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Whether legal costs, incurred in defending proceedings brought for an alleged breach of industrial property rights are deductible under subsection 51(1) of the Income Tax Assessment Act 1936 ?

The expenses incurred by the taxpayer in defending the proceedings brought by an overseas company are deductible under subsection 51(1) of the Income Tax Assessment Act 1936 .

An Australian company (the taxpayer) imports and distributes a number of products in Australia. An action is brought against the company by an overseas company accusing the taxpayer of passing off, and misleading or deceptive conduct by arranging for the manufacture, importation and sale in Australia of products substantially identical to those manufactured and imported by the overseas company. An out of court settlement is reached under which the overseas company takes out trademark protection in Australia and each company agrees to pay its own legal costs and to discontinue further legal action. The taking out of trademark protection in Australia by the overseas company does not affect the operation or structure of the taxpayer's business.

As the taxpayer is carrying on a business, the legal expenses in order to be deductible for income tax purposes must satisfy the conditions set down in subsection 51(1) of the Income Tax Assessment Act 1936 .

The legal expenses of the taxpayer were necessarily incurred in carrying on a business due to the taxpayer importing and distributing certain goods in Australia. That is, the expenses were necessarily incurred in the taxpayer gaining or producing assessable income: it was the sale of these products which gave rise to the legal proceedings which, in turn, involved the company in the expenditure under consideration.

Furthermore, the legal expenses are not capital in nature as the expenses relate to the operation of the business rather than to the business structure itself ( Case N 78 13 TBRD 378; 11 CTBR (NS) Case 21 ). The company continued to import and sell the same products after the settlement was reached and the litigation ceased. The fact that the overseas company was allowed to register its trademark in Australia did not affect the operation and structure of the business conducted by the taxpayer.