Edited version of your written advice

Authorisation Number: 1013132645125

Date of advice: 30 November 2016

Ruling

Subject: deceased estate

Question 1

Do legal costs, forensic examination and travel expenses to attend mediation incurred by the executors of a deceased estate in contesting a Will and obtaining the grant of probate form part of the cost base of the estate's assets pursuant to subsection 11-25(6) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are you entitled to claim a deduction under section 8-1 of the ITAA 1997 for the costs of administering the estate?

Answer

No.

Question 3

Do the valuation costs form part of the cost base of the estate's assets pursuant to subsection 110-25(3) or 110-25(6) of the ITAA 1997?

Answer

Yes.

Question 4

Do the costs of administering the estate form part of the cost base of the estate's assets pursuant to subsection 110-25(3) or 110-25(6) of the ITAA 1997?

Answer

No.

Question 5

Is it reasonable to apportion the legal costs between the various assets of the estate based on the market value of the assets on the date the legal costs were incurred?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 20YY

The scheme commences on

1 July 20XX

Relevant facts and circumstances

The deceased passed away.

There was a protracted dispute as to whether the deceased left their estate to an entity or died intestate.

Legal expenses were incurred to obtain probate, letters of administration and during mediation.

The administration of the estate includes management of assets, paying debts of the estate, preparation of tax returns, interim distribution of assets.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Section 8-1

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

Reasons for decision

Deductions

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, or relate to the earning of exempt income.

The courts have considered the meaning of 'incurred in gaining or producing assessable income'. In Ronpibon Tin NL Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; 56 ALR 785; 8 ATD 431 the High Court stated that:

'For expenditure to form an allowable deduction as an outgoing incurred in gaining or producing the assessable income it must be incidental and relevant to that end. The words “incurred in gaining or producing the assessable income” mean in the course of gaining or producing such income.'

Deceased estates and testamentary trusts face the same general criteria for claiming a deduction for income tax purposes that are faced by all other taxpayers. For a trustee to be able to claim a tax deduction a nexus is required to be established between the expense incurred and the activity producing the estate's assessable income.

In determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the outgoing follows the advantage which is sought to be gained by incurring the expenses.

Cost base

Where an expense is capital in nature and can't be claimed as a deduction the expense may be able to be included as part of the cost base.

Section 110-25 of the ITAA 1997 contains the five element of the cost base. In order for a cost to be incorporated into the cost base of the estate's assets, it must fall within the elements of the cost base. These elements are:

First element

The first element of cost base and reduced cost base is the total of the money paid, or required to be paid, and the market value of property given, or required to be given, in respect of the acquisition of the asset (subsection 110-25(2) of the ITAA 1997).

Second element

Under section 110-25 of the ITAA 1997, incidental costs of acquiring the capital gains tax (CGT) asset or costs that are incurred in relation to the CGT event that happens to it (including its disposal), form part of the second element of the cost base. These costs include:

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

● costs of transfer,

● stamp duty or other similar duty,

● costs of advertising or marketing (but not entertainment) to find a seller or buyer,

● costs relating to the making of any valuation or apportionment to determine your capital gain or capital loss,

● search fees relating to an asset,

● the cost of a conveyancing kit,

● borrowing expenses,

● expenditure that is incurred as a direct result of your ownership of a CGT asset ending.

Third element

The third element of cost base is the non-capital costs of ownership (subsection 110-25(4) of the ITAA 1997). These costs can include: interest on money borrowed to acquire the asset, costs of maintaining, repairing or insuring it, rates or land tax, interest on money you borrowed to refinance to acquire the asset and interest on money you borrowed to finance the capital expenditure you incurred to increase the assets value. However, this element does not apply in working out a capital loss.

Fourth Element

The fourth element of cost base and reduced cost base is capital expenditure incurred to increase the asset's value and which is reflected in the state or nature of the asset at the time of the CGT event (subsection 110-25(5) of the ITAA 1997).

Fifth element

The fifth element of cost base or reduced cost base is capital expenditure incurred to establish, preserve or defend the title to the asset, or a right over the asset (subsection 110-25(6) of the ITAA 1997).

In your case

In your case, the legal costs, forensic examination and travel expenses to attend mediation incurred by the executors are considered fifth element expenditure. Therefore these costs can be incorporated into the cost base of the deceased estate's assets on a prorated basis.

The other costs relate to either the trust or the assets of the trust and not to the earning of the income. Such costs are capital in nature and therefore no deduction is allowed as they are not connected to assessable income derived.

The valuation fee in respect of the real estate is relevant in calculating the cost base for CGT purposes and can be included in the second element of the cost base.

The ongoing legal fees in respect of administering the estate, do not fall within any elements of the cost base, and therefore would not be able to be incorporated into the cost base of the deceased estate's assets.

Should these costs have been incurred in acquiring a CGT asset or relate to a CGT event that happens in relation to the CGT asset they could've been included in the second element of the cost base. However as the costs are general administration costs, they cannot be included in the cost base of the deceased estate's assets.

Apportionment

In accordance with subsection 112-30(1A) of the ITAA 1997, the expenditure may need to be apportioned to ensure that the element includes that part of the expenditure that is reasonably attributable to that element. In other words, the legal and other costs may need to be reasonably apportioned across the various assets of the estate.

'Reasonably attributable' is not defined in the legislation, however in Taxation Ruling 2004/18 the Commissioner states that there may be a number of methods of apportioning expenditure that produces a reasonable result. One of the examples provided is apportioning on a market value basis.

If the use of the market value method to apportion the legal and other costs incurred results in a reasonable result, then that method of apportionment may be used.