Edited version of your written advice

Authorisation Number: 1012842096819

Date of advice: 17 July 2015

Ruling

Subject: Legal expenses - market value substitution rule

Question 1:

Are you entitled to a deduction for settlement expenses?

Answer

Yes.

Question 2:

Do you exclude the market value of any property you receive as a result of entering into a deed of settlement from that part of the settlement expenditure that would be otherwise deductible, in accordance with section 112-30 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2015

The scheme commenced on:

1 July 2014

Relevant facts

You are a company director.

Your duties include drafting and verifying information booklets which are produced to assist with the sale of investments offered by the company.

An investor commenced legal action against you and others in respect to representations made in an information booklet, and other statements/ actions made by you and others, in relation to their investment.

The parties have agreed to settle any and all claims and have entered into a deed of settlement and release.

Pursuant to the deed you are required to pay an amount and X Pty Ltd in its capacity as trustee for the Y Trust will receive a property.

You do not have a market valuation prepared by a registered valuer for property as at settlement.

You have provided a number of documents which forms part of and should be read in conjunction with this private ruling.

• Deed of settlement and release

• Response to request for further information.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 112-20

Reasons for decision

For the settlement sum to constitute an allowable deduction, it must be shown that it was incidental or relevant to the production of the taxpayer's assessable income.  

The nature of the expenditure must also be considered. The nature or character of the settlement sum follows the advantage that is sought to be gained by incurring the expenditure.  

Generally, the treatment of a settlement sum or damages payment will follow the treatment of the legal costs incurred in relation to a particular matter. Legal expenses that you incurred in defending an allegation that you engaged in false or misleading conduct are considered deductible (as above).

Accordingly, the settlement sum that you paid in relation to the same allegations is also an allowable deduction under section 8-1 of the ITAA 1997, as you incurred it in gaining or producing assessable income. You will need to apportion the settlement expense you incurred to account for the asset you received in return for the settlement amount. It is considered that apportioning the settlement expense in accordance with the market value of the land would be a reasonable basis to effect this apportionment.

Market value substitution rule for cost base and reduced cost base

For most CGT events, your capital gain or capital loss is the difference between your capital proceeds (what you receive when you dispose of the property) and the cost base (your costs of ownership of the property).

In some cases, the general rules for calculating the cost base and reduced cost base have to be modified. For example, the market value may be substituted for the first element of the cost base and reduced cost base if:

• You did not incur expenditure to acquire the asset

• Some or all of the expenditure you incurred cannot be valued, or

• You did not deal at arm's length with the previous owner in acquiring the asset

Determining market value of an asset for tax purposes

• You can choose to:

• obtain a valuation from a professional valuer, or

• work out the market value yourself using reasonably objective and supportable data, such as the price paid for very similar property that was sold at the same time in the same location.

Note: The Commissioner reserves the right to challenge any valuation. The valuation that you have provided appears to have been undertaken for a property which is wholly unrelated to the subject property. The valuation has been prepared on a singular, "in one line" basis, which constitutes a fundamentally different structure to the subject property. It is different in terms of size, improvements, location, utility, water rights, and most basic underlying property fundamentals. Therefore, units of comparison (such as $ rate per hectare) within the valuation hold very little (if any) comparability to the subject property and form a poor and unreliable basis on which to draw conclusions as to the potential "market value" of the subject property.