MAY 2005
USING YOUR LEGAL EXPENSES AS A TAX DEDUCTION
It is almost cliché in law, but the answer as to whether your legal costs are an
allowable tax deduction depend very much on the nature of those legal costs.
The general principle that applies to the deductibility of legal costs is
governed by Section 8-1 of the Income Tax Assessment Act 1997 (“ITAA
97”).
This section allows you to deduct losses and outgoings incurred in
gaining or producing assessable income. In general you cannot deduct any
losses which are of a capital nature or any losses or outgoings that relate to a
private or domestic nature.
Certain legal expenses can fall into very defined categories and the
deductibility of these expenses is quite clear. For example, the conveyancing
costs in connection with a purchase of real estate are clearly of a capital
nature. Similarly any legal fees incurred in connection with the purchase or
establishment of a business or other capital asset for use in a business is also
of a capital nature. These are not deductible expenses.
Other expenses are clearly of a revenue nature such as the legal costs
involved in recovering debts owed to a business, are in fact deductible. There
are also some specific provisions of the tax law which allow for certain legal
expenses to be deducted. For example, legal expenses incurred in organising
the borrowing of money used for the purpose of producing assessable income
is a deductible expense.
The legal cost of having a lease prepared for a
business is a deductible expense.
More specifically, Section 25-5 of ITAA
allows a tax payer to claim a deduction for tax related expenses and this
would include things such as the preparation of an income tax return, the
disputing of a tax assessment and the obtaining of professional tax advice.
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There are also certain capital legal expenses that are associated with the
establishment, restructuring, defence or ceasing of a business that may
qualify for a five year write off which are specifically made deductible (See
Section 40-880).
There are some borderline areas that may not fall under the general
provisions. These are dealt with on a case by case basis by the Courts, for
example:(a)
The legal costs incurred for defending your business practices have
been allowed as a deductible expense where it has related to the
marketing practices and selling of a tax payers products or in cases
where the allegations were of overcharging and unfair business
practices;
(b)
The cost of preparing a new employment agreement with an employee
is not deductible.
However the costs of altering or extending an
existing agreement is deductible, providing that the existing agreement
allows for such changes. Any costs incurred in settling disputes arising
out of employment agreements are also deductible to both the
employer and the employee;
(c)
In general legal expenses incurred by you in defending your business
or your employees from prosecutions for breaches committed in the
course of carrying on your business are not deductible. However there
have been some exceptions to this rule;
(d)
An annual retainer with a solicitor is often claimed in practice as a
deductible expense and there is no attempt to allocate the costs to the
various services that your solicitor may perform, some of which may
relate to capital items. This is not the same for actual bill of costs for
specific work performed. There are advantages in having a set annual
retainer, particularly if you are able to balance the cost of the retainer
against the amount of work your company or business needs.
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Whilst the deductibility of legal expenses is somewhat of a grey area, what is
clear is that while there are certain examples that clearly define what could be
a deductible expense, where no analogous case exists, it is often arguable in
the circumstances. If you are in any doubt, you should ask your solicitor or
accountant in each instance whether or not the expenses incurred are actually
deductible by you or your business.
LIABILITY OF FORMER DIRECTORS FOR GROUP TAX
On 3 May 2005, the Court of Appeal in Canty v Deputy Commissioner of
Taxation upheld the District Court’s decision that a former company director
can, in certain circumstances, be held personally liable for a company’s
outstanding unremitted group tax.
In this case, Mr Canty resigned from the board on 31 August 1999. At the
time of his resignation, the outstanding unremitted company group tax was
$402,917.05. Shortly after his resignation the ATO issued Notices to Mr Canty
demanding that he personally pay $402,917.05 by way of a penalty pursuant
to s222AOE of the Income Tax Assessment Act 1936 (“ITAA”).
Section 222AOB(1) of ITAA provides that directors are responsible for any
failure by the company to remit group tax instalment deductions to the ATO
on or before their due payment date.
This section further provides that
directors should, prior to or on the due payment date take certain steps:(i)
causing the company to pay the instalments due and owing to the
ATO; or
(ii)
to make the company reach agreement with the ATO to repay an
amount equal to the unremitted group tax
or in the event that the company cannot pay the unremitted group tax then
(iii)
appointing an administrator over the company’s assets; or
(iv)
begin winding up the company within the meaning of the law.
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Failure to comply with section 222AOB(1) of the ITAA can render a director
liable to pay the ATO by way of penalty, an amount equal to the unremitted
group tax.
Mr Canty denied he was personally liable to pay the penalty because he was
not a director. One of Mr Canty’s arguments in his defence was that he had
resigned from the board before he was served with the ATO’s Notice. As
such, he was powerless to compel the company to pay the group tax to the
ATO.
The Court of Appeal in considering his arguments held:(a)
The ITAA required the Notice need only be issued to a “person” from
whom the penalty is to be recovered, which person is not necessarily a
current director of the offending company;
(b)
Under the ITAA it is an essential condition of a director’s liability that
they were in office for at least some of the period before the date on
which the company became liable to payment group tax. Mr Canty
was a director during this period of time; and
(c)
That any “harshness ….imposed on the former director under ITAA… is
to some extent ameliorated by the fact that the directors cannot be
sued until …Notice… is served, and by the time it has been served and
a further fourteen days had passed, the director …including the former
director….. will have had a period sufficient to procure the company to
take one of the four steps referred in s222AB(1).”
Had the company paid the ATO the unremitted group tax or placed the
company into administration, or taken either of the other two steps (neither
of which may have been practical within the timeframe) within fourteen days
of the Notice then the penalty imposed upon Mr Canty would have been
remitted.
As this case illustrates, company directors must ensure that their company
complies with its group tax remittance obligations and that directors need to
be mindful that resigning from the board will not necessarily protect a former
director from subsequent personal liability.
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Contributions made by Greg Judd, Freya Jenkins, Annabel Murray, Ellen
Sefton and Antonio Chan.
This newsletter is provided by Judd Commercial Lawyers to guide and assist its clients and other correspondents
for their information on a complimentary basis. It represents a brief summary of the law as of May 2005 and
should not be relied on as a definitive, complete or conclusive statement of the relevant laws at any time.
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