Edited version of your written advice

Authorisation Number: 1012744876571

Ruling

Subject: Legal expenses and black hole expenditure

Question

Are you entitled to claim legal expenses related to the sale of your business under section 40-880 of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following period

Year ending 30 June 2015

The scheme commenced on

1 July 2014

Relevant facts

You operated a business as a sole trader.

Due to certain issues you were unable to operate the business and stepped aside before the business sold.

A second party took control and purchased the business after paying an initial deposit.

The second party was to pay the balance of the purchase price in instalments but unfortunately these payments were never made.

You commenced legal action. Sometime later the Court action was finalised with the Court ruling that you were entitled to full payment for the business. Prior to the Court ruling the second party abandoned the business, consequently you were left with no recourse to recover the monies owed to you.

You incurred legal expenses in seeking full payment for the business. You have not claimed these expenses against your income.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 8-1(1)

Income Tax Assessment Act 1997 Paragraph 8-1(2)(a)

Income Tax Assessment Act 1997 Section 40-880

Income Tax Assessment Act 1997 Subsection 40-880(5)

Income Tax Assessment Act 1997 Paragraph 40-880(5)(f)

Income Tax Assessment Act 1997 Subsection 110-35(1)

Income Tax Assessment Act 1997 Section 100-20

Income Tax Assessment Act 1997 Subsection 110-35(2)

Reasons for decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent that they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. However, no deduction is allowed to the extent that the losses or outgoings are of a capital, private or domestic nature or are incurred in gaining or producing exempt income.

While the legal expenses were incurred by the taxpayer in connection with their business, legal expenses are often considered by the courts to be capital in nature. In Case AAT Case 5596; AAT Case X3 90 ATC 114; (1989) 21 ATR 3154, two partners operated a business. The partners decided to terminate the business and dispose of the premises. A sale was proceeding until the purchaser withdrew. The partners sought legal advice as to whether they could take action against the purchaser. Senior Member R A Balmford confirmed the Commissioner's submission that the legal expenses were of a capital nature and thus not allowable as a deduction.

In your case the legal expenses you incurred were in relation to the sale of your business and are therefore capital in nature and not deductible under subsection 8-1(1) of the ITAA 1997 because of paragraph 8-1(2)(a) of the ITAA 1997.

Section 40-880 of the ITAA 1997 allows a deduction over 5 years for capital expenditure that is not otherwise deductible and that relates to a business that, was or is proposed to be carried on for a taxable purpose,

Subsection 40-880(5) of the ITAA 1997 in part states you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that it could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event.

Taxation Ruling TR 2011/6 discusses core issues in relation to business related capital expenditure for section 40-880 of the ITAA 1997.

Paragraph 48 states that in most cases, capital proceeds and cost base (or reduced cost base) are taken into account in working out the amount of a capital gain or capital loss from a CGT event. Therefore, capital expenditure which reduces capital proceeds from a CGT event or forms part of the cost base (or reduced cost base) of a CGT asset could be taken into account in working out the amount of a capital gain or capital loss from a CGT event for the purposes of paragraph 40-880(5)(f).

An amount which is capital in nature may be included in the cost base of a CGT asset.

There are five elements of the cost base. The second element is incidental costs.

Subsection 110-35(2) of the ITAA 1997 discusses that there are a number of incidental costs you may have incurred that related to a CGT event. One of those incidental costs is remuneration for the services of a legal adviser.

Section 100-20 discusses what events attract CGT. One of the examples of an event which attract CGT is when you sell a business.

The sale of your business was a CGT event.

After the business was sold the second party failed to pay the balance in instalments after paying the deposit. You incurred legal expenses by using the services of a legal adviser to seek full payment for the business.

As the legal expenses are an incidental cost relating to the services of a legal adviser they form part of the cost base of the business.

As outlined under paragraph 40-880(5)(f) of the ITAA 1997 the legal expenses could be taken into account in working out the amount of a capital gain or capital loss from a CGT event (included in the cost base), therefore the legal expenses are not deductible under section 40-880 of the ITAA 1997.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).