Private ruling: Income tax - deductions - rental property expenses - capital vs revenue expenditure
Date of advice: 1 August 2018
Published: September 2018
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 20 XX

Ruling: Q1: Are you entitled to a deduction for the consultancy fee? | A1: No | Q2: Are you entitled to include the consultancy fee in the cost base on the disposal of the properties? | A2: No

Relevant facts and circumstances: You each own rental properties, X held in joint names and the other solely owned. X of the properties was purchased in 20XX and the other property acquired in 20XX. You both have stable employment. Funds were borrowed for the properties. The value of the assets is now substantially less than the debt owed. The property prices have dropped by more than XX%. Servicing the debt is causing substantial out of pocket costs and has been a financial burden on both your lifestyles. The rent paid by the tenants has reduced by more than XX%. You both sought a consulting firm to provide advice and to find resolution on your financial position which included negotiating a deal with the bank which would set you free from the financial debt of the properties. You both entered into an agreement on XX Xxxxxxxx 20XX with the consultant to negotiate with your lender to acquire all of the properties back. Agreement was reached with the bank to take back the properties in exchange for a cash payment. The agreement was for the consultant to conduct an ‘initial consultation to gather relevant information regarding financial position before distressed times and comparing it to current financial position’. The Consultancy Services Agreement between the client and the consultants was entered into on DDMMYY. The Client “requested the Consultant accept an appointment to provide consulting services…..” The role of the consultant at point X of the Agreement states: The Client has appointed the Consultant for the purposes of providing consulting services and the Consultant has accepted that appointment. Both the Client and the Consultant acknowledge the relationship between them is neither that of employer and employee or agent and principal. Consultant conducts initial consultation to gather relevant information regarding financial position before distressed times and comparing it to current financial position. Consultant prepares a strategic plan which is presented to the Client. Other key roles for the Consultant includes negotiating and liaising with the relevant secured creditors and any other matters pertaining to same. Under General Disclaimer: Paragraph XX of the Agreement states: The Client agrees that they have engaged the Consultant to provide general consultancy services and in doing so the Consultant agrees that nothing in this agreement constitutes a warranty or representation by the Consultant as to the likely success by ability or achievability of the Client’s outcome, based upon advice provided. Further, Paragraph XX of the Agreement states: The Client agrees that the Consultant shall only be required to provide consultancy services of a general nature and will use the best endeavours to advise and consult with regard to the objectives set out in the Schedule. Paragraph XX states: The Client agrees that the consultancy services detailed in this agreement do not constitute any representation by the Consultant as to the ability or desire to offer any financial services, or finance to the Client. Paragraph XX states: The consultant does not provide legal services. The consultants were to prepare a strategic plan to present to you. The consulting services provided under Item X of Schedule X of the agreement were for the following stages: ● an initial consultation with you and to obtain instructions as to your complaint ● to forensically review all documents ● to assist in negotiations with all loan providers ● draft and lodge relevant applications with relevant authorities ● to assist with cash flow solutions ● negotiate with any parties in regards to finance and settlement of any outstanding agreed amounts ● to assist in any matters and to brief legal counsel (if and when required) ● to assist with other financier issues including credit cards. You both paid a consultancy fee which is the retainer fee during the investigation, assessment and finding a resolutions stage. For the financial year ended 30 June 20XX you paid $XX,XXX in consultancy fees and for the financial year ended 30 June 20XX you paid $XX,XXX in consultancy fees and $XX,XXX in success fees. The success fee is a percentage fee based on the saving amount of the negotiated agreement by the consultant. A settlement deed was executed on DDMMYY and you are waiting for the properties to be vacant so they can be handed over.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 110-25 Summary | The fee paid to the consultant for consultancy services is not deductible nor is it considered to be a capital expense for income tax purposes.

Reasons for decision: Summary: Deductibility of consultancy fees A deduction is allowed for all losses and outgoings to the extent to which they are incurred in gaining or producing your assessable income except where the outgoings are of a capital, private or domestic nature (section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)). Expenses incurred in relation to a rental property are generally deductible, to the extent that the property is held for income-producing purposes and genuinely made available for rent. An expense will generally be deductible if its essential character is that of expenditure that has a sufficient connection with the operations or activities which more directly gain or produce your assessable income. The essential character of an expense is a question of fact to be determined by reference to all the circumstances (Taxation Ruling TR 95/33). In your case, you both have engaged a consulting firm to gather information regarding your financial position and prepare a strategic plan. The costs incurred were related to your general financial situation, not to the derivation of your assessable income. As such the costs are considered to be a private expense. Consequently you both are not allowed a deduction for the consultancy fee. Capital gain – cost base You make a capital gain or capital loss if a capital gains tax (CGT) event happens. For most CGT events, your capital gain is the difference between your capital proceeds and the cost base of your CGT asset. CGT events are the different types of transactions or events that may result in a capital gain or capital loss. The disposal of your rental properties would trigger CGT event A1. The cost base of a capital gains tax (CGT) asset is generally the cost of the asset when you bought it. However, it also includes certain other costs associated with acquiring, holding and disposing of the asset. The cost base consists of five elements, as listed in section 110-25 of the ITAA 1997. These elements are added together to calculate the cost base. Briefly these are: 1. money paid or required to be paid for the property, including market value of any property given to acquire it 2. incidental costs of acquiring the property, or costs in relation to the CGT event, for example, stamp duty, legal fees, agent's commission 3. costs of owning the asset such as interest, rates, land taxes, repairs and insurance premiums. This does not include an amount that you have deducted or could deduct previously 4. capital expenditure you incur to increase or preserve the value of the asset such as renovations that are improvements rather than repairs 5. capital expenditure you incur to preserve or defend your title or right to the asset. You both paid a consultancy fee to provide advice and find a resolution to both of your financial situation. This cost is not related just to your rental properties and is not considered to have met any of the five elements of the cost base as a capital account expense. It would not be included in the cost base on the disposal of the properties.