Edited version of your written advice

Authorisation Number: 1051318628771

Date of advice: 8 December 2017

Ruling

Subject: Section 8-1 Deductions

Question 1

Is a deduction allowable under section 8-1 of the Income Assessment Act 1997 (ITAA 1997) for legal fees you incurred regarding your duties as a director of a company?

Answer

Yes.

Question 2

Is a deduction allowable under section 8-1 of the Income Assessment Act 1997 (ITAA 1997) for legal fees you incurred regarding the possible restructuring and refinancing of a company?

Answer

No.

Question 3

Is a deduction allowable under section 8-1 of the ITAA 1997 for the payment of fees on behalf of a company when you were a director?

Answer

No.

This ruling applies for the following period

01 July 2016 to 30 June 2017

The scheme commences on:

01 July 2016

Relevant facts and circumstances

1. You were a director and employee of a company.

2. You received a salary which was inclusive of director fees during the financial year.

3. You did not receive any dividends from the company.

4. An administrator was appointed to the company in 2017.

5. In 2016, you sought legal advice in relation to:

a. Corporate restructuring and the sale of the company and/or assets. The company had secured financing through creditors. At the time legal advice was sought, the creditors did not agree on the way forward, forcing the company to suspend operations. The legal advice also covered options to refinance the company to enable it to reach a positive cash flow position.

b. Your obligations as director through the potential refinancing negotiation period and if the company was forced into administration.

6. These legal fees amounted to X amount. It is estimated that the legal fees are apportioned 60% and 40% for the restructuring and your obligations as director respectively.

7. In late 2016, you also paid a fee. The fee was invoiced to the company but you paid the amount as the company was experiencing financial difficulties.

8. The company had insufficient funds to pay your salary and director’s fees, and in paying both the legal and other fees personally you considered that the salary and director’s fees the company would be able to pay you would be higher.

Relevant legislative provisions

Income Tax Assessment Act 1997 (Cth) Section 6-5

Income Tax Assessment Act 1997 (Cth) Section 8-1

Reasons for decision

Questions 1 and 2

Summary

Legal fees incurred in relation to your duties as a director are deductible under section 8-1 of the ITAA 1997. However, legal fees incurred in relation to the possible restructuring and refinancing of the company are not deductible under section 8-1 of the ITAA 1997.

Detailed reasoning

Section 8-1 of the ITAA 1997 provides:

(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) It is incurred in gaining or producing your assessable income; or

(b) It is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income

Section 6-5 of the ITAA 1997 provides:

(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Both salary and directors’ fees are ordinary income, and considered as assessable income under section 6-5 of the ITAA 1997. Accordingly, section 8-1 allows losses or outgoings incurred in gaining or producing your salary and directors fees to be deductible.

For legal fees 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). This necessitates that the taxpayer earnt assessable income in relation to the legal fees.

In Case U134 87 ATC 780; (1987) 18 ATR 3646 (Case U134), the taxpayer, who was a director and shareholder of a family company, was denied deductions for travel expenses incurred in his capacity as a director. While the taxpayer received assessable income via his position as a shareholder, the Tribunal rejected the taxpayer’s contention that the personal payment of director’s expenses was deductible because it reduced the company’s expenses so that the taxpayer’s assessable income was increased via receipt of dividends as a shareholder. The Tribunal held that because the taxpayer produced no income in his capacity as director, it could not be said that the expenses were incurred in gaining or producing assessable income in that capacity.

The Commissioner applied this reasoning in ATO Interpretative Decision ATO ID 2003/801 Income Tax Deductions: Legal expenses incurred by a company director who did not receive any director’s fees or share or profits, where a deduction for legal expenses incurred by a company director was not allowed because the company director did not derive any assessable income from their position as company director.

Applying the same principle, the courts have consistently held that a deduction is not allowable by a director where they pay company expenses, as the expenses are not incurred in gaining or producing their assessable income in their capacity as a director. Such expenses are incurred by the taxpayer in earning assessable income of the company, rather than assessable income of the taxpayer (see Federal Commissioner of Taxation v. Munro [1926] HCA 28; (1926) 38 CLR 153 (Munro)).

