Private ruling: Legal expenses for maximising liquidator's dividend
Published: March 2014
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: 1. For the period prior to the appointment of the liquidator, do your legal expenses incurred, for the purpose of maximizing your investment, form part of the CGT cost base of your shares? | Yes. | 2. For period from the appointment of the liquidator, were your legal fees incurred for the purpose of maximising your dividend deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Yes.

Relevant facts and circumstances: You were a minority shareholder in a company. You incurred a number of legal expenses for the purpose of investigating the company accounts for the purpose of maximising your final dividend to be paid by a liquidator.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 47 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1997 Section 104-35 | Income Tax Assessment Act 1997 Section 118-20

Reasons for decision: Summary: Subsection 110-25(5) of the ITAA 1997 provides the fourth element of a CGT cost base is capital expenditure incurred for the purpose or the expected effect of which is to increase or preserve the value of your CGT asset. Further, section 110-35 of the ITAA 1997 allows the remuneration for the services of a legal adviser to be included in the cost base of a CGT asset. Section 47 of the Income Tax Assessment Act 1936 (ITAA 1936) is about distributions by a liquidator and provides: Distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it. Taxation Determination TD 2001/27 explains the full amount of a final distribution made by a liquidator on the winding-up of a company constitutes capital proceeds from the ending of the shareholder's shares in the company (which is CGT event C2 in section 104-25 of the ITAA 1997). However, the anti-overlap provision in section 118-20 of the ITAA 1997 reduces any capital gain by amounts that are otherwise assessable as a result of the event (such as under section 47 of the ITAA 1936). Section 8-1 of the 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. In Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190, the Court established that in determining whether a revenue deduction is allowable, the nature of the expenditure must be considered. The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. For example, in Creer v. Federal Commissioner of Taxation (1994) 28 ATR 442; 94 ATC 4454 ( Creer ), legal expenses incurred by a taxpayer for maintaining the amount of partnership income to which they were entitled was held to be revenue in nature. In the Full Federal Court case of Putnin v. Federal Commissioner of Taxation (1991) 27 FCR 508; 91 ATC 4097; (1991) 21 ATR 1245 ( Putnin's Case ), the taxpayer, an accountant, was charged with conspiring with a debtor to defraud the Commonwealth. The Court determined the capital benefit of defending the taxpayer's business structure was an indirect consequence of proceedings that arose primarily from matters that were revenue in nature, namely, the conduct of his work duties. In your case, based on the general facts you provided, we are satisfied you incurred legal expenses for the purpose of protecting the value of your investment. For the period prior to the liquidator's appointment, such legal fees form part of your CGT cost base under sections 110-25 and 110-35 of the ITAA 1997 because to realise your investment, at that time, you had to sell your shares. However, for the period from the liquidator's appointment, those legal fees incurred for the purpose of protecting the value of your investment are deductible under section 8-1 of the ITAA 1997 because your investment would be realised by dividend paid under section 47 of the ITAA 1936. To conclude, we agree, during the period liquidation, you incurred legal expenses for the inherent purpose of maximising your dividend income (per Creer ). That the resolution of your concerns allowed the liquidation to be finalised (which is a capital benefit) was (per Putin's Case) an indirect consequence of the primary purpose of your legal expenses. It follows your relevant legal expenses directly related to maximising your liquidator's dividend are deductible under section 8-1 of the ITAA 1997.