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Your Legal Costs may be Tax Deductible

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Like most other business expenses, there are a surprising number of tax deductible legal expenses available under the Income Tax Assessment Act 1997 (Cth) (“ITAA”) with some forms of legal costs specifically tax deductible.

Revenue versus Capital Expense

According to the general provisions of the ITAA, whether legal costs will be tax deductible depends on the characterisation of the legal expense as either a revenue or capital expense. In general, a tax deductible revenue expense:

  • will arise in gaining or producing assessable income; and
  • be incurred in carrying on of a business

An example of a revenue legal expense is legal costs to recover debts owed to a business. On the other hand, legal fees arising from a capital expense, such as an acquisition of a business or business premises are non-deductible. Legal expenses relating to the earning of exempt income or private legal matters are also non-deductible.

In most scenarios there will be a clear distinction between legal costs that are a revenue expense and a capital expense. However, a significant body of case law exists in respect of scenarios where the dividing line has been less than certain. The following summary of decisions may provide some assistance:

Scenarios where legal expenses have been found to be deductible

  • costs of a landlord in ejectment proceedings against a rent-defaulting tenant
  • costs of defending proceedings for the unauthorised use of a trademark and patent infringement
  • costs of opinion as to whether goods could be sold in another state
  • costs incurred by a trustee company in defence of a writ served on a director of the trustee company
  • costs incurred by a company in supporting an application by an ex-director for leave to resume his activities as a director notwithstanding a prior conviction
  • costs incurred by a director in defending a defamation action brought against the board of directors by a dismissed executive
  • employment related legal costs in altering or extending an existing employment agreement, settling disputes arising out of employment agreements are deductible to both employer and employee and costs and damages of an employer in an employee’s personal injuries claim against the employer
  • costs of defending an action for wrongful dismissal brought by a former director
  • costs incurred in defending the taxpayer’s business methods: examples include costs in defending criminal charges brought against its directors and agents in relation to marketing practices adopted in selling the taxpayer’s products
  • costs incurred by a professional in defending charges as opposed to the right to practise a profession: examples include costs in defending charges brought by an Insurance body are deductible whereas costs in defending deregistration proceedings have been considered non-deductible
  • cost of arbitration to settle a dispute between a solicitor and his partners as to his share of the profits and his subsequent purported expulsion from the partnership
  • costs of defending an employee against corruption charges and assault charges and disciplinary charges brought against a Customs officer
  • damages paid in settlement of a misrepresentation claim against an estate agent
  • damages and costs of a newspaper in defending a libel action.

Specifically Recognised Deductible Legal Expenses

The ITAA also provides for a number of specific deductions in addition to the above general deduction provisions. Such legal expenses include:

  • certain borrowings of money and discharges of mortgages: s 25-25 ITAA specifically allows a deduction for legal expenses associated with borrowing of money where the money borrowed is used by the taxpayer solely for income producing purposes
  • the preparation of leases: s 25-20 ITAA provides that any outgoings incurred by a lessee or lessor of a business property for the preparation, registration or stamping of a lease, or an assignment or surrender of a lease, are deductible
  • the preparation of an income tax return, the disputing of a tax assessment and the obtaining of professional tax advice

5 Year Write-off for Business Capital Expenditure

Following amendments made to the ITAA in 2005, capital expenses in relation to a past, present or proposed business are now tax deductible in equal proportions over five years where certain capital expenditure is not dealt with elsewhere in the income tax laws (“blackhole expenditure”).

It is now possible to deduct capital expenditure incurred:

  • in relation to your existing business
  • in relation to your or another entity’s business that used to be carried on; or
  • in relation to your or another entity’s business that is proposed to be carried on

Author: Marie-Anne Davies