Edited version of private ruling

Authorisation Number: 1011564770355

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Ruling

Subject: Traditional securities

Question 1

Are losses on the disposal of unsecured loans made by the Taxpayer allowable deductions pursuant to section 70B of the Income Tax Assessment Act 1936? (ITAA 1936)

Answer

No

This ruling applies for the following period:

1 July 2009 to 30 June 2010

Relevant facts and circumstances

The Taxpayer advanced a series of short term loans to the Borrower.

The loans were funded by way of a combination of cash held by the Taxpayer and loans subject to interest funded by unrelated third parties.

The interest rate in relation to each loan varied. The interest was included in assessable income in the Taxpayer's tax return for the relevant income years.

A number of the loans (and the interest) were repaid by the Borrower and reinvested by the Taxpayer in new loans.

The Taxpayer discovered that the Borrower was carrying on a fraudulent investment operation.

The Taxpayer slowed funding of further loans to the Borrower when scheduled repayments of existing loans started to be delayed.

The Taxpayer was required to repay the amount loaned to it by third parties, including the interest on those loans.

The balance of the unpaid debt (i.e. principal and interest) was written off as a bad debt but was later reversed.

The Taxpayer applied for a private ruling. The Taxpayer queried whether it could claim a bad debt deduction in relation to the unpaid debt pursuant to section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997). The Commissioner issued a notice of private ruling in respect of that application, answering the Taxpayer's question in the negative.

Negotiations were entered into with third parties interested in purchasing the debt owing on the unsecured loans.

The Taxpayer accepted an offer and sold the debt to one of those third parties.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 70B,

Income Tax Assessment Act 1936 subsection 70B(2)

Income Tax Assessment Act 1936 subsection 70B(3)

Income Tax Assessment Act 1936 subsection 70B(4)

Income Tax Assessment Act 1936 subsection 70B(7)

Income Tax Assessment Act 1936 subsection 26BB(1)

Income Tax Assessment Act 1936 subsection 159GP(1)

Income Tax Assessment Act 1936 subsection 159GP(3)

Income Tax Assessment Act 1936 subsection 159GP(6)

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Summary

The unsecured loans made by the Taxpayer to the Borrower are traditional securities for the purposes of section 70B of the ITAA 1936.

A loss on the disposal of a traditional security is an allowable deduction under subsection 70B(2) of the ITAA 1936. However, subsection 70B(4) of the ITAA 1936 prevents a deduction from being allowed for a capital loss where one of the reasons for the disposal of the security is an apprehension or belief that the issuer would be unable to discharge the liability.

It is concluded that the Taxpayer disposed of the unsecured loans because of an apprehension or belief that the Borrower would be unable to discharge the liability under the loans.

Detailed reasoning

Under section 70B of the ITAA 1936 a deduction may be allowed for a loss arising from the disposal of a traditional security.

A 'security' for the purposes of section 70B of the ITAA 1936 has the same meaning as in subsection 159GP(1) of the ITAA 1936 as follows:

· stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

· a deposit with a bank or other financial institution;

· a secured or unsecured loan; or

· any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

The loans made by the Taxpayer to the Borrower are unsecured loans and, therefore, they are securities under paragraph (c) of the definition.

A 'traditional security' for the purposes of section 70B of the ITAA 1936 has the same meaning as in subsection 26BB(1) of the ITAA 1936.

That subsection broadly provides that a traditional security is a security:

1. acquired after 10 May 1989

2. that is not a 'prescribed security' (i.e. Commonwealth securities that do not bear interest)

3. that is not trading stock of the taxpayer, and

4. that does not have an 'eligible return', or where it does have an eligible return, it must not exceed the prescribed level.

The Taxpayer acquired the securities after 10 May 1989.

The loans are not prescribed securities issued by the Commonwealth and they are not trading stock of the Taxpayer.

The meaning of 'eligible return' is provided in subsection 159GP(3) of the ITAA 1936. A security has an eligible return if at the time of issue it is reasonably likely that the sum of all payments received in relation to the security, excluding 'periodic interest' payments, will exceed the issue price. The difference between these two amounts is the eligible return. The provision cites three main reasons why an eligible return may arise. Those being:

· that the security was issued at a discount

· that the security is capital indexed, or

· that the security gives rise to deferred interest.

Under subsection 159GP(6) of the ITAA 1936 'periodic interest' includes interest that is payable less than one year after the commencement of the period in which it is expressed to be payable.

The loans were made by the Taxpayer for periods of less than one year and the Borrower was to repay the loan amount and the agreed interest.

This means that the loans do not have an eligible return as the only amounts to be paid by the Borrower in addition to the loan amounts was periodic interest.

The unsecured loans made by the Taxpayer to the Borrower are traditional securities for the purposes of section 70B of the ITAA 1936.

If a loss arises on the disposal of a traditional security it is deductible under subsection 70B(2) of the ITAA 1936 unless a deduction is prohibited by another provision.

Subsection 70B(3) of the ITAA 1936 ensures that the loss on disposal of a traditional security is to be determined on the basis of arm's length considerations for the acquisition and disposal of the security.

Under subsection 70B(4) of the ITAA 1936, a loss will not be deductible to the extent that it is a loss of capital or of a capital nature if, having regard to the financial position of the issuer of the security, perceptions of the financial position of the issuer of the security and other relevant matters, it would be concluded that the disposal took place because there was an apprehension or belief that the issuer would be unable or unwilling to discharge all of the liability to pay amounts under the security.

The 'issuer' is defined in subsection 70B(7) of the ITAA 1936 as the person who is liable to pay the amount due and payable under the security.

Securities that are 'marketable securities' may be excluded from the operation of subsection 70B(4) of the ITAA 1936 by paragraphs 70B(4)(c) and 70B(4)(d) of the ITAA 1936. These paragraphs exclude securities acquired, and disposed of, in the ordinary course of trading on a securities market or other exchange.

The definition of 'marketable security' under subsection 70B(7) of the ITAA 1936 means a traditional security that is covered by paragraph (a) of the definition of security in subsection 159GP(1) of the ITAA 1936. As the unsecured loans made by the Taxpayer are securities under paragraph (c) of the definition of security in subsection 159GP(1) of the ITAA 1936 they are not 'marketable securities'. Therefore the loans are not excluded by paragraphs 70B(4)(c) and 70B(4)(d) of the ITAA 1936.

The Taxpayer began to slow down the funding of loans to the Borrower because there were delays in payments the Borrower was due to make on existing loans. The Taxpayer also became aware that the Borrower was involved in a fraudulent scheme.

The balance of the unpaid debt was written off by the Taxpayer as a bad debt. The Taxpayer applied for a private ruling asking whether an income tax deduction can be claimed for the debt under section 25-35 of the ITAA 1997. The advice given in the private ruling that issued to the Taxpayer was that a deduction is not allowable.

A loss on the disposal by the Taxpayer of the unsecured loans is a capital loss and, given the circumstances leading to the disposal of the loans, it is concluded that the Taxpayer disposed of the loans for the reason, or for reasons which included the reason, that the Borrower would be unable to discharge all of his liabilities under the loans.

Therefore subsection 70B(4) of the ITAA 1936 applies to deny the Taxpayer an income tax deduction for any loss on the disposal of the unsecured loans.

Note: Where a loss is not deductible because the loss is capital in nature, the capital gains and losses provisions may apply.

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