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Ruling

Subject: Various liquidation costs.

Questions and Answers:

1. Is remuneration paid exclusively for the services of the liquidator deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

No.

2. Is expense incurred for any external legal advice in relation to the eligible termination payment, superannuation, travel booking fee and consulting fee claims deductible under section 8-1 of ITAA 1997?

Yes.

3. Is expense incurred for any external legal advice in relation to the asset installation, director's loan, B Class shares dispute and court review of liquidator's determination claims deductible under section 8-1 of ITAA 1997?

No

4. Does expense incurred for any external legal advice in relation to the asset installation, director's loan, B Class shares dispute and court review of liquidator's determination form part of the cost base of a capital gains tax (CGT) asset under section 110-25 of ITAA 1997?

No

5. Is expense incurred for any external legal advice in relation to the claim for the repayment of the director loan deductible under section 40-880 of ITAA 1997?

No.

6. Is expense incurred for any external legal advice in relation to the asset installation, B Class shares dispute and court review of liquidator's determination deductible under section 40-880 of ITAA 1997?

Yes.

This ruling applies for the following periods:

Year ended 30 June 2010

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2009

Relevant facts and circumstances

By an order by a court, an official liquidator was appointed to wind you up. The court order was the result of a winding up application lodged by one of your shareholders.

You carried on a business. Since selling your business, the only income you received was from bank accounts and investment funds.

Since the appointment of the official liquidator, actions and claims in relation to which you have incurred liquidator and external legal expenses include the following matters:

1. The monitoring and managing investment funds including undertaking lending activities related to interest income received.

2. A claim by a creditor related to a dispute debt for the construction of a new asset in your former business. The builder was not paid because you maintained a claim against them in relation to faults in an earlier fitout.

3. A claim by a former employee of your business for an ETP.

4. A claim for a Superannuation Guarantee Surcharge.

5. A claim for a booking fee by a travel agent.

6. Claims for consulting fees by various directors and their associate companies.

7. A dispute between shareholders related to rights attaching to B class shares.

8. A court action by shareholder seeking a review of a liquidator's decision about the distribution of surplus funds.

9. A claim for loan owed to a director. Here, after the sale of your former business, it was proposed an ETP be paid to your directors. One director declined the proposal but another director accepted an ETP, which they immediately returned to the company as a loan. In making the final distributions to the shareholders, the liquidator took into account the (exclusive) ETP the director and thus did not repay the entirety of the loan in fairness to the other shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Section 40-190.

Income Tax Assessment Act 1997 Section 110-25.

Income Tax Assessment Act 1997 Section 40-880.

Reasons for decision

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

Where expenses arise as a consequence of the day to day activities of a business, the object of the expenditure is devoted towards a revenue end and the expenses are deductible (Herald & Weekly Times v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169).

Where the expenditure is devoted towards a structural rather than an operational purpose, the expenditure is of a capital nature and the expenses are not deductible (Sun Newspapers Ltd v. Federal Commissioner of Taxation (1938) 61 CLR 337; 5 ATD 87; (1938) 1 AITR 403).

Section 110-25 of the ITAA 1997 sets out the five elements that make up the cost base of an asset for CGT purposes. The second element is the incidental costs you incurred. Section 110-35 of the ITAA 1997 includes, as incidental costs, remuneration for the services of a legal adviser.

Section 40-190 of the ITAA 1997 is about the second element of cost of a depreciating asset. It states the second element is the amount you are taken to have paid under section 40-185 for each economic benefit that has contributed to bringing the asset to its present condition and location from time to time since you started to hold the asset and expenditure you incur that is reasonably attributable to a balancing adjustment event occurring for the asset. Where capital expenditure in relation to a depreciating asset does not form part of the second element of cost of a depreciating asset, it may be considered for deductibility under section 40-880 of the ITAA 1997.

Section 440-880 of the ITAA 1997, subject to its exclusions, is a provision of last resort that allows a deduction over five years for business capital expenditure that is not allowable or not prohibited by any other tax provision.

For example, paragraph 40-880(9) is an exclusion to deductibility under section 40-880 for capital expenditure that is incurred to the extent that, for another entity, the amount is a return on or of a debt interest that is an obligation of yours.

Taxation Ruling TR 2011/6 is about the core issues relating to section 40-880 of the ITAA 1997.

Paragraph 140 of TR 2011/6 provides that expenditure incurred on a thing or service as an undivided amount where distinct and severable parts of the thing or service relate to different businesses or objects needs to be apportioned against the relevant paragraphs of subsection 40-880(2) on some fair and reasonable basis.

In your case, remuneration paid exclusively for the services of the liquidator are not deductible under section ITAA 1997 because they are capital in nature. Although some of actions of your liquidator related to matters of a revenue nature, such as resolving eligible termination payment, superannuation, travel booking fee and consulting fee claims, the primary reason you incurred remuneration costs for a liquidator was to wind up your company. Therefore, the entirety of the remuneration paid exclusively for liquidation services is capital in nature because it relates to the winding up of your business structure.

However, any legal expenses incurred relating to claims of a revenue nature against your former business are deductible under section 8-1 of ITAA 1997. The claims made against you in relation to an eligible termination payment, superannuation, travel booking fee and consulting fee are revenue in nature. Thus, any legal costs you incurred in relation to these claims is deductible under section 8-1 of ITAA 1997.

The claims made against you in relation to the asset installation, director's loan, B Class shares dispute and court review of liquidator's determination are capital in nature, thus they are not deductible under section 8-1 of ITAA 1997. Similar to your liquidator remuneration, these capital expenses also do not form part of the CGT cost base of any CGT asset.

The claim made against you regarding the asset is capital in nature because it related to depreciating assets. If there were any legal expenses incurred in relation to the asset claim, the legal expenses do not form part of the second element of cost of a depreciating asset under section 40-190 of the ITAA 1997 because they are not expenditure for an economic benefit that has contributed to bringing the asset to its 'present condition and location' nor are they expenditure incurred that is reasonably attributable to a balancing adjustment event.

If the director debt claim was resolved exclusively by the personal services of the liquidator, the remuneration paid to the liquidator is deductible under section 40-880 of the ITAA 1997 over five years because the business capital expenditure relates directly to the liquidation of your company.

However, if any legal expenses were incurred in relation to the director debt claim, the deductibility of such legal expenses is prohibited by the exclusion found in paragraph 40-880(9) of the ITAA 1997 because the business capital expenditure would relate to a debt interest that is an obligation of yours.

Apart from the above, your remuneration paid exclusively for the services of the liquidator and any legal expenses you incurred in relation to the asset installation, B Class shares dispute and court review of liquidator's determination are business capital expenditure for the purposes of section 40-880 of the ITAA 1997 because they were incurred in relation to a business that used to be carried on. These expenditures will be deductible over five years starting in the year when the respective expenditures were incurred.