ATO Interpretative Decision
ATO ID 2003/801
Income Tax
Deduction: Legal expenses incurred by a company director who did not receive any director's fees or share of profitsFOI status: may be released
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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Are legal expenses incurred by a company director, who did not receive any directors fees or share of profits, in relation to an Australian Securities and Investments Commission (ASIC) investigation deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
No. Legal expenses incurred by a company director, who did not receive any directors fees or share of profits, in relation to an ASIC investigation are not deductible under section 8-1 of the ITAA 1997.
Facts
The taxpayer is a director, joint shareholder and an employee of a company.
A directors' agreement provided the taxpayer with a potential entitlement to director's fees and a share of profits as a director of and shareholder in the company.
The taxpayer did not receive any director's fees or a share of profits. However, they did receive remuneration as an employee of the company.
The taxpayer incurred legal expenses in their capacity as a company director following an investigation by the ASIC into the activities of the company.
As a result of its investigations, ASIC suspended the licence of the company and placed it under administration.
The taxpayer engaged solicitors to advise them and liaise with ASIC in relation to the investigation and consequences of the investigation.
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.
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).
The fundamental requirement that there must be a sufficient nexus between a particular expense and the assessable income such that the expense is incidental and relevant to the gaining of assessable income was also recognised in Case U134 87 ATC 780; (1987) 18 ATR 3646. That case involved a taxpayer who was a director of and a shareholder in a family company. The taxpayer did not receive any payments from the company for his services as a director of the company. However, the taxpayer did receive a dividend from the company. In disallowing the claim, the Tribunal held that:
...the outgoings were incurred in his capacity as a director and are consequently not sufficiently related to the carrying on the business of being a shareholder. Additionally, as no allowance was paid to him in his capacity as a director, it cannot be said that the expenses were incurred in gaining or producing assessable income in that capacity.
Accordingly, if a taxpayer does not derive any assessable income from their position as a director of a company and they incur expenses in respect of their position as a director, they would not be entitled to a deduction under section 8-1 of the ITAA 1997 as the expenses would not have been incurred in gaining or producing assessable income in their capacity as a director.
The taxpayer did not receive any payments from the company for the services that they provided to the company in their capacity as a director of the company, that is, they did not gain or produce any income in their capacity as a director of the company,
Therefore, they will not be able to satisfy the basic requirement of section 8-1 of the ITAA 1997 as the legal expenses were not incurred in gaining or producing their assessable income.
Accordingly, the legal expenses the taxpayer incurred in relation to the ASIC investigation are not deductible under section 8-1 of the ITAA 1997.
Date of decision: 19 August 2003Year of income: Year ended 30 June 2003
Legislative References:
Income Tax Assessment Act 1997
section 8-1
Case References:
Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation
(1949) 78 CLR 47
(1949) 4 ATR 236
(1949) 8 ATD 431
18 ATR 3646
87 ATC 780
Keywords
Legal expenses
Directors fee expenses
ISSN: 1445-2782
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