An Australian business perspective

Legal costs are an inevitable part of running a business in Australia – whether you’re negotiating leases, collecting debts, responding to ATO audits or handling employment disputes. When it comes to tax, the key question is not simply whether the cost is “legal” but its purpose, timing and character.

Australian tax law framework

Section 8-1 of the Income Tax Assessment Act 1997 (Cth) allows deductions for losses and outgoings incurred in gaining or producing assessable income, unless they are:

  1. Capital in nature
  2. Private or domestic
  3. Specifically excluded (for example, certain fines or penalties)

This principle forms the foundation for evaluating whether legal costs are deductible.

Deductible (revenue) legal costs

Expenses connected to day-to-day operations or income-generating activities are generally deductible. Common examples include:

  • Debt collection or contract enforcement
  • Employment matters (for example, workplace disputes or Fair Work claims)
  • Tax disputes (for example, ATO assessments or audits)
  • Commercial leases for business premises
  • Ongoing regulatory compliance

Non-deductible (capital) legal costs – and key exceptions

Legal expenses of a capital nature are not deductible under section 8-1. These costs usually relate to establishing, acquiring or protecting long-term assets or business structures. Examples include:

  • Incorporation costs, trust deeds or goodwill acquisition
  • Legal fees for business acquisitions or disposals
  • Title or ownership disputes over land or major assets
  • Preparing shareholder agreements or long-term financing arrangements

Important exceptions

Some capital-type legal costs may still attract deductions:

  • Start-up costs (section 40-880): Certain establishment costs may be deductible over five years, or immediately for eligible small businesses
  • Borrowing expenses (section 25-25): Legal fees tied to raising loan funds are deductible over the loan term or five years
  • Lease documents (section 25-20): Preparing, registering or stamping a lease for income-producing property is deductible

For other capital costs, deductions are denied under section 8-1, but many can still be included in the cost base for capital gains tax (sections 110-25 and 110-35).

Case law guidance: capital v revenue

Case law helps draw the line between deductible (revenue) and non-deductible (capital) legal expenses:

  • The Herald and Weekly Times Ltd v FCT: Legal expenses defending defamation claims were deductible as part of ordinary newspaper operations
  • Magna Alloys & Research Pty Ltd v FCT: Legal fees defending directors against criminal charges were deductible as they arose in the course of business
  • Hallstroms Pty Ltd v FCT: The High Court held that the key test is the advantage sought – protecting profits or current income is revenue, while defending or acquiring enduring rights is capital

Practical tips for businesses

TipWhat to doWhy it mattersDocument the purpose clearlyKeep file notes, invoices and engagement letters outlining why legal costs were incurredStrong evidence helps show connection to income productionTrack capital v revenue separatelyUse separate accounting codes for capital v trading-related feesPrevents blurring of deductible and non-deductible costsUnderstand timingDeductions arise when the liability is incurred, not when paidCritical for year-end tax planning and cash flowUse CGT cost base rulesNon-deductible legal costs may reduce future capital gains taxEnsures non-deductible expenses still provide a tax benefitApply specific provisionsCheck borrowing, lease or start-up cost rulesBusinesses often miss legitimate deduction opportunitiesAllocate mixed-purpose costsRequest itemised billing or prepare allocation schedulesThe ATO requires accurate apportionmentKeep an audit trailStore invoices and correspondence showing purposeProvides protection in an ATO reviewSeek advice earlyEngage tax advisers and lawyers for complex mattersEnsures proper classification and maximises deductions

Conclusion

For Australian businesses, legal costs directly tied to operations, income production or compliance are generally deductible under section 8-1. By contrast, capital-oriented legal expenses are non-deductible – though they may deliver benefits through CGT rules or specific provisions.

How we can help

Understanding which legal costs are deductible can be complex – and getting it wrong can be costly. Our experienced team can help you structure your legal and tax position effectively. Contact us today to ensure your business captures legitimate deductions while staying compliant.

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