Edited version of your written advice

Authorisation Number: 1051369196715

Date of advice: 11 May 2018

Ruling

Subject: CGT rollover- compulsory acquisition

Question 1

Will the disposal of the units be treated as a compulsory acquisition under section 124-70 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If the answer to Question 1 is no, is there another provision within the ITAA 1997 that allows for the gain to be rolled over where a replacement asset is acquired?

Answer

N/A

Question 3

If the answer to Question 1 or 2 is yes, can the taxpayer use the total combined proceeds from the units and acquire a single replacement asset (similar asset)?

Answer

Yes

Question 4

Can the costs associated with engaging lawyers to object to the acquisition (barrister and legal fees) be deductible under section 8-1 of the ITAA 1997?

Answer

No

Question 5

If the answer to Question 4 is no, are the costs added to the cost base of the units that were ultimately sold per section 110-25 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You are the sole owner of a number of investment units.

All the units were purchased post 1985.

The Strata Schemes Development Act 2015 (the Act) introduces a process whereby 75% of lot owners in a freehold strata scheme can agree to end their strata scheme, so the site can be redeveloped or sold.

Part 10 of the Act contains the provision that results in minority unit holders being compulsorily acquired under a strata renewal plan.

In XX/201X the lot owners requested an expression of interest regard a collective sale.

In XX/201X you confirmed that you were not interested in the collective sale.

By XX/201X, more than 75% of the lot owners had voted in favour of the collective sale expression of interest.

To start the process, any person may give a strata renewal proposal to an owner’s corporation suggesting a redevelopment or collective sale opportunity.

After the owner’s corporation receives a strata renewal proposal, the strata scheme committee must consider the proposal at a committee meeting.

If the strata committee decides that the strata renewal proposal warrants further consideration, a general meeting of the owner’s corporation must be convened.

If the strata renewal proposal gains at least 50% support at the general meeting of the owners corporation, then a strata renewal committee needs to be established and tasked with preparing a strata renewal plan.

Before the strata renewal plan can be distributed to lot owners a second general meeting needs to be held that requires 75% support at a general meeting of the owners corporation.

You received the Strata Renewal Proposal in XX/201X.

In XX/201X the owners held a general meeting and it was resolved by the owners, pursuant to section 160 of the Act that a strata renewal committee be established to prepare a Strata Renewal Plan for the strata scheme.

In XX/201X a Strata Renewal Plan was given to all owners. You received an offer without prejudice from the developer which you rejected.

In XX/201X the owner’s corporation applied to the Land and Environmental Court to approve the plan. An Application Class 3 was filed.

In XX/201X you received a letter to accept the service of application.

A dissenting owner may file an objection to the application for an order to give effect to the Strata Renewal Plan.

In XX/201X you file a Notice of Objection.

Over the months of XX and XX 201X, you participated in Court hearings and mediation to negotiate the proposal.

When a Court makes an order giving effect to a Strata Renewal Plan, matters that it will take into consideration include whether the plan was prepared in good faith, whether the appropriate disclosures were made and whether there was compliance with statutory requirements.

Once the Court makes an order those lot owners who didn’t vote to support the motion are acquired as part of the Strata Renewal Plan.

In XX/201X you reluctantly accepted the offer due to the costly process involved with the objection.

You accepted a cash offer for the investment units.

The date of exchange for all the units was XX/XX/201X, with settlement due to occur on XX/XX/201X.

You have already begun the process of purchasing replacement investment properties. You have signed a contract for X properties on XX/XX/ 201X.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 124-70

Income Tax Assessment Act 1997 paragraph 124-70(1)(a)

Income Tax Assessment Act 1997 paragraph 124-70(1)(c)

Income Tax Assessment Act 1997 section 124-75

Income Tax Assessment Act 1997 subsections 124-75(2)

Income Tax Assessment Act 1997 subsection 124-75(3)

Income Tax Assessment Act 1997 subsection 124-75(4)

Income Tax Assessment Act 1997 subsections 124-75(5)

Income Tax Assessment Act 1997 section 124-85

Reasons for decision

All legislative references referred to herein are from the ITAA 1997, unless otherwise stated

Question 1

Division 124 allows for a replacement asset roll-over to defer the making of a capital gain or loss from a CGT event happening until a later CGT event in certain circumstances.

In particular, roll-over relief may be available where a CGT asset is compulsorily acquired, lost or destroyed (Subdivision 124-B).

