Legal expense deductions to fight ASIC charges refused
The AAT has found that legal expenses incurred by a taxpayer in challenging an ASIC banning order prohibiting him from providing financial services for five years, and in defending criminal charges for alleged insider trading, were not incurred by him "in the course" of gaining or producing assessable income and were therefore not deductible under s 8-1(1)(a) of the Income Tax Assessment Act 1997 for the 2011 income year.
Background
In the 2011 income year, the taxpayer incurred legal expenses when challenging an ASIC banning order (which became effective on 7 May 2010 following review by the AAT) in proceedings before the Federal Court and Full Federal Court. (The taxpayer's appeals were dismissed by both courts.) The taxpayer also incurred legal expenses in defending 20 criminal charges for alleged insider trading. (The taxpayer was acquitted on 17 of the charges, with the remaining three withdrawn by ASIC.)
The AAT noted that the taxpayer had in April 2007 entered into an authorised representative agreement (ARA) with a company, a holder of an Australian financial services licence, to provide stockbroking services as an authorised representative (AR) on behalf of the company in accordance with the ARA. As a consequence of the ASIC banning order, the taxpayer's authorisation as an AR with the company became "void" on 7 May 2010 (under s 916A(3)(b) of the Corporations Act 2001).
In February 2012, the taxpayer applied for a private ruling from the Commissioner regarding the deductibility of the legal expenses incurred in the 2011 income year. In May 2012, the Commissioner issued the private ruling, which provided that the taxpayer was not entitled to a deduction for the legal expenses. The taxpayer then lodged his 2011 income tax return and made no claim for the legal expenses. The Commissioner then issued the taxpayer an assessment in accordance with the return. In June 2012, the taxpayer objected to the private ruling. However, by correspondence between the parties, it was agreed that the objection would be treated as an objection to the assessment, and not as an objection to the private ruling. The Commissioner then disallowed the objection in full and the taxpayer applied for a review.
Decision
Before turning to consider the deductibility of the legal expenses, the AAT was required to make findings concerning, essentially, whether the taxpayer was "employed" by the company and whether the taxpayer's appointment as an AR of the company was merely "suspended" or "terminated". This was because the taxpayer had used the words "employed" and "employment" in some of the material filed with the AAT.
The taxpayer had contended that his position as an AR of the company was merely "suspended" on 7 May 2010 when the ASIC banning order became operative, that his employment with the company had not been terminated, and that he and the company had an agreement that once the ASIC banning order was lifted, he would return to paid employment at the company. It was also contended that the "suspension" agreement was made some time after ASIC had made the banning order on 4 February 2009 but before that order became effective on 7 May 2010, and continues "to this day" pending the banning order being lifted or expiring.
The AAT noted the taxpayer's own admission that he was not an "employee" of the company and that his engagement with the company was solely to provide the services set out under the ARA as a representative. Further, based on the evidence before it, the AAT found that the taxpayer's position as an AR of the company was "terminated" on 7 May 2010 when he was unable to obtain a stay of the ASIC banning order. Among other things, the AAT noted that, in cross-examination, the taxpayer accepted that his role as an AR with the company ceased upon the banning order becoming operative on 7 May 2010, that he ceased "employment" with the company on 7 May 2010, and that in the 2011 income year he did not have a stockbroking job with the company.
The AAT held that there was an insufficient "connection" ("link" or "nexus") between the legal expenses and the production of assessable income by the taxpayer (noting that the taxpayer had ceased to occupy the position of an AR at the company when the expenses were incurred). In relation to the Federal Court legal expenses, the AAT considered that the "occasion" for and "essential character" of those expenses was to enable the taxpayer to re-enter the regulated stockbroking/financial services industry, whether that be with the company or another firm. In this regard, the AAT noted that the effect of the ASIC banning order becoming operative was that the taxpayer could no longer provide "any" financial services for "any" stockbroking firm/financial services provider for a five-year period, whether that be with the company or a different firm/provider. In relation to the legal expenses to defend the criminal charges, the AAT said the most likely "occasion" of the incurring of the expenses was to avoid the penal consequences that might follow if the taxpayer was convicted of insider trading offences (under s 1043A(1) and (2) of the Corporations Act), being potential imprisonment for up to 10 years or a substantial fine.
Furthermore, the AAT said that if it had held that the legal expenses were deductible under the first positive limb in s 8-1(1)(a), it would have held that the Federal Court legal expenses were non-deductible capital expenditure under s 8-1(2)(a), and that the legal expenses to defend the criminal charges were non-deductible private expenditure per s 8-1(2)(b). In relation to the Federal Court legal expenses, the AAT said the reason the expenses were incurred was essentially to defend the taxpayer's authorisation to provide stockbroking/financial services as an AR in the financial services industry generally, and that such expenses relate to the profit-yielding structure and are "capital" in nature. In relation to the legal expenses to defend the criminal charges for alleged insider trading, the AAT said the expenditure was incurred to prevent the taxpayer from suffering adverse personal consequences (ie potential imprisonment or a substantial fine), and that the expenditure was therefore "private" in nature.
In addition, the AAT held that a private ruling relating to the 2009 and 2010 income years (which had allowed deductibility for legal expenses incurred in connection with the AAT review of the ASIC banning order, but not for expenses to have the taxpayer's name withheld in proceedings) was not binding on the Commissioner in relation to the 2011 income year.
The AAT said there were several reasons why the private ruling for the 2009 and 2010 years was not binding on the Commissioner in relation to the 2011 year. Among other things, the AAT noted that the earlier private ruling was for a specified "scheme" arising in the 2009 and 2010 years and that the question of deductibility of the legal expenses incurred in the 2011 year was concerned with a different factual context to the 2009 and 2010 legal expenses. It also said a private ruling may specify the time from which it begins to apply and the time at which it ceases to apply – in this case, the earlier private ruling specified that it ceased to apply at the end of the 2010 income year. However, the AAT noted that in any event, no conduct on the part of the Commissioner could operate as an estoppel against the operation of the taxation legislation.
AAT Case [2013] AATA 783, www.austlii.edu.au/au/cases/cth/AATA/2013/783.html.
