Edited version of your written advice

Authorisation Number: 1012720853378

Ruling

Subject: Blackhole Expenditure

Question 1

Can the Taxpayer claim deductions for the Interim Distribution Costs under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) to the extent that they were incurred in relation to the First and Second Interim Distributions?

Answer:

Yes.

Question 2

Can the Taxpayer claim deductions for the full amount of the Liquidation Decision Costs under section 40-880 of the ITAA 1997?

'Answer:

No.

Question 3

Can the Taxpayer claim deductions for the full amount of the Administrative Liquidation Costs under section 40-880 of the ITAA 1997?

Answer:

No, but the Taxpayer can claim deductions for some of the Administrative Liquidation Costs under section 40-880 of the ITAA 1997.

Question 4

Can the Taxpayer claim deductions for the full amount of the Proper Liquidation Costs under section 40-880 of the ITAA 1997?

Answer:

No.

Question 5

Can the Taxpayer claim deductions for the full amount of the lnterim Distribution Costs under section 40-880 ITAA 1997 to the extent that they were incurred in relation to the Third Interim Distribution?

Answer:

No.

Question 6

Can the Taxpayer claim deductions for the full amount of the Liquidator Remuneration Costs under section 40-880 of the ITAA 1997?

Answer:

No.

Question 7

Can the Taxpayer claim deductions for the full amount of the Costs Recovery Costs under section 40-880 of the ITAA 1997?

Answer:

No.

This ruling applies for the following periods:

Year ended 30 June 2011;

Year ended 30 June 2012;

Year ended 30 June 2013; and

Year ended 30 June 2014

The scheme commences on:

The scheme has commenced

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Background

1. The Taxpayer is a shareholder of a Company (in Liquidation) (the Company) and currently holds ordinary shares in the Company in Liquidation (Shares).

2. The Taxpayer is also one of two directors of the Company. The other director of the Company in Liquidation is X.

3. The Taxpayer alleged, from time to time, that X breached their duties as director of the Company (Dispute) and that the Company suffered a loss as result of that breach (Causes of Action).

4. The Company was subsequently placed into liquidation ("Liquidation") and a liquidator was appointed (Liquidator).

5. The Taxpayer engaged a legal firm (the Law Firm) to act as legal counsel in relation to the Liquidation, and to advise on certain matters preliminary to the Liquidation. That engagement commenced in 20XX. It is noted that the Law Firm has also previously acted for the Taxpayer in relation to other matters.

6. The legal services provided by the Law Firm to the Taxpayer (Services) in relation to the Liquidation are summarised and classified in your ruling application into the following categories:

(a) providing legal advice to the Taxpayer relating to the decision to put the Company into liquidation ("Liquidation Decision Costs"). This includes:

i) meetings and telephone calls with the Taxpayer to discuss the options available to the Taxpayer in relation to the Company, including alternatives to placing the Company into liquidation;

ii) meetings and telephone calls with the Taxpayer to discuss the consequences of putting the Company into liquidation;

(b) preparing Court documents for, providing legal advice and other work in relation to conducting, the Liquidation of the Company (together, "Administrative Liquidation Costs"). This includes:

i) preparing Court documents required to obtain a winding up order from the Court;

ii) briefing Counsel in relation to the Court proceedings to obtain the winding up order;

iii) attending the hearing of the winding up application;

iv) meetings, telephone calls and emails with the Taxpayer;

v) reviewing and preparing correspondence to the Liquidator's legal counsel in relation to the conduct of the Liquidation, including concerns in relation to the way in which the Liquidator was handling the sale of the Company's assets; and

vi) providing advice to the Taxpayer in relation to the conduct of the Liquidation;

(c) provision of legal advice and the preparation of Court and other documents in relation to ensuring the proper administration of the Liquidation. More specifically, causing the Liquidator to deal with the assets of the Company as part of the Liquidation process (together, the "Proper Liquidation Costs"). This includes:

i) preparing correspondence to the Liquidator to:

(A) ensure that the Liquidator had sufficient information to identify all of the assets of the Company (for example, information regarding X's conduct as director to enable the Liquidator to assess whether the Causes of Action was an asset that should be given due consideration in the Liquidation process); and

(B) inform the Liquidator of the Taxpayer's concern in relation to how the Liquidator was dealing with those assets identified (for example, submitting proposals in relation to the Causes of Action (under which the Liquidator would assign claims including the Causes of Action to the Taxpayer for a fee to be negotiated ("Proposals")) to enable and ensure that the Liquidator realised value from all assets of the Company during the Liquidation process. This also included responding to the Liquidator's counterproposal under which the Liquidator considered it more appropriate to deal with the Causes of Action by assigning them to the Taxpayer on terms that no fee be paid for the assignment, but that the Taxpayer would undertake to provide half of any proceeds to another shareholder and X);

ii) advising the Taxpayer, appearing in Court, instructing Counsel and preparing submissions in response to the Liquidator seeking judicial directions on what the Liquidator should do in respect of the Causes of Action to ensure the proper Liquidation of the Company;

iii) advising the Taxpayer and providing legal services in relation to preparing the Taxpayer's response to the Liquidator's decision to deal with the Causes of Action during the Liquidation process by way of a competitive tender process ("Tender Process") in response to the judicial direction; and

iv) appearing in Court and preparing submissions in response to another shareholder applying to the Supreme Court to injunct the Tender Process and to review the Liquidator's decision to conduct the Tender Process;

