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20 Aug 2009
Appeal Status

Legal expenses non-deductible

2009 case note – whether or not legal expenses are deductible depends on reason for incurring expense - Dairy cooperative merger, legal expenses, capital or revenue.

TRA Number 05/08; Decision Number 14/2009


Legal expenses incurred in challenging the differential between the milk payouts to the taxpayers of a merged dairy cooperative were capital in nature and therefore non-deductible.

Impact of decision

This judgment confirms that whether or not legal expenses are deductible will depend upon the reason for incurring the expense.


The disputants were dairy farmers who had been supplying milk solids to a dairy cooperative (Company A). In 1996, Company A merged with another dairy cooperative (Company B).

The directors for both Company A and Company B, expected Company A's shareholders to benefit to a greater degree from the merger than Company B's shareholders. In terms of increased payouts, the merger agreement provided that, following the merger, Company A shareholders would receive a lower payment per unit of milk product supplied to the merged entity (Company B). The difference between the rates of payment for milk products supplied was referred to as "the differential".

The disputants unsuccessfully challenged the differential in the High Court and subsequently appealed the decision to the Court of Appeal where they were also unsuccessful.

For the 2002 to 2005 income tax years, the disputants claimed a deduction for their legal expenses incurred in the High Court and Court of Appeal proceedings. The disputants claimed that the legal expenses were incurred in order to obtain further revenue and were therefore deductible.

The Commissioner disallowed those claims and argued that the differential the disputants sought to recover in the High Court and Court of Appeal proceedings were capital in nature and therefore non-deductible.


The expenditure incurred by the disputants in seeking to recover the differential must be calculated from a practical and business point of view in order to determine whether it is capital or revenue in nature.

The Authority found that the differential reflected the value which Company A brought to the merger compared with what Company B brought to the merger. The merger gave company A shareholders a greater benefit than Company B shareholders in terms of an increased payout for milk-products supplied.

Part of the price to be paid by the disputants to participate in and benefit from the merger and to become supplying shareholders of the merged company, was that they accepted less income than other shareholders in Company B.

The Authority agreed with the Commissioner that the reduction in income for the first three or four seasons post merger was the price which the former Company A shareholders paid to belong to the new merged company and it was that price that the disputants sought to recover in the High Court and Court of Appeal litigation.

The fact that the price paid was taken out of the disputants income did not mean that they funded the litigation to achieve more income but that they were seeking to reduce the price required from them by the merged company for the right to supply their milk products to the merged company.

The Authority found that on the evidence presented before it, there was no rational approach to apportionment in this case, because the expenses were wholly capital in nature.

Income Tax Act 1994