Edited version of private advice

Authorisation Number: 1051538368965

Date of advice: 2 July 2019

Ruling

Subject: Loan used to fund legacy payment as an additional cost base of land used as security

Question

Can you add the amount paid to discharge a mortgage over a land distributed in specie to a beneficiary from the estate of the deceased to the cost base of the land under section 112-35 of the Income Tax Assessment Act of 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20xx

Year ended 30 June 20xx

Year ended 30 June 20xx

The scheme commences on:

01 July 20xx

Relevant facts and circumstances

The deceased left a number of Wills which caused disputes over the administration of the estate.

Following negotiations the relevant parties entered into a binding agreement which set the final Will for probate application.

They agreed that the Executors must from the estate of the deceased pay a legacy amount. The payment shall be a charge upon the assets of the estate and raised out of or on the assets of the estate.

The Court granted probate for the final Will.

Following the grant of Probate, the Executors paid out the legacy money.

The Executors raised the legacy money by taking out a loan using a number of the land assets of the estate as security for the borrowing.

The land will be distributed in specie subject to the existing charge and any mortgage to the beneficiaries of the residuary estate.

Where the land is transferred in specie to a beneficiary charged or mortgaged with the payment of any amount, the beneficiary will be required to pay out that amount to discharge the charge or mortgage.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 112-35

Income Tax Assessment Act 1997 subsection 128-15(2)

Income Tax Assessment Act 1997 subsection 128-15(3)

Income Tax Assessment Act 1997 subsection 128-15(4)

Income Tax Assessment Act 1997 section 104-215

Income Tax Assessment Act 1997 section 128-20

Income Tax Assessment Act 1997 subsection 110-25(2)

Reasons for decision

Summary

The amounts to be paid to discharge a loan that funded a legacy payment by the Trustee of the Estate of the deceased cannot form part of the cost base of the land used as security and distributed in specie to the beneficiaries under section 112-35 of the ITAA 1997.

Detailed reasoning

Application of Division 128 to Deceased Estates

Division 128 of the ITAA 1997 contains rules that apply when an asset owned by a person just before they die passes to their legal personal representative or to a beneficiary in a deceased estate.

In accordance with subsection 128-15(2) of the ITAA 1997, a legal personal representative or beneficiary is taken to have acquired the asset on the day the deceased person died.

Any capital gain or capital loss that the legal personal representative makes if the assets passes to a beneficiary is disregarded (subsection 128-15(3) ITAA 1997) unless CGT event K3 in section 104-215 of the ITAA 1997 happens as a result of the asset passing to a tax-advantaged beneficiary. However, the beneficiary will be the relevant taxpayer if a CGT event happens to the asset after it has passed to the beneficiary.

The table in subsection 128-15(4) of the ITAA 1997 sets out the modifications to the cost base and reduced cost base in the hands of the legal personal representative (LPR) or beneficiary.

Item 1 in the table in subsection 128-15(4) of the ITAA 1997 states that the first element of the cost base to the LPR or beneficiary for assets that the deceased acquired after 19 September 1985, is the cost base of the asset on the day the deceased person died. While item 4 in the same table states that the first element of the cost base for assets the deceased acquired before 20 September 1985 is the market value of the asset on the day the deceased died.

A capital gains tax asset passes to a beneficiary if the beneficiary becomes the owner in one of the ways set out in section 128-20 of the ITAA 1997, including:

·  under the Will, or the Will as varied by a court order,

·  under a deed of arrangement which the beneficiary entered into to settle a claim to participate in the estate.

Distribution in specie subject to charge to secure legacy

Section 112-35 of the ITAA 1997 states that if you acquire a CGT asset from another entity that is subject to a liability, the first element of your cost base and reduced cost base of the asset includes the amount of the liability you assume.

The reference to "a CGT asset that is subject to a liability" implies that the assumption of liability rule will only operate in relation to liabilities that are attached or specific to the asset at the time of its acquisition. Such liabilities in existence at that time are to have effect on the first element of the cost base and reduced cost base of the asset.

The time of acquisition of the CGT asset is considered to be determined under subsection 128-15(2), being the day that the deceased died.

The first element of cost base of the CGT asset as at the day of the deceased's death is subject to the modification rule contained in subsection 128-15(4), being that a post-CGT asset of the deceased is taken to have been acquired by the Legal Personal Representative (LPR) or beneficiary for the cost base or reduced cost base of the asset in the hands of the deceased at their date of death, and a pre-CGT asset of the deceased is taken to have been acquired by the LPR or beneficiary for its market value at the date of the deceased's death.

What constitutes the first element of the cost base of a CGT asset is stated in subsection 110-25(2) as being the total of:

a)    the money the taxpayer paid, or is required to pay, in respect of acquiring it, and

b)    the market value of any other property the taxpayer gave, or is required to give, in respect of acquiring it (worked out as at the time of the acquisition).

Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts (at paragraph 101), contains the Commissioners opinion that money, property, or money and property may be regarded as having been paid or given in respect of the acquisition of an asset if there is some direct and substantial link between the money or property and the acquisition of the asset.

The phrase "in respect of'' should be read to convey a connection between the amount paid (or required to pay) for the asset being acquired (see State Government Insurance Office (Qld) v Rees (1979) 144 CLR 549 at paragraph 561). However, liabilities that are not "in respect of'' any particular asset cannot be taken into account.

Consideration needs to be given to the nature of the charge, the purpose in incurring it and its relationship to the assets of the estate.

In a situation in which the LPR of the estate resolves to borrow funds rather than to use the existing resources of the estate to pay a gift, that decision gives rise to a relation between the liability arising from the borrowing and the borrowed funds in the hands of the estate.

Upon that purpose being effected by disposing of the cash which represented the borrowing, there ceases to be a relevant ongoing connection between the liability and the assets of the estate other than for the reason than that the decision to borrow was made in the alternative to using the existing resources of the estate.

If the outlay, made with borrowed funds, was to purchase an asset, then the liability represented by the borrowing would relate to that asset. Rather, as the borrowing was for another purpose being to pay a gift (and is immediately and identifiably used only for that purpose), the liability does not relate to any asset of the estate and therefore section 112-35 cannot operate in respect to that liability to include it in the first element of cost base for that CGT asset.

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