(d) provision of legal advice and the preparation of documents (including Court documents) in relation to what should be the appropriate interim distributions made by the Company during Liquidation (the "lnterim Distribution Costs"). This includes:

i) preparing letters to the Liquidator's legal counsel to request that interim distributions be made during the Liquidation process;

ii) reviewing and preparing Court documents in relation to a Court application to compel the Liquidator to make an interim distribution; and

iii) appearing in Court and briefing Counsel in relation to the Court applications regarding interim distributions;

(e) preparing applications in relation to the Liquidator's remuneration (Liquidator Remuneration Costs). This includes:

i) reviewing the Liquidator's remuneration applications;

ii) preparing objections to the Liquidator's remuneration applications;

iii) attending Court and instructing Counsel in relation to the applications;

iv) reviewing and preparing correspondence to the Liquidator's legal counsel in relation to the remuneration approval process; and

v) advising the Taxpayer in relation to this process;

(f) work relating to recovering costs incurred by the Taxpayer in relation to an application to place the Company into liquidation and to recover costs ordered to be paid by X and a further shareholder in relation to the application referred above (together, Costs Recovery Costs). This includes:

i) engaging a costs consultant to prepare a bill of costs;

ii) preparing an application for the assessment of party/party costs;

iii) reviewing and preparing correspondence in relation to the Liquidator's legal counsel in relation to the assessment process;

iv) reviewing and preparing correspondence to X and a further shareholder's legal counsel in relation to the assessment process and the recovery of costs; and

v) providing advice to the Taxpayer in relation to the above.

7. The first two interim distributions (First and Second Interim Distributions) received by the Taxpayer were treated as dividends of SCW and included in the Taxpayer's income tax return as assessable income for the year ended 30 June 20YY.

8. The date of the first interim distribution in 20XX, of which the Taxpayer received a fully franked cash distribution;

9. The date of the second interim distribution was in 20YY, of which the taxpayer received a fully franked cash distribution

10. The date of the third interim distribution (Third Interim Distribution) was in 20ZZ at which time the Taxpayer received a Share Capital Return;

11. The Third Interim Distribution was a distribution of share capital and therefore was not deemed under section 47(1) of the ITAA 1936.

It is intended that the Company will be deregistered. Once the Liquidation is finalised, the shares will become worthless. The Company's only remaining asset is cash at bank and the only liability is the Liquidator's fees

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Section 102-23

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-135

Income Tax Assessment Act 1997 Section 104-145

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1936 Section 47

Corporations Act 2001 Section 501

Corporations Act 2001 Section 509

ATO view documents

ATO Interpretative Decision 2006/179

Taxation Determination TD 95/10 Income Tax: what is the significance of the Archer Brothers principle in the context of liquidation distributions?

Taxation Determination TD 2000/7 Income Tax: capital gains: when does a CGT even happen to shares in a company, for the purposes of Part 3-1 and Part 3-3 of the Income Tax Assessment Act 1997, if the company is deregistered under the Corporations Law?

Taxation Determination TD 2001/27 Income Tax: capital gains: how do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 ('ITAA 1997') treat:

(a) a final liquidation distribution, including where all or part of it is deemed by section 47(1) of the Income Tax Assessment Act 1936 ('ITAA 1936') to be a dividend; and

(b) an interim liquidation distribution to the extent it is not deemed to be a dividend by subsection 47(1)?

Taxation Ruling TR 95/35: capital gains: treatment of compensation receipts.

Draft Taxation Determination TD 2007/D5 Income tax: consolidation: does the single entity rule in section 701-1 of the Income Tax Assessment Act 1997 apply in determining whether distributions by the liquidator of a head company represent 'income derived' by the head company for the purposes of section 47 of the Income Tax Assessment Act 1936?

Taxation Ruling TR 2011/6 Income Tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997

Taxation Ruling 2012/8 Income tax and fringe benefits tax: assessability of amounts received to reimburse legal costs incurred in disputes concerning termination of employment

Other references (non ATO view)

IRC v Burrell [1924] 2 KB 52

Commissioner of Taxation (NSW) v Stevenson (1937) 59 CLR 80

Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the Taxpayer

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

Yes, the Taxpayer can claim deductions for the Interim Distribution Costs under section 8-1 of the ITAA 1997 to the extent that they were incurred in relation to the First and Second Interim Distributions made by the Liquidator for the year ended 30 June 20YY.

