Question

Windmill Ltd commenced a takeover of its principal competitor WindPower Ltd in June 2019. The takeover was hostile and WindPower Ltd fought it vigorously.

WindPower Ltd was under financial stress due to misappropriation of funds by a former employee. This provided Windmill Ltd with the opportunity to mount the takeover.

Legal costs were significant due to the hostility against the takeover.

Just prior to the finalisation of the documentation, the senior management staff of Windpower Ltd won Lotto and were in a position to take over the company and pay off all outstanding debts.

Windmill Ltd spent a total of $1.5 m on the unsuccessful takeover in both 2019 and 2020.

Mr Abbott, the Managing Director of Windmills Ltd, has asked for your advice of how this large expense is to be treated for tax purpose..

Research this problem. In presenting your argument provide any relevant sections, cases and rulings which may support your position. You should also provide commentary on any possible opposing arguments.

This section must be referenced in accordance with the Australian Guide to Legal Citation (AGLC)

Answer 1

In most instances, taxpayers claiming deductions will rely on the provisions of section 8-1.  This section provides:

(1) You can deduct from your assessable income any loss or outgoing to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

(2) However, you cannot deduct a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or

(d) a provision of this Act prevents you from deducting it.

Section 8-1 allows a deduction for outgoings incurred in the carrying on of income producing activity.  The income producing activity must have the aim of producing assessable income.

Section 8-1(2) provides that no deduction is allowable for expenses to the extent they are of a capital, private or domestic nature.  Further, no deduction will be allowed for an expense that is incurred in the gaining, or producing, of your exempt income or non-assessable non exempt income.  And finally, you cannot claim a deduction when a section of the ITAA97 prohibits it.  

The courts, on a number of occasions, have determined legal expenses to be an allowable deduction if the expenses arise out of the day to day activities of the taxpayer's business.

The ITAA97 contains a number of sections which allow a specific deduction for legal expenses.

The ‘blackhole expenditure’ provisions found at section 40-880 of ITAA97 allow taxpayers to claim deductions for certain capital expenditures (including legal expenses) that had previously been excluded from deduction.

Under section 40-880, 20 % of the expenditure is deductible in the income year in which it is incurred.  This continues for the next four tax years. a deduction may be claimed for:

• expenditure to establish your business structure;

• expenditure to convert your business structure to a different structure;

• expenditure related to raising equity for your business;

• expenditure to defend your business against a takeover

• expenditure incurred in unsuccessfully launching a takeover bid;

• expenditure incurred in winding up a company in liquidation and in which you are a shareholder; and

• other costs associated with ceasing to carry on a business.

Accordingly, many of the deductions for the legal fees taxpayers, have been unable to claim to date (eg because they were capital) are now available under these provisions.  

The expenditure incrred for legal cost is cost incurred for excecution of acquisition. Under acquisition there are two type of cost one is relating to decision to evaluate target and reach to decision for take over -- these cost are in nature of business expense to earn profit hence it is allowable as business expenses.

However once decision made, then cost incurred are executory in nature and they are capital expenditure. However cosidering specific deduction allowed over 5 year for unsucessful take over expenses, it gets qualifies for deduction over 5 year.