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Ruling

Subject: Allowable deductions

Question 1:

Are the valuation costs an allowable deduction?

Answer:

No.

Question 2:

Are the legal costs in relation to probate and the properties an allowable deduction?

Answer

No.

Question 3

Are the GST amounts an allowable deduction?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on

1 March 2012

Relevant facts

The deceased had pre-CGT investment properties.

The assessable income of the deceased estate includes rental income.

The rental properties will pass to the beneficiaries.

The deceased estate has incurred legal costs in relation to the transmission of the properties and obtaining probate.

The deceased estate will incur costs in obtaining the valuation of the properties at the date of death from a registered valuer.

The estate is registered for GST.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Section 27-5.

Income Tax Assessment Act 1997 Section 110-35.

Income Tax Assessment Act 1997 Subsection 128-15(5).

Income Tax Assessment Act 1997 Section 103-30.

Income Tax Assessment Act 1997 Section 112-30(1A).

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 (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.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining

· assessable income or, in other words, of an income-producing expense

· (Lunney v. FC of T; (1958) 100 CLR 478 (Lunney's case)),

· there must be a nexus between the outgoing and the assessable income so

· that the outgoing is incidental and relevant to the gaining of assessable

· income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

· it is necessary to determine the connection between the particular outgoing

· and the operations or activities by which the taxpayer most directly gains or

· produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v.

· FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

In determining whether a deduction is allowable, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; 8 ATD 190; 3 AITR 436 per Dixon J). The nature or character of expenses follows the advantage which is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Valuation costs

The costs of obtaining the market value of a property relates to the property itself and not to the earning of the rental income. Such valuation costs are capital in nature. Therefore no deduction is allowed for the costs incurred in obtaining the market value of the properties, as they are capital in nature and not sufficiently connected to the assessable rental income derived. However, these costs are relevant in calculating the cost base of the properties for CGT purposes - please see below.

Legal expenses

Where legal 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 legal expenses are deductible (Herald & Weekly Times v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169). However, 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. FC of T (1938) 61 CLR 337; 5 ATD 87; (1938) 1 AITR 403).

The legal expenses incurred in relation to the properties were not for the purpose of producing assessable rental income of the estate but for transferring the relevant assets to the beneficiaries. The expenses do not have the necessary connection to the gaining or producing of the estate's assessable rental income. Furthermore, such expenses are capital in nature and relate to a capital asset.

Accordingly, as your legal expenses relating to the property are of a capital nature, they are not deductible under section 8-1 of the ITAA 1997. However, these legal expenses are relevant in calculating the cost base of the property for CGT purposes.

The legal expenses incurred to obtain probate or letters of administration of the deceased estate are not incurred in gaining or producing assessable income of the estate. Accordingly, such legal expenses are not an allowable deduction.

No deduction is allowable under section 8-1 of the ITAA 1997 or any other provision for the above legal expenses.

GST

As the valuation and legal costs are not deductible, the GST paid in relation to these costs is also not deductible. Also, under section 27-5 of the ITAA 1997, you cannot deduct a loss or outgoing you incur, to the extent that the loss or outgoing includes an amount relating to an input tax credit to which you are entitled or a decreasing adjustment.

Capital gains

The cost base of a CGT asset consists of five elements. The second element includes incidental costs. Section 110-35 of the ITAA 1997 lists incidental costs that may be incurred to either acquire a CGT asset or that relate to a CGT event. Some of these are:

· remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant, or legal advisor,

· costs of transfer and

· valuation or apportionment costs.

Costs in confirming the validity of the deceased's will can also form part of the cost base of the estate's assets. Therefore the relevant portion of the costs of probate, solicitor's fees, and transmission application fees can be included in the cost base.

Under subsection 128-15(5) of the ITAA 1997, a beneficiary can include in their cost base (and reduced cost base) any expenditure the legal personal representative (for example, the executor) would have been able to include in their cost base if they had sold the asset instead of distributing it to the beneficiary.

Please note that under section 103-30 of the ITAA 1997, the cost base is reduced by net input tax credits.

Where the expenses relate to more than one asset, the expenses need to be apportioned to the various assets of the estate in accordance with subsection 112-30(1A) of the ITAA 1997.

As the investment properties are passing to the beneficiaries, the CGT is disregarded for the deceased estate. However, the above cost base elements are relevant for the beneficiaries.

For further information on capital gains, please refer to the publication Guide to capital gains tax 2012 which is available on the Tax Office website www.ato.gov.au.