HARMON & KARDOS

Harmon & Kardos (a firm) and Harmon & Kardos (a partnership) (the plaintiffs) brought proceedings against the Commissioner of Taxation (the defendant) in the Supreme Court of New South Wales. The dispute concerned the deductibility of certain expenses incurred by the plaintiffs, specifically legal fees and associated costs, which they claimed were incurred in the course of their business as solicitors. The Commissioner had disallowed these deductions, leading to the present litigation.

The central legal issue before Young J was whether the expenses incurred by the plaintiffs, which included costs associated with defending themselves against allegations of professional misconduct and breaches of fiduciary duty, were properly deductible under section 82(1) of the *Income Tax Assessment Act 1936* (Cth) as outgoings incurred in gaining or producing assessable income. The court was required to determine if these expenses had the necessary character of being "incidental and relevant" to the business operations of the solicitors, or if they were of a capital or private nature.

Young J reasoned that the expenses, although relating to the conduct of the solicitors in their professional capacity, were not incurred in the ordinary course of gaining or producing assessable income. His Honour found that the defence against allegations of misconduct and breach of duty was a separate and distinct matter from the day-to-day activities of earning fees. The court applied the principle that expenses incurred in defending one's business against charges of impropriety, rather than in carrying on the business itself, are generally not deductible. The expenses were considered to be of a capital nature, relating to the preservation of the plaintiffs' professional standing and ability to practice, rather than directly producing income.

The court therefore dismissed the plaintiffs' appeal and upheld the Commissioner's disallowance of the deductions.