ATO Interpretative Decision

ATO ID 2004/150

Income Tax

• This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

Issue

Are legal fees incurred by a taxpayer in winding up a company included under Division 110 of the Income Tax Assessment Act 1997 (ITAA 1997), in the second element of the cost base and reduced cost base of a debt owed by the company to the taxpayer?

Decision

Yes. The legal fees are included in the second element of the debt's cost base and reduced cost base under Division 110 of the ITAA 1997.

Facts

The taxpayer was a director and shareholder of a company.

The taxpayer guaranteed the payment of a bank loan obtained by the company.

The company failed to meet its obligations under the loan and the bank sought to enforce the guarantee.

As a result, the taxpayer paid out the full amount of the loan.

The taxpayer incurred legal fees in applying, as a creditor, to the relevant State Supreme Court for the company to be wound up on the basis that it was insolvent. The Court made the order and a liquidator has been appointed.

Reasons for Decision

The taxpayer's right to be indemnified by the company in respect of the payment made by the taxpayer to the bank is a CGT asset (section 108-5 of the ITAA 1997). Essentially, the payment of the amount by the taxpayer gave rise to a debt owed by the company to the taxpayer (paragraph 37 of Taxation Ruling TR 96/23).

CGT event C2 in section 104-25 of the ITAA 1997 will happen when the debt expires - for example, when the company is deregistered. The taxpayer will make a capital gain if the capital proceeds from the ending of the debt are more than the debt's cost base, and will make a capital loss if the capital proceeds from the ending are less than the debt's reduced cost base (subsection 104-25(3) of the ITAA 1997).

The cost base of a CGT asset consists of five elements (subsection 110-25(1) of the ITAA 1997). The elements of the reduced cost base are the same as for the cost base, except for the third element (subsection 110-55(2) of the ITAA 1997).

The first element of the cost base and reduced cost base of the debt is the amount the taxpayer paid under the guarantee (subsections 110-25(2) and 110-55(2) of the ITAA 1997). At issue is whether legal fees incurred by the taxpayer in winding up the company are 'incidental costs' that can be included in the second element of the debt's cost base and reduced cost base.

The second element of the cost base and reduced cost base consist of incidental costs incurred to acquire the asset, or that relate to a CGT event that happens in relation to the asset (subsections 110-25(3) and 110-55(2) of the ITAA 1997). Incidental costs are listed in section 110-35 of the ITAA 1997 and include costs incurred for the services of a legal adviser (subsection 110-35(2)).

It is considered that the legal fees incurred by the taxpayer in winding up the company relate to CGT event C2 when it happens to the debt. The legal fees would therefore be included in the second element of the debt's cost base and reduced cost base.

Amendment History

Year of income:  30 June 2004

Legislative References:
Income Tax Assessment Act 1997
   section 104-25
   subsection 104-25(3)
   section 108-5
   Division 110
   subsection 110-25(1)
   subsection 110-25(2)
   subsection 110-25(3)
   section 110-35
   subsection 110-35(2)
   subsection 110-55(2)

Related Public Rulings (including Determinations)
Taxation Determination TD 2000/7

Related ATO Interpretative Decisions
ATO ID 2003/215

Keywords
capital gains tax
CGT assets
CGT cost base
CGT events C1-C3 - end of a CGT asset
CGT reduced cost base
guarantees
liquidation

Siebel/TDMS Reference Number:  3786884; 1-5IPTUPB; 1-AX3H1N0

Business Line:  Private Groups and High Wealth Individuals

Date of publication:  13 February 2004
Date reviewed:  3 March 2017

ISSN: 1445-2782