Detailed reasoning

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

(a) It is incurred in gaining or producing your assessable income; or

(b) It is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

This is qualified by subsection 8-1(2) which states

However you cannot deduct a loss or outgoing under this section to the extent that:

(a) It is a loss or outgoing of capital, or of a capital nature; …

The Taxpayer has incurred legal expenses in gaining or producing their assessable income. The issue is to what extent such outgoings are of capital or a capital nature.

It has been submitted that the Taxpayer, as a shareholder of the Company, has derived assessable income from the Company's business, both prior to and during the Liquidation, in the form of dividends. Accordingly, it has been submitted that the costs in each category should be considered to have a connection with the Taxpayer deriving assessable income from the Company's business of a revenue nature because they relate to the Taxpayer's entitlement to a share in the profits from the Company's business. This is consistent with Taxation Ruling TR 2012/8, which provides at paragraph 38 that:

Legal costs take their quality as an outgoing of capital or revenue nature from the cause or purpose of incurring the expenditure. If the advantage to be gained is of a revenue nature, then the costs incurred in gaining the advantage will also be of a revenue nature.

Distributions made by liquidators will, under general law, be capital in the hands of shareholders. This is the case, whether or not it encompasses amounts that were income in the hands of the company (see for example Inland Revenue Commissioners v Burrell [1924] 2 KB 52 (Burrell) or Commissioner of Taxation (NSW) v Stevenson (1937) 59 CLR 80 (Stevenson).

However, subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) provides:

Distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

Critically, the Commissioner's view at paragraph 17 of Draft Taxation Determination TD 2007/D5 provides that:

The effect of section 47 is to treat certain distributions by a liquidator as dividends paid out of profits when they otherwise would have been treated as capital. (emphasis added).

Therefore, based on the Commissioner's view in Draft Taxation Ruling TR 2007/D5, section 47 deems distributions by liquidators to be dividends paid out of profits. Furthermore, it is accepted that the Archer Brothers principle in Archer Bros Pty Ltd (In Vol Liq) v. FCT (1952-53) 90 CLR 140 at 155, and as explained in Taxation Determination TD 95/10, applies such that the character of the distribution for the purposes of section 47 has already been determined by the liquidator who has not made the first two interim distributions a return of capital.

It is accepted, consistent with Taxation Ruling TR 2012/8, that as the advantage to be gained is of a revenue nature, then the costs incurred in gaining the advantage will also be of a revenue nature. Accordingly, the legal costs, to the extent that they have been incurred in respect of the first two interim distributions are deductible under section 8-1.

Question 2

Summary

No, the Taxpayer cannot claim deductions for the full amount of the Liquidation Decision Costs under section 40-880 of the ITAA 1997.

Detailed reasoning

The deduction under subsection 40-880(2)

Capital expenditure incurred to liquidate or deregister a company is specifically dealt with by paragraph 40-880(2)(d) of the ITAA 1997 . Essentially:

You can deduct, in equal proportions over a period of 5 income years starting in the year in which you incur it, capital expenditure you incur:

(a) in relation to your business; or

(b) in relation to a business that used to be carried on; or

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

(c) 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. (emphasis added).

It should be noted that whereas paragraphs 40-880(2)(a) to 40-880(2)(c) use the expression 'in relation to' to link the expenditure to the business, paragraph 40-880(2)(d) uses the preposition 'to' as the connector. Accordingly, the Commissioner's view in Taxation Ruling TR 2011/6 that '[t]o come within the scope of this paragraph, the expenditure must be meant directly to initiate or advance the process of bringing to an end, the structure (i.e: the company) through which the business is or was carried on.

Whilst the Taxpayer has asserted that the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 1) Bill 2006 (Explanatory Memorandum) is silent as to whether the expenditure must be connected with the actual liquidation of the company, instead emphasising that the expenditure must be incurred during the close down (or liquidation) of the company, this silence is not particularly instructive. It is clear from TR 2011/6 that the expenditure requires a link that bears a causal nexus to the liquidation or deregistration. Indeed, the ordinary meaning of the legislation contained in paragraph 40-880(2)(d) makes the requirement of a causal nexus abundantly clear. The absence of the words 'in relation to', in the context of liquidation or deregistration of the company, clearly indicate that the expenditure incurred to liquidate or deregister the company must not be expenditure merely in relation to the liquidation process, but must be expenditure incurred to liquidate or deregister the company, in other words 'to initiate or advance the process of bringing to an end, the structure through which the business is or was carried on.'

TR 2011/6 is specific and instructive as to the type of costs contemplated by paragraph 40-880(2)(d). These are specifically those costs 'directly referable to the liquidation of a company … for example, the legal and administrative costs of the winding up application and any government fees or charges for deregistration' (paragraph 132 of TR 2011/6).Accordingly, it is evident that fees in the nature of advice could not be within the contemplation of paragraph 40-880(2)(d).

