Edited version of private advice

Authorisation Number: 1051504620389

Date of advice: 10 May 2019

Ruling

Subject: Legal expenses

Question

Can the legal fees incurred by trust to defend court action in relation to a loan that was not taken out to purchase a property form part of the cost base?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The trust intended on purchasing a property.

Another trust was going to run the property.

The trust attempted to get finance through a private finance company.

Pre-approval was obtained.

The trust defaulted on the purchase contract and the owner sold to another party.

The finance company said that the Trust owed them money for the interest and set up fees on the loan even though the loan was never made.

The matter went to court and the finance company went into receivership and this was the end of the matter.

You incurred legal fees in relation to the court action.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 110-25

Reasons for decision

You make a capital gain or a capital loss if a CGT event happens to a CGT asset. Under section 108-5 of the ITAA 1997, a CGT asset can include any kind of property, or a legal or equitable right that is not property such as a debt owed to a taxpayer or a right to enforce a contractual obligation.

Cost base

Section 110-25 of the ITAA 1997 sets out the five elements that make up the cost base of an asset for CGT purposes. These elements are:

·         first element: money or property given for the asset

·         second element: incidental costs of acquiring the CGT asset or of the CGT event (such as agent's commission, stamp duty and legal costs and fees)

·         third element: costs of owning the asset

·         such as interest on money borrowed to buy the asset, the costs of maintaining and insuring it, rates or land tax, interest on money you borrowed to refinance the money you borrowed to acquire it and interest on money you borrowed to finance capital expenditure you incurred to increase its value.

·         These costs can only be included in the cost base of assets acquired after 20 August 1991

·         this element does not apply to a personal use asset or a collectable

·         fourth element: capital expenditure incurred to increase or preserve the value of your asset or to install or move it, and

·         Fifth element: capital expenditure incurred in establishing, preserving or defending your ownership of or rights to your asset. Please note that this only applies once a person has acquired the asset.

Note: Expenditure does not form part of the second or third element of the cost base of a CGT asset to the extent that the taxpayer has deducted or can deduct it. That is, if an expense has been or can be deducted because the property was income producing, (a rental property) that expense cannot form part of the cost base.

In your case the legal expenses were incurred in relation to the Finance Company taking you to court for interest and set up fees relating to a loan to purchase the property. It cannot be said that the legal fees related to the ownership or acquisition of an asset as required to be an element in the cost base.

The legal fees cannot form part of the cost base of the property as the property was never acquired and the right to acquire the property had ceased to exist before the loan had been agreed to.

First element, No money or property was given for the property as you defaulted on the sale and the property was sold to a third party.

Second element, There was no incidental expenses relating to the acquisition of the property as it was not purchased or in relation to any other CGT event.

Third element, There were no costs in owning the asset as the property was not purchased.

Fourth element, there was no capital expenditure incurred to increase or preserve the value of your asset or to install or move it as the property was not purchased.

Fifth element, there was no capital expenditure incurred in establishing, preserving or defending your ownership of or rights to your asset because the property was not purchased and therefore you did not own it.