ATO ID 2010/69: Capital Allowances: business related costs - limitation of deduction - could be taken into account in working out the amount of a capital gain or capital loss - time allowed to amend assessment expired
Date of decision: 17 March 2010
Year of income: Year ended 30 June 2008
Business line: Public Groups and International

Issue
If the amendment period in section 170 of the Income Tax Assessment Act 1936 (ITAA 1936) has expired and the taxpayer's capital expenditure forms part of the cost base of a capital gains tax (CGT) asset but was not taken into consideration when working out the taxpayer's net capital gain for the relevant income year, is that capital expenditure 'taken into account in working out a capital gain or capital loss from a CGT event' for the purpose of paragraph 40-880(5)(f) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Decision
Yes. As the taxpayer's capital expenditure forms part of the cost base of a CGT asset, it could be taken into account in working out the amount of a capital gain from a CGT event for the purposes of paragraph 40-880(5)(f) of the ITAA 1997. The application of paragraph 40-880(5)(f) of the ITAA 1997 is not affected by the expiry of amendment periods prescribed by section 170 of the ITAA 1936.

Facts
The taxpayer sold a business which they had carried on - they disposed of all of the assets of the business, including the goodwill. A CGT event happened to the assets when the taxpayer disposed of them and, as a result, the taxpayer included a net capital gain in their assessable income for the income year in which the CGT event happened. Subsequently, the purchaser of the business commenced legal action against the taxpayer for allegedly misrepresenting the value of the goodwill of the business. For several income years after the one in which the CGT event happened, the taxpayer incurred legal fees in relation to the legal action. The legal fees are capital expenditure incurred in relation to a business the taxpayer used to carry on for the purposes of paragraph 40-880(2)(b) of the ITAA 1997. The fees are also incidental costs of the disposal of the goodwill of the business and form part of the cost base of the goodwill. The amount of the capital gain made from the CGT event happening to the goodwill was worked out using a cost base of the goodwill which did not include the legal fees. Therefore, the legal fees were not reflected in the net capital gain included in the taxpayer's assessable income in the year in which the CGT event happened. The time allowed by section 170 of the ITAA 1936 to amend the taxpayer's assessment for the income year in which the CGT event happened has expired.

Reasons for decision
Summary: Section 40-880 of the ITAA 1997 allows certain business capital expenditure to be deducted in equal proportions over five income years. Paragraph 40-880(5)(f) of the ITAA 1997 provides that you cannot deduct anything under section 40-880 for an amount of expenditure you incur to the extent that 'it could, apart from this section, be taken into account in working out the amount of a capital gain or capital loss from a CGT event'. In most cases, capital proceeds and cost base (or reduced cost base) are taken into account in working out the amount of a capital gain or capital loss from a CGT event. Therefore, capital expenditure which reduces capital proceeds from a CGT event or forms part of the cost base (or reduced cost base) of a CGT asset could be taken into account in working out the amount of a capital gain or capital loss from a CGT event for the purposes of paragraph 40-880(5)(f) of the ITAA 1997. In the present case, the capital expenditure forms part of the cost base of the goodwill and, therefore, could be taken into account in working out the capital gain made from the CGT event that happened to the goodwill. However, an issue arises where the expenditure is then not reflected in the net capital gain included in the taxpayer's assessable income for the income year in which the CGT event happened because the time allowed by section 170 of the ITAA 1936 to amend the taxpayer's assessment for that income year has expired. Whether capital expenditure could be taken into account in working out the amount of a capital gain or capital loss from a CGT event for the purposes of paragraph 40-880(5)(f) of the ITAA 1997 pays no regard to the inability of the taxpayer to amend the net capital gain for the income year in which the CGT event happened. Expenditure could be taken into account in working out the amount of a capital gain or capital loss from a CGT event even though it was not able to be reflected in the net capital gain included in a taxpayer's assessable income for an income year and the time allowed by section 170 of the ITAA 1936 to amend the taxpayer's assessment for that income year has expired. In the present case, the legal fees form part of the cost base of the goodwill of the business. Therefore, the legal fees could be taken into account in working out the amount of a capital gain or capital loss from a CGT event for the purposes of paragraph 40-880(5)(f) of the ITAA 1997, despite the fact that the time allowed by section 170 of the ITAA 1936 to amend the taxpayer's assessment for the income year in which the CGT event happened has expired.

Legislative references: Income Tax Assessment Act 1997 section 40-880 paragraph 40-880(2)(b) paragraph 40-880(5)(f)
Subject references: Blackhole expenditure Capital Allowances CoE Capital gains Capital losses Net capital gains