Capital gains tax: incidental costs forming part of the cost base

Can Subco Pty Ltd index incidental costs relating to the acquisition of shares during 1995 under subsection 110-25(7), section 114-1 and subsection 960-275(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes. The incidental costs relating to the acquisition of shares were incurred by Subco Pty Ltd in 1995 for the purposes of subsection 110-25(7), section 114-1 and subsection 960-275(2) of the ITAA 1997 and can be indexed from the June 1995, September 1995 or December 1995 quarter as relevant.

Subco Pty Ltd was allotted shares in an Australian company in July 1995.

Subco Pty Ltd disposed of its shares in the company in the year ended 31 March 2000.

Between June and December 1995, Subco Pty Ltd received invoices from its legal advisers, accountants and financial consultants for services rendered to facilitate the acquisition of the shares.

The invoices were arranged to be paid by Headco Ltd on behalf of its subsidiary, Subco Pty Ltd. The payment was to be recharged to Subco Pty Ltd in the year ending 31 March 1996.

Due to untimely account keeping, the journal entry to recharge the expenditure from Headco Ltd to Subco Pty Ltd was not raised in the year ended 31 March 1996. However, Subco Pty Ltd and its auditors recognised the omission and ensured that the relevant recharge journal entry was raised and booked in the year ended 31 March 2001.

Subsection 110-25(1) of the ITAA 1997 provides that the cost base of a CGT asset consists of five elements.

Subsection 110-25(3) of the ITAA 1997 provides that the second element of the cost base of a CGT asset is the incidental costs the owner of the asset incurred to acquire it. Incidental costs are further defined in section 110-35 of the ITAA 1997. In particular, subsection 110-35(2) of the ITAA 97 defines the first type of incidental costs as: 'remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant or legal adviser.'

The time when incidental costs are incurred is relevant for the purposes of cost base indexation.

The cost base of a CGT asset acquired at or before 11.45 am (by legal time in the Australian Capital Territory) on 21 September 1999 also includes indexation of the elements of the cost base (except the third element) if the requirements of Division 114 are met: subsection 110-25(7) of the ITAA 1997. For these assets, expenditure incurred at or before that time can be indexed: subsection 114-1 of the ITAA 1997.

Subsection 960-275(2) of the ITAA 1997 sets out the formula used to calculate an indexation factor to be applied to an element of the cost base of a CGT asset - the denominator of the formula is the index number for the quarter in which expenditure in an element was incurred.

The expenses in this case clearly come within the category of incidental costs defined in subsection 110-35(2) of the ITAA 1997. The main issue is whether, and if so when, the incidental costs were incurred by Subco Pty Ltd.

No guidance on the meaning of the term 'incurred' is offered in any of these provisions nor in the Explanatory Memorandum to the bill which became the Tax Law Improvement Act (No 1) 1998 , that introduced them. Similarly the Explanatory Memorandum to the bill which became the Income Tax Assessment Amendment (Capital Gains) Act 1986 is also silent on the meaning of the term 'incurred' in this context.

The term 'incurred' was recently considered in Dolby v. Commissioner of Taxation [2002] FCA 1065 (Dolby) in the context of subsection 960-275(2) of the ITAA 1997.

In determining the meaning of incurred in this context, Spender J in Dolby observed - ' While it is wise to heed the caution that an exhaustive definition of the conceptions intended by the expression "incurred" is neither prudent nor possible New Zealand Flax Investments Pty Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 at 207, it has been held that a liability presently existing or which has accrued but is not payable until a future time is sufficient ... In Australian and New Zealand Banking Group Ltd v Federal Commissioner of Taxation (1994) FCR 268, Hill J, with whom Northrop and Lockhart JJ agreed, said at 278: "...for a loss or outgoing to be incurred it must be more than 'impending threatened or expected'. Rather the taxpayer must have been definitively committed in the year of income to that loss or outgoing: New Zealand Flax Investments Ltd v Commissioner of Taxation (Cth) (1938) 61 CLR 179 at 206-207 per Dixon J; Commissioner of Taxation (Cth) v James Flood Pty Ltd (1953) 88 CLR 492 at 506-507. The loss or outgoing must represent a present liability, albeit not immediately payable but payable in the future, and whether or not defeasible; Nilsen Development Laboratories Pty Ltd v Commissioner of Taxation (Cth) (1981) 144 CLR 616 at 627-628 per Gibbs J; Commissioner of Taxation v Australian Guarantee Corporation Ltd (1984) 2 FCR 483 at 486-487 per Toohey J"

A similar view is reflected in Taxation Determination TD 2000/39 which states that in subsection 124-75(2) of the ITAA 1997 (about roll-over for assets compulsorily acquired, lost or destroyed) 'incur' has the same meaning as it has in its context in the general deduction provision in subsection 8-1(1).

It is considered that the findings of Spender J in Dolby as to the meaning of 'incurred' will apply equally to the meaning of the term in subsections 110-25(3) and 110-35(2) and section 114-1 of the ITAA 97.

In this case the expenses represented a presently existing liability for Subco Pty Ltd in 1995 and were more than merely impending, threatened or expected. The fact that the recharge journal entry was not made until the 2001 income year does not prevent the expenses having been incurred in 1995 as the services to which the invoices related were provided to Subco Pty Ltd in 1995 and the services were invoiced for payment in that year. The quantum of the expenses was known and liability relating to these expenses was presently existing in 1995.

Accordingly it is considered that the incidental costs of acquisition were incurred by Subco Pty Ltd in the period June to December 1995 and can be indexed from that time. The relevant indexation numbers will be those for the June 1995, September 1995 and December 1995 quarters depending on the month that the particular expenditure was incurred. Note: This note has been added to explain a legislative change made by Act No 32 of 2006 which repealed subsection 110-25(7) of the Income Tax Assessment Act 1997. For CGT events happening on or after 1 July 2005, subsection 110-36(1) of the Income Tax Assessment Act 1997 applies with the same effect. This change does not affect the decision in this interpretative decision.