Private ruling: Deductions - legal expenses
Published: May 2013
Ruling period: Year ending 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Are you entitled to a deduction for legal expenses incurred in relation to the legal action you undertook? | A1: No.

Relevant facts and circumstances: You were a trainee. Your employment was terminated due to you not disclosing certain information to your employer. You took legal action against your employer. You were required to pay your own costs.

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

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act (ITAA 1997) allows a deduction for all losses or 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 that purpose. However, where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income they will not be deductible (subsection 8-1(2) of the ITAA 1997). In determining whether a deduction for legal expenses is allowed 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. 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. The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer's business ( Magna Alloys & Research Pty Ltd v. Federal Commissioner of Taxation 80 ATC 4542; (1980) 11 ATR 276). The action out of which the legal expenses arise has to have more than a peripheral connection to the taxpayer's business or income earning activities. The expense may arise out of litigation concerning the taxpayer's professional conduct. ( Putnin v. Federal Commissioner of Taxation (1991) 27 FCR 508; 91 ATC 4097; (1991) 21 ATR 1245 and Elberg v. Federal Commissioner of Taxation (1998) 82 FCR 440; 98 ATC 4454; (1998) 38 ATR 623). However if the expenses were incurred in protecting the underlying profit yielding structure or assets of the business they are considered to be capital in nature and will not be deductible. In Case V140 88 ATC 874; AAT Case 4596 (1988) 19 ATR 3859, a solicitor was denied a deduction for legal expenses incurred in defending certain allegations before the Statutory Committee of the Law Society of New South Wales, concerning the solicitor's trust account. The Committee ordered the taxpayer be suspended from practice for a period of twelve months, and to pay the costs of the Law Society. The Administrative Appeals Tribunal (AAT) held that the payments made by the taxpayer were not deductible under subsection 51(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as the payments were characterised as capital expenditure. Further, in Case X84 90 ATC 609; AAT Case 6528 (1990) 21 ATR 3721, the AAT held that legal expenses incurred by a medical practitioner in defending charges brought against him at a Medical Disciplinary Tribunal inquiry, were not deductible under subsection 51(1) of the ITAA 1936 because the expenditure was incurred to protect a structural asset, that is, their registration as a medical practitioner, and was of a capital nature. In your circumstances, the legal proceedings did not arise out of any actions related to the day to day carrying on of your training. The expenses were incurred in defending the non disclosure of certain information and the relevance of the information in relation to your training. The action that you launched was to protect your right to continue working in the same job, and so was capital in nature. Therefore, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for the legal expenses incurred in relation to your legal action undertaken.