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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your private ruling

Authorisation Number: 1012507977333

Ruling

Subject: bankruptcy issues

Question 1

Are you entitled to claim a deduction under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for interest on a loan for a rental property which neither you nor the trustee in bankruptcy, have paid?

Answer

Yes

Question 2

Will any capital gain on the sale of your investment properties be assessable to you under Part 3-1 of the ITAA 1997 and will you be required to include this gain in your income tax return?

Answer

Yes

Question 3

Are you entitled to a deduction for legal expenses under section 8-1 of the ITAA 1997 incurred in relation to your bankruptcy?

Answer

No

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You own rental properties.

You borrowed money to finance the purchase of the rental properties.

You declared yourself bankrupt and a trustee in bankruptcy was appointed.

The trustee in bankruptcy received rent from the rental properties.

Neither you, nor the Trustee, have paid interest on the investment loans used to finance the rental properties.

You have incurred legal expenses in the process of being discharged as a bankrupt.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 106-30

Income Tax Assessment Act 1997 Subsection 106-30(2)

Reasons for decision

Summary

You are entitled to a deduction for interest on a loan as the interest has been incurred even though it has not been paid. The disposal of an asset by the trustee of a bankrupt estate is considered to be a disposal by the bankrupt individual and therefore assessable to that individual and not the trustee. You are not entitled to a deduction for legal expenses in relation to your bankruptcy as it is private in nature.

Detailed reasoning

Interest Deduction

Subsection 8-1(1) of the ITAA 1997 states you can deduct from your assessable income any loss or outgoing to the extent that:

Taxation Ruling TR 97/7 explains the meaning of 'incurred'. Paragraph 5 states, as a broad guide, that 'you incur an outgoing at the time you owe a present money debt that you cannot escape'. Paragraph 6 provides, in accordance with case law, that:

Whether there is a presently existing pecuniary liability is a question which must be determined in light of the particular facts of each case, and especially by reference to the terms of the contract or arrangement under which the liability is said to arise (Nilsen Development Laboratories; James Flood (1953) 88 CLR 492; Ogilvy and Mather Pty Ltd v. FC of T 90 ATC 4836; 21 ATR 841; and FC of T v. Woolcombers (WA) Pty Ltd 93 ATC 5170).

In your case you own two properties which are being rented out. You declared yourself bankrupt and a trustee in bankruptcy was appointed to look after your financial affairs. Interest on the loans used to finance the properties was not paid by you or the trustee in bankruptcy however the interest expense is a presently existing pecuniary liability, the outgoing is of a revenue nature and all of the loss or outgoing is properly referable to the particular year in question.

Therefore as the expense has been incurred you are entitled to a deduction for the interest on the loan.

Capital Gain

Section 106-30 of the ITAA 1997 advises that the vesting of assets in a trustee under bankruptcy law is ignored for CGT purposes. The effect of this is that the asset is still considered to be owned by the insolvent person, even though the asset is vested in the trustee.

The acts of the trustee in relation to the vested asset are taken to be the bankrupt's acts under subsection 106-30(2) of the ITAA 1997.

When the bankruptcy trustee sells the rental properties CGT event A1 happens (section 104-10 of the ITAA 1997).

Consequently, no disposal takes place on the vesting of the asset to the trustee, but a disposal of the asset by the trustee is considered to be a disposal by the insolvent person.

The liability for CGT on the capital gain on disposal of the investment properties is borne by the insolvent person in the year of income in which the disposal occurred.

In your case any capital gain on the sale of the investment properties is assessable to you and you will be required to include this gain in your income tax return for the relevant year.

Legal Expenses

Subsection 8-1 of the ITAA 1997 states you can deduct from your assessable income any loss or outgoing to the extent that:

Subsection 8-1(2) of the ITAA 1997 states however, you cannot deduct a loss or outgoing under this section to the extent that:

In your case you have incurred legal expenses in the process of being discharged as a bankrupt. The incurring of these expenses is considered private in nature and therefore not deductible under section 8-1 of the ITAA 1997.

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