ATO Interpretative Decision

ATO ID 2002/666

Income Tax

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Issue

Is the taxpayer entitled to a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for legal expenses incurred in taking defamation action?

Decision

No. The taxpayer is not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in taking defamation action.

Facts

The taxpayer is employed and holds tertiary qualifications in their field.

A letter was published allegedly containing defamatory comments about the taxpayer's abilities and experience.

The taxpayer took defamation action against the author of the letter. The claims listed in the action were damages, aggravated damages, costs and interest. The basis of the taxpayer's action was that they had been held up to public ridicule and contempt and had suffered damage to their credit and reputation and continued to suffer damage to their credit and reputation.

The defamation action was eventually settled and the taxpayer received a letter retracting the comments.

In the course of the defamation action the taxpayer incurred legal expenses.

Reasons for Decision

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 except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

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. The action out of which the legal expense arises 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.

In FC of T 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. No significance was placed by the court on the taxpayer's status as an employee.

However, there must be an evident connection between the expenditure in instituting the proceedings and the taxpayer's earning activities. Legal expenses are also capital or private in nature where the legal action taken is to protect the taxpayer's personal good name and reputation (Case U102 87 ATC 621; AAT Case 72 (1987) 18 ATR 3515).

The taxpayer's legal expenses were not sufficiently connected with the income earning activities of the taxpayer and were essentially private or capital in nature and character. The need for them arose out of the taxpayer's reaction to what they saw as damage to their credit and reputation.

The taxpayer's legal expenses incurred in taking defamation action are therefore not deductible under section 8-1 of the ITAA 1997 as they are considered to be insufficiently connected with the taxpayer's income earning activities and are private or capital in nature.

Year of income:  Year ended 30 June 2001

Legislative References:
Income Tax Assessment Act 1997
   section 8-1

Case References:
Hallstroms Pty Ltd v. Federal Commissioner of Taxation
   (1946) 72 CLR 634
   (1946) 3 AITR 436
   (1946) 8 ATD 190

Keywords
Damages claim
Deductions & expenses
Defamation
Legal action
Legal expenses

Siebel/TDMS Reference Number:  DW380199

Business Line:  Small Business/Individual Taxpayers

Date of publication:  26 June 2002

ISSN: 1445-2782