Deductibility of legal expenses - public liability insurance for rental property

Are the taxpayer's legal expenses, in seeking its insurer pay damages, deductible under section 8-1 of the Income Tax Assessment Act 1997 ('ITAA 1997')?

No. The taxpayer's legal expenses are not deductible under section 8-1 of the ITAA 1997.

The taxpayer, a company with a single shareholder and director, owned a house. The taxpayer rented the house to a relative of the director.

The oral rental agreement required the tenant to mow the grass surrounding the house.

The director mowed the grass on one occasion because the tenant's mower was broken. Whilst doing this, a person visiting the tenant was injured.

The injured person started a damages action against the director. The taxpayer incurred legal fees in seeking its insurer pay any damages.

A settlement was reached.

So far as is relevant here, section 8-1 of the ITAA 1997 allows a deduction for an outgoing to the extent that it is incurred in gaining or producing assessable income. However, to the extent an outgoing is of a private nature, it is not deductible.

Expenditure by a company to defend a director against legal proceedings may be deductible ( Magna Alloys & Research Pty Ltd v FCT 80 ATC 4542; (1980) 11 ATR 276). However in this case, there is an insufficient connection between the legal fees and the rental income as: • The rental agreement does not require the taxpayer to mow the lawn; indeed the tenant was required to do this. • The taxpayer's reason for mowing the lawn, because the tenant's mower was broken, does not show a connection with gaining income. • The director and the tenant are relatives. • The director is the sole director and shareholder of the company.