1011661528577 | Legal database

Disclaimer
This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of private ruling

Authorisation Number: 1011661528577

This edited version of your ruling will be published in the public Register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. Contact us at the address given in the fact sheet if you have any concerns.

Ruling

Subject: Bad debt

1. Can you claim a deduction against your ordinary income if you incur a bad debt in relation to funds lent to a property developer?

No.

2. Will a bad debt incurred in relation to funds lent to a property developer be a capital loss?

Yes.

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commenced on:

1 July 2006

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You loaned funds for use in property development. You were not carrying on a business of money lending. The loan contract was for a period of three months, with interest payable on a monthly basis.

At a later time, the property developer was declared bankrupt. A bank holding mortgages over the properties sold the properties, from which remained a relatively small surplus. You and a number of other parties are involved in legal action trying to recover your funds or a share of the surplus.

To date, you have received neither the principal nor the interest and, in your opinion, it is unlikely you will receive your money back. Further, the bank your borrowed the funds from has commenced legal action against you to recover the on-lent amount plus interest.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-35

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 110-55

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.

Section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997) is about deductions for bad debts. To qualify for a bad debt deduction under section 25-35 of the ITAA 1997, the debt, in addition to being bad, must satisfy two criteria:

There must be a physical writing off of the debt.

The debt must have been included in your assessable income for the income year or for an earlier income year (unless you were in the business of lending money).

Section 108-5 of the ITAA 1997 is about capital gains tax (CGT) assets and includes debts owed to you as CGT assets. When a debt owed to you ends, CGT event C2 in section 104-25 of the ITAA 1997 happens.

When a capital loss happens under CGT event C2, subsection 104-25(3) of the ITAA 1997 specifies the capital loss is calculated by using the assets 'reduced cost base'.

The reduced cost base of a CGT asset is defined under section 110-55 of the ITAA 1997. It allows legal expenses in its second element but does not allow interest expense in its third element. It follows legal expenses incurred in attempting to recover a debt owed to you will form part of the reduced cost base of a capital loss under section 104-25 of the ITAA 1997. However, interest expense incurred on borrowings in relation to the debt will not form part of the reduced cost base.

The time of CGT event C2 in relation to a debt owed to you will occur when you enter into the contract that results in the asset ending (for example, a settlement deed) or, if there is no contract, when the asset ends (for example, it becomes irrecoverable at law).

In your case, you cannot claim a bad debt deduction under section 25-35 of the ITAA 1997 because your bad debt is not an amount you previously included in your assessable income and because you were not in the business of lending money. Whatever portion of your bad debt you cannot recover will be a capital loss under section 104-25 of the ITAA 1997. You can include your relevant legal costs in the capital loss but you cannot include your interest expenses imposed by the bank. The time of the CGT event will happen in the income year when the debt owed to you ends.

Copyright notice

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).