Private ruling: Deductions - deceased estate under bankruptcy administration
Date of advice: 8 June 2016
Published: July 2016
Ruling period: Year ended 30 June 2014 | Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: 1 July 2013

Ruling: Q1: Are the following expenses incurred during the period of the administration of the deceased estate deducible in full, against the assessable income of the estate • fees for review of history of litigation prior to appointment of the trustee • examination and review of evidence and preparation of advice • trustee fees for the administration of the estate? | A1: Yes. | Q2: Are the following expenses incurred during the period of the administration of the deceased estate deducible in part, against the assessable income of the estate • legal fees for reinstatement of dividends, compulsory acquisition of shares, ancilliary and related matters • trustee fees for realisation of assets? | A2: Yes. | Q3: Is the following expense incurred during the period of the administration of the deceased estate deductable against the assessable income of the estate • trustee fees for administration of creditors? | A3: No.

Relevant facts and circumstances: The deceased owned assets in their own right and through companies controlled by them. For an extended period of time the deceased and related entitles conducted legal proceedings in claims and cross claims. The deceased was seeking rectification of the breach of a shareholders agreement and the failure to pay dividends in accordance with the shareholders agreement. They also sought orders for the compulsory purchase of their share interests. The deceased's estate had no significant assets other than shares held in the related entitles. A trustee was appointed for the deceased estate, under Part XI of the Bankruptcy Act 1966 (Bankruptcy Act). The deceased taxpayer's interest in the assets passed to the trustee and formed part of the estate. The trustee has administered the estate subject to the provisions of the Bankruptcy Act. The trustee engaged lawyers to assess the circumstances of the case, form an opinion and to negotiate a settlement. The estate has incurred legal fees and trustee fees in relation to the legal action taken, administration of the estate and of creditors. The settlement was the payment to the estate by way of share buy-back.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (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. The courts have considered the meaning of 'incurred in gaining or producing assessable income'. In Ronpibon Tin NL Tong Kah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; 56 ALR 785; 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 gaining or producing such income.' Deceased estates and testamentary trusts face the same general criteria for claiming a deduction for income tax purposes that are faced by all other taxpayers. For a trustee to be able to claim a tax deduction a nexus is required to be established between the expense incurred and the activity producing the estate's assessable income. In determining whether a deduction is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the outgoing follows the advantage which is sought to be gained by incurring the expenses. Fees for administration of the estate Part XI of the Bankruptcy Act 1966 (the Bankruptcy Act) provides for the property of the deceased to be vested in the official trustee, and for the estate of an insolvent debtor to be administered in a similar manner to the way bankruptcy would operate if the person were still alive. As a trustee appointed under the Bankruptcy Act you are to realise the assets of the estate. Where the realisation of the assets results in assessable income there, is a connection between the expenses incurred and that income. Therefore, the related trustee fees for the administration of the estate are deductible to the estate. Review of prior litigation, examination and review of evidence and the preparation of advice If the outcome sought by the legal action is revenue in nature then the legal expenses will also be revenue in nature. Similarly, if the advantage sought is capital in nature the expenses will also be capital in nature. In this particular circumstance the cause of the trustee incurring legal fees was to assess whether it was commercially viable to pursue legal proceedings to recover the unpaid dividends for the benefit of the estate. We consider the fees incurred for the review of the prior litigation and the examination and review of evidence and the preparation of advice, have a nexus to the earning of assessable income of the deceased estate and are deductible. Fees for negotiation and mediation and realisation of assets There are often occasions where the expenses are incurred in relation to proceedings that relate both to amounts that are income in nature as well as amounts which are not. In these situations, the expenses need to be apportioned between the income and non-income claims sought. Consequently, it is necessary to consider the reason why the expenses were incurred. It also follows that the character of legal expenses is not determined by the success or failure of the legal action. In your case, you have taken action to obtain the unpaid dividends and negotiate a buy-back of the underlying shares. The dividends are revenue assets, while the payment of the shares is a return of capital. As there is both a capital and revenue component for the actions the associated fees should be apportioned between the two. The portion of the fees which relates to the payment of the dividends is an allowable deduction. The remaining fees attributed to the share buy-back are capital in nature and not deductible. Fees for the administration of creditors The fee incurred by the deceased estate for the administration of creditors is not a tax related expense and is excluded from being deducted under section 8-1 of the ITAA 1997 as it was not incurred in gaining or producing the assessable income of the estate. It is an expense incurred by the trustee as a direct result of fulfilling their obligations under the Bankruptcy Act to manage the creditors of the deceased estate. Accordingly, the fee relating to the administration of the creditors is not deductible.