Edited version of private ruling

Authorisation Number: 1011513927204

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Ruling

Subject: Expenses for legal advice on various matters

Questions and Answers:

Can you claim a deduction under section 25-5 or section 40-880 of the Income Tax Assessment Act 1997 (ITAA 1997) for your expenses listed on invoice A?

No.

Can you claim a deduction under section 25-5 of the ITAA 1997 for your expenses listed on invoice B?

No.

Can you claim a deduction spread over five years under section 40-880 of the ITAA 1997 for your expenses listed on invoice B?

No.

If a deduction was allowable under section 40-880 of the ITAA 1997 for your expenses listed on invoice B, would the deduction be quarantined as a deferred loss by the operation of subsection 35-10(2B) of the ITAA 1997?

Yes.

Can you claim a deduction under section 25-5 of the ITAA 1997 for your expenses listed on invoice C in relation to advice received regarding the ability to claim deductions against other income through an investment in units of a newly established trust?

Yes.

Can you claim a deduction under section 25-5 or section 40-880 of the ITAA 1997 for your expenses listed on invoice C in relation to advice received regarding the stamp duty implications of a transfer of an investment property and the establishment of a new structure?

No.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-5

Income Tax Assessment Act 1997 Paragraph 35-10(2B)

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Section 110-35

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling

· the invoices that were attached with the application for private ruling

· two letters from your solicitor

· the email from your tax agent

You earn income from salary and operate self-employed professional practices. You also own one rental property.

You sought legal advice in relation to business structures and received three invoices from your solicitor for the advice received.

Your tax agent provided the following description of the advice received:

In relation to invoice A the solicitor's specific advice was on the CGT consequences and relevant bankruptcy provisions on asset protection carried out for the client in relation to his personally held assets.

In relation to invoice B the solicitor's specific advice was on the tax rules that apply to the client's business structure, personal services income rules and new business structures established for the client.

In relation to invoice C the solicitor's specific advice was on the ability to claim deductions against other income through an investment in units on a newly established trust, advice on stamp duty implications of a transfer of an investment property of the client, establishment of the new structure.

Your solicitor provided further information about invoice B as follows:

The advice relating to that invoice related to the following:

· Review of the client's existing structures and advice in relation to the current structure and alternatives and tax implications of those structures;

· Advice in relation to deductibility of interests on borrowings;

· Advice in relation to capital gains tax;

· Advice in relation to the differentiation between personal services income and business income.

In response to a request for clarification of which assets or purposes did the advice in relation to deductibility of interests on borrowings and in relation to capital gains tax pertain to, your solicitor replied as follows:

The advice provided was in relation to what situations interest will be deductible to the client's business and the capital gains tax consequences on the sale of business assets, depending on the type of business entity in which the client operates.

In relation to invoice B, we requested you answer the following questions:

Your client registered a company, for which they are the sole shareholder.

In relation to invoice B, could you please provide answers to the following questions:

Did your client register the company for the purpose of carrying on the proposed business under the new structure? If not, what exactly was the new business structure proposed?  

Has your client commenced the proposed business under the new structure? If so, why does the company not have an ABN?

If not, does your client ever propose to commence a new business under the new structure or does your client remain undecided?

if proposing to commence a new business, what is the approximate date that new business will commence?

We received the following reply to our questions from your tax agent:

We advise that we have been in contact with our client and the solicitors regarding your questions in relation to invoice B.   We have been advised that the company was registered with the intention of acting as trustee of an investment trust.  Neither the company or the trust will be conducting the taxpayer's current business they are for future investment purposes.

Reasons for decision

Tax-related expenses

Paragraph 25-5(1) of the ITAA 1997 states you can deduct expenditure you incur to the extent that it is for managing your tax affairs. 'Tax affairs' means affairs relating to income tax.

Paragraph 25-5(4) of the ITAA 1997 states you cannot deduct capital expenditure under subsection (1). However, for this purpose, expenditure is not capital expenditure merely because the tax affairs concerned relate to matters of a capital nature. For example, under this section, you can deduct expenditure you incur in applying for a private ruling on whether you can depreciate an item of property.

Capital gains tax (CGT) cost base

The cost base of a CGT asset is determined in accordance with section 110-25 of the ITAA 1997, which includes incidental costs. There are nine categories of incidental costs set out in section 110-35 of the ITAA 1997. These include remuneration for the services of a legal adviser.

Deductibility under section 40-880

Section 40-880 of the ITAA 1997 provides a deduction over five years for certain business capital expenditure incurred after 30 June 2005 which is not otherwise taken into account or denied a deduction by some other provision.

Subsection 40-880(2) of the ITAA 1997 states you can deduct, in equal proportions over a period of five income years starting in the year in which you incur it, capital expenditure you incur:

· in relation to your business; or

· in relation to a business that used to be carried on; or

· in relation to a business proposed to be carried on; or

· to liquidate or deregister a company of which you were a member, to wind up a partnership of which you were a partner or to wind up a trust of which you were a beneficiary, that carried on a business.

To ascertain whether paragraph 40-880(2)(c) applies in this case, any business proposed to be carried on must be considered. Subsection 40-880(7) of the ITAA 1997 states:

You cannot deduct an amount under paragraph 2(c) in relation to a business proposed to be carried on unless, having regard to any relevant circumstances, it is reasonable to conclude that the business is proposed to be carried on within a reasonable time.

In considering the term 'proposed to be', paragraphs 2.31, 2.32 and 2.33 of the Explanatory Memorandum to Tax Laws Amendment (2006 measures No. 1) Bill 2006 state:

2.31 For a business to be proposed to be carried on for the purposes of this provision, the taxpayer needs to be able to demonstrate a commitment of some substance to commence the business, and sufficient identity about the business that is proposed to be carried on. The deductibility of expenses in advance of the business being carried on will rest on the facts of each case, but this commitment and identity must be tangible; that is, there would need to be some evidence that would enable an objective assessment of the existence of that commitment and identity.