The Taxpayer contends that the Liquidation Decision Costs are advisory in nature and include 'meetings and telephone calls with the Taxpayer to discuss the options available to the Taxpayer in relation to the Company, including alternatives to placing the Company into liquidation.' Further, the Taxpayer concedes that the Liquidation Decision Costs 'relate to legal costs incurred by the Taxpayer to discuss the Taxpayer's right to put, and the consequences of putting, the Company into liquidation and the alternatives available to the Taxpayer.'

We consider that such legal costs are too remote in nature and are not directly referable to the liquidation of the Company itself. The expenditure is incurred prior to making a final decision to liquidate the Company. If the expenditure related to a decision to liquidate that had already been made, discussion of the taxpayer's right to put and the alternatives to liquidation available to the Company would be unnecessary. Accordingly, it is considered that the expenditure incurred by the Taxpayer is prior to making the decision to liquidate or wind up the Company.

Even if this were not the case, it is clear that the expenses incurred would be 'in relation to' the liquidation, rather than be incurred directly to initiate or advance the actual process of bringing the Company to an end as is required by paragraph 40-880(2)(d) and explained in paragraph 131 of TR 2011/6.

The exclusion in paragraph 40-880(5)(f)

Alternatively, even if the Taxpayer's contentions that the Liquidation Decision Costs relate entirely to the Liquidation Process are accepted, paragraph 40-880(5)(f) excludes deduction of these costs as they could, apart from this section be taken into account in working out the amount of a capital gain or a capital loss from a CGT Event.

Contrary to the Taxpayer's submission that the costs should not be included in the second element of the cost base of the shares, because the costs do not relate to a particular CGT event, it is evident that the Liquidation Decision Costs relate to two possible CGT events.

The Cost Base rules provide that included in the second element of the cost base are incidental costs (subsection 110-25(3)).

The Cost base rules further provide that incidental costs include costs that you may have incurred that relate to a CGT event (paragraph 110-35(1)(b) of the ITAA 1997) (emphasis added). The connector 'relate to' used above is highly significant, because it indicates that the incidental costs need only to relate to a CGT Event, rather than be incurred to acquire a CGT Asset, as is required by the first limb of sub-section 110-35(1).

The relevant incidental costs would be the fees for remuneration of a legal adviser (subsection 110-35(2)).

As indicated in the Taxpayer's submission, as paragraph 40-880(5)(f) uses the world 'could', it is irrelevant whether the CGT event has, in fact been taken into account, but rather, whether it could be taken into account.

Two CGT events could happen in the current circumstances, namely CGT Event C2 and CGT Event G3 and the Liquidation Decision Costs paid to the legal adviser relate to either event.

CGT Event C2

Paragraph 104-20(1)(a) provides that CGT event C2 happens if your ownership of an intangible asset ends by the asset being redeemed or cancelled. Taxation Determination TD 2000/7 provides that a CGT event happens when a company is deregistered in accordance with the Corporations Law (i.e.: the Corporations Act 2001). This is because a company ceases to exist upon deregistration. The Taxpayer has advised that the Company will be deregistered. Accordingly, it is clear that CGT Event C2 could happen, and in fact will happen, in relation to the shares.

The Taxpayer has asserted that neither the placing of an entity into liquidation, nor the liquidation process by itself (as opposed to the ending of the shares) is a CGT event. The Commissioner rejects this contention. Liquidation and Deregistration are inextricably linked by the totality of the winding up process. Essentially liquidation cannot be viewed in isolation from deregistration, and vice versa. Indeed, liquidation is an indispensable condition without which deregistration cannot occur.

Taxation Determination TD 2007 provides (at paragraph 4) the following:

If a company is wound up voluntarily, it is deregistered three months after the liquidator lodges a return of the holding of the final meeting of members or of members and creditors (subsection 509(5) of the C[orporations] Law) or on such other date as a Court, by order specifies (subsection 509(5) of the C Law. A CGT Event (usually CGT Event C2 in section 104-25 of the 1997 Act) happens to the members' shares … either 3 months after the return is lodged or on the date specified in the Court order, subsection 509(5) and (6).

The Corporations Act 2001 provide the critical link between liquidation and deregistration such that both events can be viewed as substantially relating to the one CGT Event C2. Subsections 509(3) and (5) of the Corporations Act 2001, when read together support the view that liquidation and deregistration essentially relate to the same CGT Event.

Subsection 509(3) of the Corporation Act 2001 provides:

The liquidator must, within 7 days after the meeting, lodge a return of the holding of the meeting and of its date with a copy of the account [showing how the winding up has been conducted and the property of the company has been disposed of] attached to the return;

whilst subsection 509(5) of the Corporations Act 2001 provides:

ASIC must deregister the company at the end of the 3 month period after the return was lodged.

