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Are legal expenses paid to secure tenants' enjoyment of strata title common property deductible under section 8-1 of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Yes, the legal expenses paid to secure tenants' enjoyment of strata title common property are deductible under section 8-1 of the ITAA 1997.

The taxpayer is a registered proprietor of a Strata Plan lot. They and their tenants have been denied access to part of the common property by another strata proprietor. Legal expenses were incurred in attempting to regain access to part of the common property. The dispute between the taxpayer and the other proprietor has not settled, despite an order in the taxpayer's favour from the Strata Title Referee.

Section 8-1 of the ITAA 1997 provides that expenses will generally be deductible if their essential character is that the expenditure has a sufficient connection with the operations or activities that more directly gain or produce assessable income, provided that the expenses are not of a capital, private or domestic nature.

In this case, the expenses are not of a private of domestic nature, but may be capital, as the legal action taken relates to access to a capital item. Case law provides examples of situations where taxpayers have attempted to prevent damage to, or a reduction in value of, capital assets.

In AAT Case 5012 (1989) 20 ATR 3425; Case W30 89 ATC 300, the taxpayers merely sought retention of the status quo so as to avoid perceived damage to their business ( FC of T v. Snowden & Willson Pty Ltd (1958) 99 CLR 431; John Fairfax & Sons Pty Ltd v FC of T (1959) 101 CLR 30 applied). No asset was acquired and no added benefit accrued to the partnership. All that accrued was the limitation of the nuisance. Therefore, the legal costs were not outgoings of a capital nature ( Sun Newspapers Ltd v. FC of T (1938) 61 CLR 337 applied).

As a proprietor and tenant in common, the taxpayer is entitled to access and use the common property under the Strata Plan. In taking legal action against the other strata proprietor, they have not sought any new asset, advantage or right. The desired outcome of their legal action was merely to ensure the continued enjoyment of the area and to limit any adverse effects on the rental income from the unit and the common property. Therefore, the legal expenses are deductible under section 8-1 of the ITAA 1997.