You financed part of the loan to the developer from a financial institution, in your personal capacity, and not as trustee for the trust.

Unfortunately the period passed without the borrower repaying any interest or capital amount of the loan.

A Receiver/Manager was appointed to the developer. The property was sold for $xx however the proceeds were not enough to pay any money to you for the advance of capital.

The guarantor was suffering financial stress at the time and has now entered in bankruptcy.

Development No 2

A development was to be undertaken by entity 1 with finance to acquire the asset. You were to provide additional finance.

Entity 1 entered into an agreement with entity 2 to purchase assets.

Entity 1 paid a deposit in relation to the asset.

Entity 1 submitted a development application with the local authority. The development application was approved subject to a number of conditions. As a result of the conditions placed on the development, it was decided by entity 1 that the development would not be viable and therefore it did not proceed with the purchase of the asset.

Entity 2 terminated the contract and retained the deposit.

You are a director and shareholder in entity 1. The guarantor is also a director and owned the remaining share in entity 1.

Legal Expenses

Entity 1 incurred legal expenses. Those fees were paid by entity 3.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25-35

Reasons for decision

Question 1

Bad debt under section 25-35 of the ITAA 1997

Section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997) deals with bad debts. Subsection 25-35(1) of the ITAA 1997 states that you can deduct a debt (or part of a debt) that you write off as bad in the income year if:

a) it was included in your assessable income for the income year or for an earlier income year; or

b) it is in respect of money that you lent in the ordinary course of your business of lending money.

Paragraph (a) is not relevant here as you have stated that when the development was sold by the Receiver the proceeds were not enough to pay you what was owed and as a consequence you did not include any amount in your assessable income in any year.

Therefore, the only avenue in which you may be able to claim a deduction for a bad debt under section 25-35 of the ITAA 1997, is if it can be determined that the money was lent in the ordinary course of a business of lending money.

Are you in the business of lending money?

The question whether a taxpayer is carrying on the business of lending money is a question of fact (Newton v. Pyke (1908) 25 TLR 127). It is only necessary that the business of money lending be carried on; it need not be the only business or the principal business. It does not appear to be sufficient, however, if the lending of money is merely ancillary to or an adjunct of the business carried on by the taxpayer (11 CTBR Case 29). Also, it is not enough merely to show that a person has on several occasions lent money at remunerative rates of interest; there must be a certain degree of continuity and system about the transactions. The activity should be capable of being described as 'business operations intended to yield a profit' (Richard Walter Pty Ltd v. FC of T 31 ATR 95; 95 ATC 4440 per Tamberlin J at p 4457) (Taxation Ruling TR 92/18, paragraphs 42-45).

Ordinarily, a money lender is one who is ready and willing to lend to all and sundry. However, as stated in paragraph 46 of TR 92/18:

…a money lender need not necessarily be ready and willing to lend moneys to the public at large or to a wide class of borrowers. It would be sufficient if the taxpayer lends moneys to certain classes of borrowers provided the taxpayer does so in a business-like manner with a view to yielding a profit from it.

The above comments explain that to be considered to be in the business of lending money a taxpayer must be able to satisfy the following factors;

• there is continuity and system about their money lending transactions

• there is a willingness to lend money to the public, or at least a particular class of borrowers

• the transactions are undertaken in a business-like manner, and

• the transactions are undertaken with a view to a profit

Failure to satisfy a majority (or even merely one) of the factors listed above may lead to the conclusion that a taxpayer is not in the business of lending money as occurred in Case M74 80 ATC 521. In that case, the taxpayer made between one and 12 loans each year from money originally derived from share sales. Some loans were to clients of the taxpayer's solicitor and some were "on demand" loans to companies associated with the taxpayer. The taxpayer had no standard loan application form and did not advertise. Borrowers were selected on the quality of the security and the rate of return. Unsecured loans were made if considered safe and if the interest rate was attractive. It was held that the taxpayer was merely investing its funds and was not carrying on business as a money lender. This was so despite the fact that at the time the loans were provided the taxpayer had insisted that its main function had been lending money.

In your case you, in your personal capacity, borrowed money which was in turn on- loaned to the developer by you as trustee for the trust to enable it to fund a development. You were also willing to provide finance to entity 1 for the second development, but never actually provided any funding. As previously stated the loan to the first developer was made through you, in your capacity as the trustee of the trust, as outlined in the schedule to the loan agreement. You also didn't provide any funding to the second development as it did not proceed, consequently there is no continuity or system to your money lending transactions. You also stated that you became aware of an opportunity to make profits by providing finance to developers however, there is only evidence to suggest that there was only the one interaction with a developer (where funds were provided) so there is no evidence to suggest that there is any willingness to lend money to the public, or at least a particular class of borrower. There is also no evidence to suggest that the one transaction (actual financing) was, or wasn't, conducted in a business-like manner. You have stated however that the rate of interest payable under the one financing was x% per annum. This is an indication of the undertaking of this activity for profit.

Based on the information provided, we consider that one transaction is not enough to indicate continuity of your money lending transactions, therefore it is considered you are not in the business of lending money, consequently a deduction for a bad debt is not allowable under section 25-35 of the ITAA 1997.

Question 2

Detailed reasoning

Subsection 8-1(1) of the ITAA 1997 states you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Subsection 8-1(2) of the ITAA 1997 states that you cannot deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income and is not:

n Capital, private or domestic in nature,

n Incurred in gaining or producing exempt income, or

n a provision of the Act prevents you from deducting it.

In this case a loan agreement was drawn up between you, as trustee for the trust, and the first developer. You (personally) and two other entities provided the funds on a progressive basis.

Despite the fact that there was no income to pay you after the sale of the property from the Receiver/Manager, there was no obligation on the developer to pay you as it had a legal loan agreement with the trust. If income had been available from the sale, the developer was legally obligated to pay the trust, the capital and interest on the loan and not to pay you. You produced no assessable income, nor would you have, had there been income available from the Receiver/Manager therefore, the required nexus is not established between you incurring the expense and any assessable income. You are therefore not entitled to claim loss for the capital amount of the loan or a deduction for the interest on the loan.

Question 3

Detailed reasoning

Subsection 8-1(1) of the ITAA 1997 states you can deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Subsection 8-1(2) of the ITAA 1997 states that you cannot deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income and is not:

n Capital, private or domestic in nature,

n Incurred in gaining or producing exempt income, or

n a provision of the Act prevents you from deducting it.

In this case you were to provide financing for the construction however no construction occurred as entity 1 decided not to proceed with the project even after approval was given. Entity 1 paid a deposit. After entity 1 did not proceed with the purchase, the deposit was forfeited. As entity 1 incurred and paid the deposit expense, you are not entitled to a deduction as the loss or outgoing was not incurred by you in gaining or producing your assessable income.