The statutory requirement imposed by the Corporations Act 2001 on the liquidator to lodge the abovementioned return to ASIC, coupled with the legislative requirement by ASIC to deregister the company at the end of 3 months after the liquidator's return is lodged together indicated that there is little practical distinction between liquidation and deregistration. In any event, it clear that liquidation, at the very least, relates to deregistration such that any legal costs relating to the liquidation relate to the ending of the shares in the Company, in other words, CGT Event C2.

The fact that liquidation and deregistration should properly be considered to be a fused expression encompassing the entirety of the winding up process is further supported by the context of the wording of paragraph 40-880(2)(d) itself, which provides that you can deduct capital expenditure you incur:

(d) 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 (emphasis added).

The fact that the wording "wind up" has been used in relation to the ending of the partnership and the trust would also indicate that liquidation and deregistration are used together to connote the ending of a company - or specifically, shares in the company - further indicating that liquidating does indeed relate to ending of the company shares.

Therefore, we consider that, consistent with the view in TR 2011/6, the costs pertaining specifically to advance the liquidation process and the deregistration process are deductible under section 40-880. Conversely those costs which are merely incidental to or relating to either process should properly be considered to relate to a CGT Event, being CGT Event C2. The Liquidation Decision Costs are considered incidental to or otherwise relating to the ending of the shares in the Company and therefore cannot be deducted under section 40-880.

CGT Event G3

Another CGT event that could apply to the current circumstances is CGT Event G3. Section 104-145 of the ITAA 1997 relevantly provides that CGT Event G3:

'happens if you own shares in a company … and a liquidator or administrator of the company declares in writing that the liquidator or administrator has reasonable grounds to believe (at the time of the declaration) that … there is no likelihood that shareholders in the company … will receive any further distributions of shares'.

The Taxpayer, by letter dated dd/mm/yyyy, has provided that '…once the liquidation is finalised, the shares will become worthless at that time.'

Accordingly, there is a possibility that the liquidator could make a declaration that the shares in the Company are worthless after the finalisation of the liquidation. Indeed TD 2000/7 provides at Note 1 in paragraph 7 that CGT event G3 provides a mechanism for a shareholder to make a capital loss on worthless shares before the time of deregistration of a company. It is irrelevant whether this declaration is made by the liquidator or not. All that is necessary is that there exists a possibility that this declaration could be made, and therefore the Liquidation Decision Costs, could be taken into account in determining the extent of the capital loss from a CGT Event, this being CGT Event G3.

Question 3

Summary

No, The Taxpayer cannot claim deductions for the full amount of the Administrative Liquidation Costs under section 40-880 of the ITAA 1997, but the Taxpayer can claim deductions for some of the Administrative Liquidation Costs under section 40-880 of the ITAA 1997.

Detailed reasoning

Various costs (Administrative Liquidation Costs) were incurred in relation to the preparation of Court Documents for providing legal advice and other work in relation to conducting the Liquidation of the Company. Specifically, these costs include:

(i) preparing Court documents required to obtain a winding up order;

(ii) briefing Counsel in relation to the Court Proceedings to obtain the winding up order;

(iii) attending the hearing of the winding up application;

(iv) meetings, telephone calls and emails with the Taxpayer;

(v) Reviewing and preparing correspondence to the Liquidator's legal counsel in relation to the conduct of the Liquidation, including concerns in relation to the way in which the Liquidator was handling the sale of the Company's assets; and

(vi) Preparing advice to the Taxpayer in relation to the conduct of the liquidation.

The Taxpayer submits that there is a clear nexus between these costs and the Liquidation. The Commissioner agrees with this contention in relation to paragraphs (i) to (iv) listed above. TR 2011/6 specifically provides that to come within the scope of paragraph 40-880(2)(d), the expenditure must be meant directly to initiate or advance the process of bringing to an end, the structure through which the business was or is carried on. Paragraph 132 of TR 2011/6 prescribes that 'the legal and administrative costs of the winding up application' would be examples of such expenses. We agree that the expenses listed at paragraphs (i) to (iv) above have been incurred directly to initiate or advance the process of bringing the Company to an end.

However, our view that attributing costs in relation to reviewing and preparing correspondence regarding the way in which the Liquidator is handling the sale of the Company's assets are ancillary to the process of bringing the Company to an end. Such costs refer to the manner in which the liquidation is conducted, rather than the matter of the liquidation itself. The cost incurred in how the liquidation is conducted is not seen as costs to advance or initiate the liquidation itself, and therefore cannot be deducted under paragraph 40-880(2)(d).

The importance of the connector 'to liquidate', as opposed to 'in relation to' has been emphasised by paragraph 131 of Taxation Ruling 2011/6.

