When a legal expense is incurred in relation to the operation of a business to produce assessable income, it is generally allowable as a deduction. Exceptions are when the legal fee is capital, domestic or private in nature, if it is specifically excluded by another section of income tax legislation, or is incurred in earning exempt and non-assessable non-exempt income.
In this regard, for individuals incurring legal fees, the expense incurred would not be deductible unless there is a clear nexus with the expense being incurred in deriving assessable income (for example, for an investment property). In other cases, the expense may be private in nature so a deduction would not be available in any case.
The following types of legal expenses are not deductible under the general deductibility provisions because they are of a capital or private nature. Instead they may be deductible under a specific provision in tax law:
- the preparation of an income tax return, the disputing of a tax assessment and the obtaining of professional tax advice
- the preparation of lease documents
- certain borrowing expenses, and
- certain mortgage discharge expenses.
A private ruling may be necessary for some legal expense claims, although certain specific information may be required.
Employment agreement legal expenses
According to taxation ruling TR 2000/5, there are certain legal fees with regard to employment that can be deductible. For employees the following are an allowable deduction:
- costs of drawing up an employment agreement with an existing employer to replace an award or in accordance with a provision in the existing agreement
- costs associated with settlement of disputes arising out of an existing employment agreement, including the cost of representation
- costs of changing the conditions of an existing employment agreement with the same employer (providing the existing agreement allows for changes), be it a variation, re-negotiation of an existing agreement or upon a promotion
- costs of renewing or extending a fixed term agreement that has a provision allowing for renewal or an extension at the end of a term.
The following costs incurred by an employee are not allowable deductions:
- costs of drawing up an employment agreement with a new employer
- costs of drawing up an employment agreement upon re-employment with an employer following termination of a fixed term employment contract where the agreement makes no provision for renewal or extension.
For employers, the following are allowable deductions:
- costs of drawing up employment agreements for existing employees and new employees of an existing business
- costs incurred in the settling of disputes arising out of existing employment agreements.
However costs incurred by an employer in drawing up employment agreements for a new business are not an allowable deduction.
Business lease expenses
The cost of preparing, registering and stamping a lease is deductible if the taxpayer is using or will use the property for earning assessable income. The lease payments themselves will be deductible under the general deduction rules, and are therefore subject to special prepayment rules.
If valuation fees are paid to help decide whether to buy a business, these are generally capital costs and not an allowable deduction. However if the valuation is used to support an application to borrow money for use in the business, those expenses can be claimed as borrowing costs immediately if under $100 or over the life of the loan, or five years from the date of the loan, whichever is shorter.
Fines and breaches of law
Deductions are specifically denied for fines or penalties (however described) that are imposed as a consequence of a breach of any Australian or foreign law. This rule does not apply to administratively imposed penalties such as the general interest charge (which the ATO applies to unpaid tax liabilities) and penalties for underestimating GST instalments. However, while the fines and penalties may be specifically disallowed, the costs incurred in defending an action may be deductible.
Evicting a tenant
A taxpayer may acquire premises (all or a portion of) that were leased to a tenant of the former owner. Any expenses incurred trying to evict the tenant will not be deductible. This expense becomes part of the cost of acquiring the property and a capital expense for income tax purposes. Arguably, the expense could form part of the “cost base” of the property, being expenditure of a capital nature incurred in establishing the taxpayer’s title to, or a right over, the asset. However a private ruling for a particular set of circumstances could be required.