In circumstances where the company is having financial difficulty, deductions for costs incurred by a director personally to assist the company to reach a profitable position have also been disallowed. In Case 26/94 94 ATC 258; (1994) 28 ATR 1133 (Case 26/94), the taxpayer, who was a shareholder and director of a family company, borrowed money which he on-lent to the family company as the family company was unable to borrow in its own capacity. The taxpayer did this to ensure the company’s profitability so as to derive dividends from the company in the future. The Tribunal held that the taxpayer was unable to deduct interest and other costs associated with the loan as the connection between the costs incurred and future income was too remote.

Legal fees incurred regarding your duties as director

In your case, you are a director of the company and you receive a director’s fee. Legal fees incurred to determine your obligations and duties as a director are directly relevant to your role as a director.

Deductions in Case U134 and ATO ID 2003/801 were disallowed on the basis that the directors in both cases did not earn assessable income in their capacity as directors. However, in your case, you are paid a director’s fee which is assessable income under section 6-5 of the ITAA 1997. Accordingly, the legal fees in relation to your duties as a director were incurred in gaining your assessable income in your capacity as a director, and are therefore deductible under section 8-1 of the ITAA 1997.

Legal fees incurred regarding possible restructuring and refinancing of the company

In your case, legal fees were incurred to seek advice on corporate restructuring and refinancing options for the company. This advice was sought to enable the company reach a cash flow positive position. The advice was therefore sought to enable the company to gain assessable income.

Applying Munro, because these legal fees relate to the production of assessable income by the company, they are not deductible by you. Even if the company’s financial position is considered, your circumstances are akin to those in Case 26/94 in that you incurred costs so that the company could gain assessable income, and as a result, you could potentially be in a position to derive assessable income. As the Tribunal held in Case 26/94, this connection is too remote. Accordingly, legal fees incurred regarding possible restructuring and refinancing of the company are not deductible by you under section 8-1 of the ITAA 1997.

Conclusion

As a result, only the portion of the legal fees that are estimated to be in relation to your obligations as director (40%) are deductible under section 8-1.

Question 3

Summary

A deduction is not allowable under section 8-1 of the ITAA 1997 for the payment of fees on behalf of the company.

Detail reasoning

Section 8-1 of the ITAA 1997 provides:

(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) It is incurred in gaining or producing your assessable income; or

(b) It is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income

Section 6-5 of the ITAA 1997 provides:

(1) Your assessable income includes income according to ordinary concepts, which is called ordinary income.

Both salary and directors fees are ordinary income, and considered as assessable income under section 6-5 of the ITAA 1997. Accordingly, section 8-1 allows losses or outgoings incurred in gaining or producing your salary and directors fees from the company to be deductible.

For the reasons provided in questions 1 and 2, you cannot deduct the cost of the assay fees under section 8-1 of the ITAA 1997. The fees were invoiced to the company and are an expense of the company.

Applying Munro, because the fees relate to the production of assessable income by the company, they are not deductible by you. Even if the company’s financial position is considered, your circumstances are akin to those in Case 26/94 in that you incurred costs so that the company could gain assessable income, and as a result, you could potentially be in a position to derive assessable income. As the Tribunal held in Case 26/94, this connection is too remote. Accordingly, the fees are not deductible by you under section 8-1 of the ITAA 1997.

ATO view documents

ATO ID 2003/801 Income Tax Deductions: Legal expenses incurred by a company director who did not receive any director’s fees or share or profits

Case law

Case U134 87 ATC 780; (1987) 18 ATR 3646

Case 26/94 94 ATC 258; (1994) 28 ATR 1133

Federal Commissioner of Taxation v. Munro [1926] HCA 28; (1926) 38 CLR 153

Ronpibon Tin NL & Tong Kah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431

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