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13 Nov 08 High Court dismisses Commissioner's appeal on legal expenses - Day

The High Court, by majority (Gummow, Hayne, Heydon and Kieffel JJ, Kirby J dissenting) has dismissed the Commissioner's appeal from the decision of the Full Federal Court (Spender and Edmonds JJ, Dowsett J dissenting), which allowed the taxpayer's appeal against the decision of Emmett J, who had held that legal expenses incurred by the taxpayer (a Customs officer) in defending 2 of 3 sets of disciplinary charges were not deductible.

One set of disciplinary charges against the taxpayer was brought for the wrongful use of his Customs identity badge other than in the course of his duty as a Customs officer. The other set of charges was also brought for improper conduct. It was the Commissioner's principal contention that the legal expenses were incurred in defending charges of conduct extraneous to the performance of the respondent's income-producing activities and therefore could not be said to have been incurred in the course of gaining or producing assessable income within s 8-1(1) ITAA 1997.

In upholding the appeal, the majority said, at paras 37-38:

"The respondent's position as an officer subject to the Public Service Act 1922 obliged him to observe standards of conduct extending beyond those in the performance of tasks associated with his office and exposed him to disciplinary procedures within the Service which might have consequences for the retention of his office or his salary. What was productive of his income must be understood in this light. It is neither realistic nor possible to excise from the scope of the respondent's service as an officer elements which may be associated with tasks and so identify them as income-producing. What was productive of his income by way of salary is to be found in all the incidents of his office in the Service to which the Act referred, including his obligation to observe standards of conduct, breach of which might entail disciplinary charges. The respondent's outgoings, by way of legal expenses, followed upon the bringing of the charges with respect to his conduct, or misconduct, as an officer. He was exposed to those charges and consequential expenses, by reason of his office. The charges cannot be considered as remote from his office, in the way that private conduct giving rise to criminal or other sanctions may be.

It was necessary for the respondent to obtain legal advice and representation in order to answer the charges and to preserve his position, in the same way that the company in Snowden & Willson was obliged to act defensively. Whether the charges were well-founded, a fact which had not been established by the time the Full Court determined this matter, is not relevant to the question of deductibility. The incurring of expenditure by an employee to defend a charge because it may result in his or her dismissal may not itself be sufficient in every case to establish the necessary connection to the employment or service which is productive of income. Much will depend upon what is entailed in the employment and the duties which it imposes upon an employee. In the present case the requisite connection is present."

The majority also dismissed the Commissioner's other contention, which relied upon the terms of s 8-1(2)(b) of ITAA 1997, that the expenses were of a private nature: FCT v Day [2008] HCA 53 (High Court; Gummow, Kirby, Hayne, Heydon and Kieffel JJ; 12 November 2008).

For a copy of the decision, go here.

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