Edited version of private ruling

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Ruling

Subject: Loan Release Payment - income or capital

Question 1

Are you entitled to claim a deduction under section 8-1 of the ITAA 1997 for payments made a Deed of Release and Assignment?

Answer

No

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent that 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 a settlement sum to constitute an allowable deduction, it must be shown that it was incidental or relevant to the production of your assessable income. Also, in determining whether a deduction for the settlement sum is allowable, the nature of the expenditure must be considered. The nature or character of the settlement sum follows the advantage that is sought to be gained by incurring the expenditure.

In Foley Brothers Pty Limited v FC of T (1965) 13 ATD 562, a payment was made by a taxpayer under terms of settlement to obtain a release from obligations undertaken by a previous agreement. It was held to be a payment on capital account. In the course of their judgment, Kitto, Taylor and Menzies JJ said: 'The freedom thus acquired was clearly enough an enduring advantage.'

In Taxation Determination TD 93/58 where a taxpayer receives an undissected lump sum which includes assessable and non-assessable or capital components that cannot be identified or quantified, the whole of the lump sum amount is treated as a non-assessable or capital receipt.

In your case, you paid an undissected amount as settlement under a deed of settlement between you and your financier. The deed fully and forever releases you from all claims, suits, actions and demands each may have against each other. The advantage that you obtained upon signing the deed of the settlement is of an enduring benefit which allows you to continue without the burden of the dispute and is considered capital in nature.

Question 2

Are you entitled to claim a deduction under section 8-1 of the ITAA 1997 for the payment legal costs incurred in arranging a Deed of Release?

Answer

No

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent that 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.

Based on the reason identified above, the payment of legal costs incurred in arranging a Deed of Release was not acquired in connection with carrying on a business for the purpose of gaining or producing assessable income.

However subsection 110-35(1) of the ITAA 1997 allows incidental costs to be included in the reduced cost base incurred in relation to a CGT event. In particular, subsection 110-35(2) of the ITAA 1997 defines the first type of incidental costs as: 'remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser.'

Subsection 104-10(1) of the ITAA 1997 states that a CGT event A1 occurs if you dispose of a CGT asset. In particular, subsection 104-10(2) of the ITAA 1997 identifies that the disposal of a CGT asset takes place if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

In your case, you paid legal fees in arranging a Deed of Release for the disposal of your allotment in the Project. The disposal was not a deduction allowable against your assessable income and as a result the connecting legal fees will not be allowed. However the disposal is seen as a CGT event therefore, the legal fees are seen to be an incidental cost connection to the disposal and can be included in the reduced cost base.

This ruling applies for the following periods:

Year ending 30 June 2010

We considered these to be the relevant facts

You were an investor in the Project.

Your investment in the Project was financed using a loan which was repayable to the financier.

You made cash payments to the promoter, trustee or lender under the original contractual obligation for specified income years.

You claimed income tax deductions in relation to the Project in your income tax returns for the specified income years.

The Australian Taxation Office (ATO) formed the view that income tax deductions were not allowable to participants in the Project for the following reasons:

· The expenditure was not incurred in gaining or producing assessable income;

· The expenditure was not incurred in carrying on a business; or

· The expenditure was incurred for a purpose other than to derive assessable income.

· Part IVA of ITAA 1936 applied to cancel any tax benefits;

The deductions you had claimed were therefore disallowed by way of amended assessments.

You entered into a settlement arrangement with the ATO. The terms of the settlement agreement explained the terms of the settlement and allow a deduction equal to the cash payments that you contributed to the scheme/s excluding the amount for capital items.

You entered into a Deed of Release and Assignment with the financier, who owned the loan books for the Project whereby:

· You assigned to financier all of you rights, title and interest in the Project - for this you received a specified amount from the financier; and

· The financier released you from all claims, obligations, costs and expenses arising under the Loan and other agreements for the Project - for this you agreed to pay the financier a specified amount.

A letter from the financier advising that the Deed of Release and Assignment had been executed and that they had received the specified amount.

You paid a lawyer a specified amount for arranging a Deed of Release with the financier.

Relevant legislative provisions

Income Tax Assessment Act 1936, Part IVA.

Income Tax Assessment Act 1936, subsection 51(1).

Income Tax Assessment Act 1997; section 8-1.

Income Tax Assessment Act 1997, subsection 110-35(1).

Income Tax Assessment Act 1997, subsection 110-35(2).

Income Tax Assessment Act 1997, Subsection 104-10(1).

Income Tax Assessment Act 1997, Subsection 104-10(2).

Other relevant comments

You entered into a Settlement Deed with the Commissioner of Taxation in regard to your participation in the Project. The settlement deed which is commercial in nature allowed a deduction equal to the cash payments that you contributed to the scheme excluding the amounts for capital items.

As the Deed of Release and assignment between the financier and you is a new contract or agreement, the settlement agreement that you entered into with the ATO would prevent the specified amount from being an allowable income tax deduction in any income year. It can only be offset against any income received from the Project.