Edited version of private advice

Authorisation Number: 1051594953075

Date of advice: 25 October 2019

Ruling

Subject: Deceased estate

Question 1

Can you apply the legal expenses incurred in the 2019 financial year retrospectively against a capital gain event that occurred in the 2018 financial year?

Answer

No

Question 2

Can you claim the legal expenses incurred of $XX,XXX in the cost base of property 1?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2018

Year ending 30 June 2019

The scheme commences on:

15 January 2018

Relevant facts and circumstances

The deceased passed away.

The deceased estate incurred a capital gain in 2018 when it sold Property 1.

The estate's money was frozen due to a Family Provision Act challenge.

The estate sold Property 2 in 2019. No capital gains tax is applicable as the property value didn't increase from the date of death.

The Family Provision Act claim caused the estate to incur significant legal fees in the 2019 financial year.

The total legal and accounting fees incurred was $XX,XXX. Most of the fees were incurred in the 2019 financial year.

The legal fees were incurred for the purpose of challenging and defending the estate.

You would like to claim a portion of the total legal fees and other expenses to reduce the capital gain incurred for Property 1 in the 2018 financial year.

The matter went to mediation in late 2018 and was officially signed off on by the Supreme Court in 2019.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1.

Income Tax Assessment Act 1997 section 110-25.

Reasons for decision

Question 1 - Deductions

Section 8-1 of 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.

The courts have considered the meaning of 'incurred in gaining or producing assessable income'. In Ronpibon Tin NL & Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; [1949] HCA 15; (1949) 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 producing such income.'

The expenditure must be related to the production of assessable income.

In your case, the legal expenses incurred were not for the purpose of producing assessable income of the estate but for determining the beneficiaries correct entitlement to distributions of the corpus of the estate. Therefore, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for legal expenses incurred in challenging or defending an action against the will.

Question 2 - 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.

The cost base of a CGT asset is generally the cost of the asset when you bought it, plus certain other costs associated with acquiring, holding and disposing of the asset.

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

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 (section 110-25 of the ITAA 1997). 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

The legal fees incurred in respect of challenging and defending 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 legal costs were incurred to challenge and defend the estate, they cannot be included in the cost base of the deceased estate's assets.

Additionally, the legal expenses were not related to the specific sale of the asset and therefore the costs were not incurred in to establish, preserve of defend your ownership of the title. Therefore, element five cannot be applied.