Edited version of your private ruling

Authorisation Number: 1051843005659

Date of advice: 25 May 2021

Subject: Deductibility of legal expenses

Question

Are the legal fees incurred by the taxpayer deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period

Year ending 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

Background

The taxpayer was charged with a criminal offence under the Crimes Act 1958 (Vic) (Crimes Act) and is seeking a deduction under section 8-1 of the Income Tax Assessment Act 1997 for the legal fees incurred in defending those charges. The taxpayer has no prior criminal convictions or record.

The taxpayer was employed as the managing director of Company A.

Following cessation of their employment with Company A, other than being a director of their personal investment vehicles, the taxpayer has not sought or obtained any further employment opportunities or in external engagements.

Details of the alleged criminal charges were provided and form part of the facts for the ruling.

Legal representation and fees

A law firm represents the taxpayer in defence of their criminal charges.

The taxpayer has personally incurred and paid legal fees to the law firm.

The costs and disclosure letter and all invoices issued by the law firm are addressed to the taxpayer only. The costs and disclosure letter was provided and form part of the ruling facts.

The work performed by the law firm for the taxpayer relates solely to the defence of the criminal charges.

No part of the defence or the criminal charges relate to the taxpayer's right to hold the office of director.

No civil proceedings are on foot.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 paragraph 8-1(1)(a)

Income Tax Assessment Act 1997 paragraph 8-1(2)(b)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise indicated.

Summary

The legal fees incurred by you are not deductible under section 8-1.

Detailed reasoning

Section 8-1 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.

In determining whether a deduction is allowable under section 8-1, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; 8 ATD 190; 3 AITR 436 per Dixon J). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses.

The criminal law applies regardless of any employment obligation, and the duty to obey it and to respond to criminal proceedings is owed by every man or woman to the Crown as a subject of the law, and not as an employee to an employer.

You were charged under the Crimes Act.

In the income year ending 30 June 20XX, you incurred legal expenses defending criminal charges laid by the Director of Public Prosecutions (DPP). We consider your legal expenditure to have been incurred involuntarily as you have been accused and charged personally.

Involuntary expenditure may be deductible when the occasion for the expenditure is the taxpayer's income-producing activities which have commenced and have not ceased.

In the case of FC of T v. Day 2008 ATC 20-064 (Day) the claim for deductions was allowed; however, this case can be distinguished from your case on its facts primarily because the employee in Day still had an ongoing employment relationship with his employer. In his dissenting judgment, Kirby J at [69] stated:

Having regard to the purpose of s 8-1(1), and to the context (including s 8-1(2)(b)) essential to whether a loss or expenditure has been "incurred in [the course of] gaining or producing assessable income" is the determination of what it is that is productive of assessable income. However, the interposition of the words "in the course of" in the legislation places emphasis upon a temporal and functional connection between the gaining or production of the assessable income and the incurring of the propounded deduction. It is not enough that the deduction claimed has some general, even causative, connection with the derivation of income. Nor is it enough that the outgoings were incurred for the purpose of deriving, or continuing to derive, the income. This has not been the discrimen accepted by this Court in decisions going back three-quarters of a century.

We also considered the following cases and decisions:

•         Elberg v. FC of T 98 ATC 4454

•         Putnin v. FC of T 91 ATC 4097

•         Creer v. FC of T 94 ATC 4454

•         FC of T v. Rowe 95 ATC 4691

•         Herald and Weekly Times Limited v FC of T (1932) 2 ATD 169; (1932) 48 CLR 113

•         Case V116 88 ATC 737

We concluded that these cases are not applicable because they are factually different to your circumstances. Relevantly, these cases discussed section 8-1 in the context of a business, or the taxpayer(s) had not ceased their employment.

Although your legal expenditure was involuntary, the occasion for the expenditure was in responding to criminal proceedings. They were not incurred in the course of your ongoing employment which had ceased in 20XX as a result of your own resignation.

In addition to the cases above, we also considered the following cases and decisions:

•         Case 36/95 95 ATC 327

•         Case N9 81 ATC 56; 24 CTBR (NS) Case 81

•         Case 9/2013 [2013] AATA 783; 2013 ATC 1-058

You were charged with criminal offences and you assert that these criminal charges relate to functions you performed in your role as a director. You incurred legal expenses in the income year ended 20XX in defending these charges. You ceased employment with Company A in 20XX, a number of years before the legal expenses were incurred and you have not sought other employment as a director, or in other engagements, since that time.

In these circumstances, we do not consider the nexus between your legal expenses and the occasion of the outgoing, as required by section 8-1(1)(a), has been established.

You also incurred the legal expenses in defending criminal charges laid in relation to alleged breaches of the Crimes Act. The legal expenses were not incurred to defend an action undertaken in the proper conduct of your duties as a director. It is 'not within the scope of the normal duties of a director to act in any kind of improper or dishonest way' (Case N9 81 ATC 56; 24 CTBR (NS) Case 81).

The legal expenses you incurred in defending the criminal charges are not deductible under section 8-1.

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