action brought against you for restraint of trade.