The description provided under paragraphs (v) and (vi) above, namely:

(v) Reviewing and preparing correspondence to the Liquidator's legal counsel in relation to the conduct of the Liquidation, including concerns in relation to the way in which the Liquidator was handling the sale of the Company's assets; and

(vi) Preparing advice to the Taxpayer in relation to the conduct of the liquidation (emphasis added)

suggests that these costs incurred are in relation to the liquidation rather than to liquidate or deregister the Company is as required by paragraph 40-880(2)(d).

It is also submitted that such costs - on the basis of the connector used - relate to a CGT event, namely CGT Event C2 or CGT Event G3, and could therefore be taken into account in working out the capital gain or capital loss from a CGT Event.

Accordingly, the costs described at paragraphs (i) to (iv) above are deductible under paragraph 40-880(2)(d), but paragraphs (v) and (vi) would not be so deductible.

Question 4

Summary

No, the Taxpayer cannot claim deductions for the full amount of the Proper Liquidation Costs under section 40-880 of the ITAA.

Detailed reasoning

The Proper Liquidation Costs relate to legal costs incurred by the Taxpayer in response to his concern with the way the Liquidator was dealing with the assets of the Company during the liquidation process. The costs were in respect of legal work performed by the Law Firm:

(i) In preparing correspondence to ensure that the Liquidator had sufficient information to identify all of the assets of the Company

(ii) Inform the Liquidator of the Taxpayer's concern in relation to how the Liquidator was

(iii) dealing with those assets identified to enable and ensure that the Liquidator realised value from all assets of the Company during the Liquidation process;

(iv) Advising the Taxpayer, appearing in Court, instructing Counsel and preparing submission

(v) in response to the Liquidator seeking judicial directions on what the Liquidator should do in respect of an alleged breach of director's duties for which the Company suffered loss;

(vi) Advising the taxpayer and providing legal services in relation to preparing the taxpayer's response to the Liquidator's decision to deal with the alleged breach of director's duties by way of a competitive tender process (Tender Process); and

(vii) Appearing in Court and preparing submissions in response to an additional shareholder applying to the Supreme Court to injunct the Tender Process and to review the Liquidator's decision to conduct the Tender Process.

It is considered that the abovementioned expenses are too remote from the type of expenses that paragraph 40-880(2)(d) were intended to cover. For expenses to be deducted under this paragraph, TD 2011/6 clearly clarifies that the expenditure must be meant directly to initiate or advance the process of bringing the Company to an end. It may be argued that incurring the above expenses has an identity with the overall winding up process of the Company. However, advancing the winding up of the Company is not the primary purpose for which the above expenses have been incurred. Indeed the effect of incurring the above expenses, if anything, delays the winding up of the Company (albeit unintentionally). The expenses incurred have, as a primary goal ensuring the optimal commercial outcome in relation to the liquidation of the Company, but they cannot be regarded as initiating or advancing the administrative or legal process of bringing the Company to an end.

In any event, such costs could be taken into account in working out the capital gain or capital loss from a CGT Event, namely CGT Event C2 or CGT Event G3. Accordingly, even if these costs were considered to be deductible under paragraph 40-880(2)(d), they would be precluded under paragraph 40-880(5)(f).

Question 5

Summary

No, the Taxpayer cannot claim deductions for the full amount of the lnterim Distribution Costs under section 40-880 ITAA 1997 to the extent that they were incurred in relation to the Third Interim Distribution.

Detailed reasoning

The Taxpayer has submitted that the Interim Distribution Costs relate to legal costs incurred by the Taxpayer to request the Liquidator to make interim distributions during the liquidation process. The Taxpayer submitted that such costs also relate to the proper administration of the Liquidation of the Company, as they ensured that the Liquidator made appropriate distributions to the shareholders of the Company during the Liquidation process.

The Third Interim Distribution was a distribution of share capital, and as such, not a deemed dividend under subsection 47(1) of the ITAA 1936.

Taxation Determination TD 2001/27 directly addresses the question of the Capital Gains Tax implications of an interim liquidation distribution to the extent it is not deemed to be a dividend by subsection 47(1) of the ITAA 1936.

Given that the Taxpayer has advised that the Third Interim Distribution was a distribution of share capital, and therefore not deemed dividend under subsection 47(1), we consider that the legal expenses could be taken into account in working out the amount of a capital gain or capital loss from a CGT Event. This precludes the operation of section 40-880, based on paragraph 40-880(5)(f), to the extent that the legal expenses could be taken into account in calculating the capital gain or capital loss from the CGT Event(s). The relevant CGT Events which could happen are either CGT Event G1 (about capital payments for shares) or CGT Event C2 (about ending of shares).

