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Whether legal expenses incurred by a firm of solicitors in challenging the validity of search warrants are allowable deductions under subsection 51(1) of the Income Tax Assessment Act 1936.

The legal expenses incurred by a firm of solicitors in challenging the validity of search warrants are allowable deductions under subsection 51(1) of the Income Tax Assessment Act 1936.

The Federal Police by authority of two search warrants, seize moneys deposited by certain of the taxpayer's existing clients along with documents and records relating to the deposits of the moneys. The deposits had been made to cover legal costs relating to criminal proceedings.

The taxpayer has never before received warrants seizing documents and funds in its possession.

The taxpayer brings an action to challenge the validity of the warrants. The taxpayer does not charge the expenses incurred in challenging the warrants to any client. The taxpayer is ultimately successful in having the search warrant relating to the seizure of the documents declared void and of no effect and having the various documents returned. However, the firm is unsuccessful in having the warrant relating to the seizure of moneys deposited overturned.

The taxpayer's dominant purpose in challenging the warrants is to defend the practice of the firm of accepting funds in advance from clients who are subject to criminal charges. The taxpayer encourages this practice as it makes good commercial sense: the firm is assured of being paid for its costs and outlays in a timely manner and the risk that the firm will incur a bad debt is also reduced or eliminated.

The legal expenses are not incurred by the taxpayer for any purpose other than defending its business method of accepting money in advance from clients in relation to costs and outlays in criminal matters, defending funds in a trust account, and protecting the trail of documents which governed deposit of these funds. The decision to challenge the warrants is thus related to an integral part of the taxpayer's business, namely the receiving of funds in advance to cover anticipated expenses. The expenditure is necessarily incurred in carrying on the business for the purpose of gaining assessable income.

Furthermore, the negative limbs of subsection 51(1) of the Income Tax Assessment Act 1936 have no application: the legal expenses are not capital in nature. The expenditure incurred by the taxpayer produces no benefit of an enduring nature nor does it relate to the preservation of a capital asset (compare Case V140 88 ATC 875, 19 ATR 3859 where there was a threatened extinction of the taxpayer's business when the police executed the search warrants).

Finally, the fact that the expenses are unusual and the taxpayer has not on previous occasion needed to take such legal action does not prevent the expenses being deductible (see for example FC of T v Snowden and Wilson Pty Ltd (1958) 99 CLR 431).