Relevant to your circumstances of a compulsorily acquired asset, the CGT asset must have been compulsorily acquired in the following circumstances:

a. by an Australian government agency (paragraph 124-70(1)(a)), or

b. disposed of to an entity following the service of a notice advising that the asset will be compulsorily acquired if agreement cannot be reached for you to dispose of the asset to an entity (paragraph 124-70(1)(c)).

You must receive money or another *CGT asset (except a car, motor cycle or similar vehicle), or both:

a. as compensation for the event happening; or

b. under an insurance policy against the risk of loss or destruction of the original asset.

In circumstances where money is received for the compulsory acquisition of an asset, section 124-75 provides that you can choose to obtain a roll-over if:

a. you incur expenditure in acquiring another CGT asset, which is not a depreciating asset, or trading stock. (subsections 124-75(2) and (5))

b. at least some of the expenditure must be incurred no earlier than one year before the event happens or no later than one year after the end of the income year in which the event happens. The Commissioner can extend this time period in special circumstances. (subsection 124-75(3))

c. if the original asset was used in your business, installed ready for use, or in the process of being installed ready for use, just before the event happened, the replacement asset must be used in your business, or installed ready for use, for a reasonable time after it is acquired. (subsection 124-75(4))

d. if you are not carrying on a business, the replacement asset must be used for the same, or a similar purpose as the original asset for a reasonable period of time after it is acquired. (subsection 124-75(4))

You owned the assets in the form of residential units which you used to produce rental income.

You will receive an amount of money as compensation for the disposal of the rental units to an entity in circumstances meeting the conditions in paragraph 124-70(1)(c) and you state that you will incur expenditure to acquire replacement assets in the form of other residential properties. You will use the residential properties to produce rental income for an indefinite period.

Because you used the residential units to produce rental income and you will use the new residential properties for the same purpose, the residential units will satisfy the same or similar purpose test required by subsection 124-75(4) for the purposes of the replacement asset roll-over.

Question 2

N/A

Question 3

Taxation Determination TD 94/77 states there is no restriction on the number of assets that can be acquired in replacement of an original asset. In order to fully defer the making of a capital gain from a CGT event, replacement assets must be purchased for an amount at least equivalent to all of the amounts received in compensation for the original assets.

Question 4

Section 8-1 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature.

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations (Ronpibon Tin NL & Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

Also, in determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190 (Hallstroms)). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses.

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).

The question of whether legal fees are capital in nature has been the subject of much judicial consideration. The classic exposition of the test was by Dixon J in Sun Newspapers Ltd & Associated Newspapers Ltd v. FC of T (1938) 61 CLR 337; (1938) 5 ATD 87; (1938) 1 AITR 403. In his judgment he referred to three tests:

There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it, that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment.

In Hallstroms, Dixon J said that legal expenses:

… take the quality of an outgoing of a capital nature or of an outgoing on account of revenue from the cause or purpose of incurring the expenditure. We are, therefore, remitted to a consideration of the object in view when the legal proceedings were undertaken, or of the situation which impelled the taxpayer to undertake them.

In your case, the legal action arose as a result of the objection to the acquisition. The sales of the units were not in the normal course of your income producing activities. The legal action therefore does not have a direct connection with your income producing activities.

The resulting legal expenses paid are therefore not a normal incident of the day to day activities undertaken by you to generate assessable income. The legal expenses were paid in relation to the disposal of the properties. As such, any legal expenses incurred by you in relation to the acquisition objection are of a capital nature, and consequently are not deductible under section 8-1.

Question 5

The cost base of a CGT asset is generally the cost of the asset when a taxpayer bought it. However, it also includes certain other costs associated with acquiring, holding and disposing of the asset.

In order to work out how much a taxpayer’s capital gain or capital loss is, a taxpayer must first establish the cost base or reduced cost base of a taxpayer’s ownership interest in the property.

Section 110-25 states that the cost base of a CGT asset is made up of five elements.

1. Money you paid for the asset.

2. Incidental costs of acquiring the property, they are:

3. Costs of owning the asset including:

4. Capital costs to increase or preserve the value of your asset or install or move it

5. Capital costs of preserving or defending your ownership of or rights to your asset.

In your case, you incurred legal costs in relation to objecting to the acquisition, to retain your ownership of the units. As such, the legal expenses incurred by you in relation to the objection are of a capital nature. Therefore, these costs can be included under the fifth element of the cost base.

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