CGT Events G1 or C2

CGT Event G1 (about capital payment for shares) is described in subsection 104-135(1) of the ITAA 1997,

A CGT Event G1 happens if:

(a) company makes a payment to you in respect of a share you own in the company (except for CGT event A1 or C2 happening in the share); and

(b) some or all of the payment is not a dividend under section 47 of the ITAA 1997; and the payment is not included in your assessable income.

Therefore, the capital gain can only happen to the extent that the Third Interim Distribution is not an amount deemed to be a dividend under subsection 47(1) of the ITAA 1936 and the payment is not returned as assessable income. On the information provided by the Taxpayer, the Third Interim Distribution is neither deemed to be a dividend, nor will it be returned as assessable income.

Based on subsection 104-135(6), an exception for CGT event G1 happening is if the Company ceases to exist within 18 months of the payment being made. We note the payment was made on dd/mm/yyyy. Accordingly, if the Company ceased to exist on or before 12 September 2015, then CGT Event G1 would not happen. In such a situation, CGT Event C2, relating to the ending of shares, would happen.

In either situation, it is clear that the Interim Distribution Costs in relation to the Third Interim Distribution could be taken into account in working out the capital gain or capital loss from a CGT Event (being either CGT Event G1 or C2). It is clear in that Third Interim Distribution Costs are incidental costs (as described by paragraph 110-35(1)(b)), being remuneration to a legal adviser incurred that relate to a CGT Event. Critically, all that is necessary is that the remuneration paid to the Law Firm relates to a CGT Event. In this case, the remuneration paid to the Law Firm must relate to either one of two CGT Events happening.

Question 6

Summary

No, the Taxpayer cannot claim deductions for the full amount of the Liquidator Remuneration Costs under section 40-880 of the ITAA 1997.

Detailed reasoning

Various legal costs were incurred in reviewing and preparing objections to the Liquidator's remuneration applications. The Taxpayer submitted that these costs relate to the proper administration of the Liquidation as they ensured that the remuneration received by the Liquidator for the work performed was appropriate and are accordingly deductible under section 40-880.

Consistent with the line of reasoning provided for Question 2 and Question 3, we consider that the costs incurred are too remote to fall within the scope of costs that paragraph 40-880(2)(d) were intended to cover. As noted in TR 2011/6, to come within the scope of this paragraph, 'expenditure must be mean directly to initiate or advance the process of bringing to an end the structure through which the business is or was carried on.' It cannot be argued that the costs incurred in reviewing and prepared objections to the Liquidator's remuneration applications either directly initiate or advance the process of winding up the Company.

Further, or in the alternative, the Liquidator Remuneration Costs could be taken into account in working out the amount of a capital gain or capital loss from a CGT Event. Our view is that that CGT Event C2 could apply in respect of the shares in the Company.

This being the case, the Liquidator Remuneration Costs could be included in working out the capital gain or capital loss from CGT Event C2.

Although the Taxpayer has argued that 'neither the placing of an entity into liquidation, nor the liquidation process by itself (as opposed to the ending of the Shares), is a CGT Event', the Commissioner's view in TD 2000/7 is that liquidation, whether voluntary or involuntary, is the necessary step in the deregistration (and therefore ending) of an entity.

In a voluntary liquidation, CGT Event C2 occurs when ASIC determines to deregister a company upon expiration of the appropriate period. Specifically, TD 2000/7 provides that the deregistration in a voluntary liquidation is conducted by ASIC under subsection 601AA(4) of the Corporations Act 2001 two months after publication of notice of an application to deregister a company under subsection 601AA(1) of the Corporations Act 2001. At this time, for the purposes of paragraph 104-25(3)(b) of the ITAA 1997, a final distribution will be treated as the capital proceeds which a taxpayer receives from the ending of an intangible CGT Asset, being the shares which end, when the intangible chose is 'released, discharged or satisfied' by the shareholder in accordance with the requirements of CGT Event C2.

Critically, for present purposes, according to the Commissioner's view as stated in paragraph 1 of Taxation Determination TD 2001/27:

[t]he full amount of a final distribution made by a liquidator on the winding-up of a company constitutes capital proceeds from the ending of the shareholder's shares in the company for the purposes of capital gains or capital losses made on the happening of CGT event C2 (about cancellation, surrender and similar endings) in section 104-25 of the ITAA 1997.

As the Liquidator Remuneration Costs are being incurred to ensure that the remuneration received by the Liquidator is appropriate, the amount of costs paid to the Liquidator have a direct bearing on the amount of the capital proceeds received in respect of CGT Event C2 (being the amount of the final distribution received by the Taxpayer). Specifically the Liquidator Remuneration Costs paid to the Law Firm are aimed at reducing the costs payable to the Liquidator and therefore maximising the final distribution received in the event of CGT Event C2 happening.

The second element of the cost base and reduced cost base each comprise of incidental costs an entity incurs to acquire a CGT Asset or that 'relate to a CGT event' (subsection 110-35(1) of the ITAA 1997). The term 'incidental costs' includes 'remuneration for the services of a … legal adviser (subsection 110-35(2) of the ITAA 1997).