2.32 Further guidance as to the level of commitment required to deduct pre-business expenditure is provided by subsection 40-880(7). In essence, this requires that, having regard to relevant circumstances, it must be reasonable to conclude that the commitment exists. One of these circumstances is that the business be proposed to be carried on within a reasonable time. This may vary according to the industry or the nature of the business and would recognise the long lead times that may be involved. [Schedule 2, item 30, paragraph 40-880(2)(c ), subsection 40-880(7)].

2.33 Such commitment could be shown by, but is not limited to, at least some of the following:

· a business plan;

· the establishment of a business premises;

· research into the likely markets or profitability of the business; and

· capital investment in assets of the business.

Further, an exclusion to deductibility exists in subsection 35-10(2B) of the ITAA 1997, which states if you are an individual, you cannot deduct an amount under section 40-880 for expenditure in relation to a business activity you or another entity proposes to carry on for an income year before the one in which the business activity starts to be carried on.

Apportionment of legal expenses

Taxation Determination TD 93/29 is about the deductibility of legal expenses and states there will often be occasions where only a portion of the legal expenses are considered to be deductible. Where the solicitor's account is itemised, one reasonable basis for apportionment would be the time spent on the work done that is considered to be deductible relative to the work that is not deductible. If the solicitor's account is not itemised, a possible basis for apportionment would be a reasonable costing of the deductible work undertaken by the solicitor.

Application of law in your case

Your legal expenses listed on invoice A were primarily incurred for the purpose of asset protection. It is expected the CGT advice you received here would be two-fold in nature, namely, the CGT consequences of disposing of your currently held assets and the CGT consequences applicable to a new ownership structure (such as a trust). Although the advice may discuss the CGT consequences of disposing of your currently held assets, we consider this advice is merely incidental to the primary purpose of the advice, namely, asset protection.

Advice on asset protection (for example, protecting assets from creditors or litigants in potential law suits in the future) is not considered to be taxation advice. In any case, even if the advice was considered to relate to taxation, this advice is not in relation to 'your' tax affairs, as the advice relates to another entity, namely, the trust or another future new owner of your currently held assets.

Also, as the expense relate to personal assets, they cannot be deducted under section 40-880 of the ITAA 1997 because the expense is not 'business capital expenditure'.

It follows you cannot claim a deduction under section 25-5 or section 40-880 of the ITAA 1997 for your expenses listed on invoice A.

Your expenses listed on invoice B appear to be for the primary purpose of inquiring into a new business structure, that is, of a company or trust to provide personal services. Although such advice would naturally discuss your current business structure as a sole trader, again, this is merely incidental to the primary purpose of the advice. It follows you cannot claim a deduction for this legal advice under section 25-5 because the advice does not relate to your tax affairs. It is advice that relates to another entity, namely, the new (proposed) business structure.

Further, your expenses listed on invoice B are not an incidental cost of the acquisition of the new business asset for CGT purposes under section 110-25 of the ITAA 1997 because the expenditure was not incurred by the (proposed) new entity.

Also, your expenses listed on invoice B are not deductible over five years under section 40-880 of the ITAA 1997 because you did not satisfy subsection 40-880(7) of the ITAA 1997, which states:

You cannot deduct an amount under paragraph 2(c) in relation to a business proposed to be carried on unless, having regard to any relevant circumstances, it is reasonable to conclude that the business is proposed to be carried on within a reasonable time.

When we questioned you about a proposed business, you did not provide any answers to demonstrate a commitment of some substance to commence the business and you did not provide a sufficient identity about the business that is proposed to be carried on (as stipulated in the Explanatory Memorandum to Tax Laws Amendment (2006 measures No. 1) Bill 2006).

Further, theoretically, if your expenses listed on invoice B were deductible under section 40-880 of the ITAA 1997 (given these expenses are 'business capital expenditure'), the operation of subsection 35-10(2B) of the ITAA 1997 would quarantine the deductions until the income year in which the new business activity starts to be carried on.

However, in your case, it is likely any future new business would not commence 'within a reasonable time', as required by subsection 40-880(7) of the ITAA 1997. Therefore, your capacity to claim a deduction under section 40-880 of the ITAA 1997, in relation to invoice B, has probably been extinguished because you received the advice more than 18 months ago.

Your expenses listed on invoice C in relation to advice received regarding the ability to claim deductions against other income through an investment in units of a newly established trust are deductible under section 25-5 of the ITAA 1997 because they relate to your tax affairs.

However, your expenses listed on invoice C in relation to advice received regarding the establishment of the new structure cannot be deducted under section 25-5 of the ITAA 1997 because they are not related to you; rather they relate to the new entity.

Also, as the expenses relate to an investment property, they cannot be deducted under section 40-880 of the ITAA 1997 because the expense is not 'business capital expenditure'. Your rental property is a passive investment and is not part of a current business nor will it be part of a proposed rental property business. The Tax Office publication Rental properties 2009 (NAT 1729-6.2009) states on page 4:

A person who simply co-owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business, either alone or with the other co-owners. This is because of the limited scope of the rental property activities and the limited degree to which a co-owner actively participates in rental property activities.

Also, your expenses listed on invoice C in relation to advice received regarding the stamp duty implications of a transfer of an investment property are not deductible under section 25-5 of the ITAA 1997 as stamp duty is not income tax.

To conclude, you cannot claim a deduction under section 25-5 or section 40-880 of the ITAA 1997 for any of the legal advice mentioned in this private ruling, apart from a portion of invoice C. This deductible expense should be apportioned on a reasonable basis, following the guidance in TD 93/29.

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