It follows that this remuneration paid to the Law Firm would have a direct correlation with the ascertainment of the amount of capital proceeds (being the amount of the final distribution) from CGT event C2 and is therefore an incidental cost that relates to the CGT Event, which is included in the second element of the shares in the Company's cost base. This was the process followed in determining whether remuneration paid to legal advisors is included in the cost base in ATO Interpretative Decision 2006/179. Accordingly, this precludes deduction of the remuneration paid to the Law Firm under section 40-880 of the ITAA 1997 in respect of the Liquidator Remuneration Costs.

Question 7

Summary

No, the Taxpayer cannot claim deductions for the full amount of the Costs Recovery Costs under section 40-880 of the ITAA 1997.

Detailed reasoning

Various costs were incurred by the Taxpayer to recover costs in relation to an application to place the Company into liquidation and to recover costs ordered to be paid by X and an additional shareholder. The legal costs were specifically incurred to obtain advice and prepare documents to respond to objections made by X to a competitive tender process (Tender Process) in which the Liquidator sought legal services in relation to certain causes of action (Causes of Action) against them for alleged breach of directors duties, for which the taxpayer suffered loss. The following together constitute the Costs Recovery Costs:

(i) Engaging a costs consultant to prepare a bill of costs;

(ii) Preparing an application for the assessment of party-party costs;

(iii) Reviewing and preparing correspondence in relation to the Liquidator's legal counsel in relation to the assessment process;

(iv) Reviewing and preparing correspondence to X and the additional shareholder's legal counsel in relation to the assessment process and the recovery of the costs; and

(v) Providing advice to the Taxpayer in relation to each of the above.

As discussed in Question 2 above, the Commissioner's view in TR 2011/6 relating to the scope of paragraph 40-880(2)(d) is the following:

Unlike paragraphs 40-880(2)(a) to 40-880(c) which uses the expression 'in relation to' to link the expenditure to the business, paragraph 40-880(2)(d) uses the expression 'to' as the connector. To come within the scope of this paragraph, the expenditure must be meant directly to initiate or advance the process of bring to an end, the structure through which the business is or was carried on. (Paragraph 131 of TR 2011/6.)

It is considered that costs incurred to recover costs properly payable by X and the additional shareholder may have be incurred in relation to the liquidation, but cannot be said to have been incurred by the Taxpayer to liquidate or deregister the company. Instead, critically, the costs have been incurred to seek recovery for costs incurred to liquidate the Company and to seek recovery of various other legal costs incurred in relation to the Tender Process for the Causes of Action.

Even if an argument were established that these costs were incurred directly to liquidate the Company, which we do not accept, it is clear that these costs would be precluded from deduction under 40-880 under paragraph 40-880(5)(f). That paragraph provides that you cannot deduction anything under 40-880 for an amount of expenditure you incur to the extent that it could be taken into account in working out the amount of a capital gain or a capital loss from a CGT Event (emphasis added).

Taxation Ruling TR 95/35 deals with the capital gains treatment of compensation receipts. The ruling advocates a 'look-through' approach, which identifies the most relevant asset to which the compensation amount is most directly related. Paragraph 11 of TR 95/35 states that if an amount is not received in respect of an underlying asset, the amount relates to the disposal by the taxpayer of the right to seek compensation.

As the amount received by the taxpayer is not in respect of any underlying asset, the whole of the settlement amount is treated as capital proceeds from a CGT event (CGT event C2) happening to the taxpayer's right to seek compensation. The cost base of the right to seek compensation is determined in accordance with the provisions sections 110-25 and 110-35 of the ITAA 1997.

The consideration in respect of the acquisition of the right to seek compensation, for the purposes of paragraph 110-25(2)(a), includes the money paid as a result of acquiring the right to seek compensation as a first element of cost base. Alternatively, the legal costs incurred to acquire the right to seek compensation could be captured as an incidental cost, the first of which includes remuneration for the services of a legal adviser. In any event, the cost base would comprise of the costs incurred for the liquidation and the legal costs incurred to contest the objections raised by X. If recovery actions were completely successful, the proceeds received would include both the liquidation costs and recovered legal fees, the receipt of which would cancel out the cost base, leaving no capital gain or loss.

These costs either have been incurred by the taxpayer to acquire the right to seek compensation as required by paragraph 110-35(1)(a) or that relate to a CGT Event as required under paragraph 110-35(1)(b).

As stated before, it is not necessary that a CGT event actually occurs. All that it necessary is the expenditure could be taken into account in working out the amount of a capital gain or a capital loss from a CGT Event. It should be noted that even if there is not capital gain or capital loss, section 102-23 still provides that a CGT event still happens. In the current situation, not only could CGT Event C2 happen, however it is likely to happen or already have happened.

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