Edited version of your written advice

Authorisation Number: 1012714921038

Ruling

Subject: Assignment of asset

Questions and Answers:

1. Does the assignment of the loans (including interest accrued) create a transaction whereby the unpaid interest component of loan crystallises and therefore is assessable income to you, the Estate, for income tax purposes, on the date of the assignment?

No.

2. Does the inability of the Estate to make any call on the above mentioned companies "to make any payment of capital, interest and any other monies pursuant to any such loan or loans" cause a revenue loss to the Estate whereby the unpaid interest component of the loan assigned should be treated as non-recoverable on a cash basis for income tax purposes on the date of the assignment?

No.

3. Does the inability of the Estate to make any call on the above mentioned companies "to make any payment of capital, interest and any other monies pursuant to any such loan or loans" deem the capital component of the loans (including the crystallised unpaid interest) as non-recoverable thereby giving rise to a capital gains tax (CGT) event?

Yes.

4. Does the above CGT event cause a capital loss to happen to the Estate?

No. Unless the market value of the loans on the date of the assignment was less than their original cost.

5. Do the commercial debt forgiveness rules apply?

This question is invalid.

6. Would the interest payments received by the Estate, or interest payments received by way of payments made by each of the companies on behalf of the Estate, prior to the signing of the deed, meet the definition of ordinary income for the purposes of calculating the net income of the Estate for taxation purposes on a cash basis?

Yes.

This ruling applies for the following period:

Year ended 30 June 2014

The scheme commences on:

1 July 2013

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.

On the day the deceased died, they were owed significant sums for loans they lent to their private companies, in which shares were also held by their family trust (Trust). In addition, his Executor was also the trustee of their Trust, prior to their death. When probate was granted, the Executor established loan agreements between The Estate and the indebted companies.

The will provided the Executor shall hold the whole of the estate in trust for the benefit of the grandchildren but not divide the Estate until the death of the children of the deceased.

At later time, various legal actions were commenced against the Estate by members of the deceased's family, particularly those who were not beneficiaries of the will.

A Deed was signed to settle and resolve all legal actions against the Estate, which included the following outcomes:

• The Executor resign as Trustee of the Trust;

• Family members appointed as Trustees of the Trust (who are also included as specified beneficiaries);

• Legal and beneficial title of shares in the companies be transferred to family members in their capacities as trustees of the Trust;

• The Executor resign as director of the companies and various family members appointed in their place;

• The new trustees realise the assets of the Trust and pay to the Estate from the Trust a certain cash amount;

• The Executor distribute to each grandchild their share of this cash estate;

• The Executor assign the relevant loans owed to the Estate to one of the companies;

• The Executor to not make any further call on the Trust and each of the companies to make payment of capital, interest and any other monies pursuant to any such loan or loans; and

• The beneficiaries indemnify the Executor for their agreement to call into the Estate only the cash sum.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 25-35

Income Tax Assessment Act 1997 Section 102-25

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 116-25

Income Tax Assessment Act 1997 Section 116-30

Income Tax Assessment Act 1997 Section 128-15

Reasons for decision

Question 1

Section 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) includes debts owed to you as examples of CGT assets.

Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year.

Interest is generally derived when it is received or credited (except for, for example, interest earned in a business of money lending: paragraph 47 of Taxation Ruling TR 98/1 Income tax: determination of income; receipts versus earnings).

Where there is the absence of any actual or express appropriation by the debtor or the creditor and a debtor owes both interest and principal, a payment is treated as applicable to interest in priority to principal (Falk v Haugh (1935) 53 CLR 163).

Under subsection 6-5(4) of the ITAA 1997 a taxpayer is taken to have received an amount of ordinary income when the amount is applied or dealt with in any way on the taxpayer's behalf or as the taxpayer directs.

In your case, on the day before the assignment date, accrued interest payable to the Estate (you) was merely a right, i.e., a debt owed to you, since it had not been received or credited. Therefore, the assignment of the debts owed to you did not result in you deriving assessable income on the assignment date in relation to accrued interest you did not receive.

Question 2

Section 25-35 of the ITAA 1997 states 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.

In your case, the accrued interest payable to you that had not been received by or credited to you and was ultimately assigned cannot be deducted because it was never included in your assessable income and because you were not carrying on a business of money lending.

Question 3

Section 108-5 of the ITAA 1997 includes debts owed to you as examples of CGT assets.

Section 104-10 of the ITAA 1997 states CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Subdivision 104-C of the ITAA 1997 is about the end of a CGT asset and includes section 104-25 of the ITAA 1997, which states CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset, for example, being released or forfeited.

If more than one CGT event happens in respect of a transaction, the most specific event is to be used (subsection 102-25(1) of the ITAA 1997).

Some published Tax Office principles that help distinguish between CGT events A1 and C2 include:

Yes, the forfeiture of a property under a State law is a disposal of a CGT asset under subsection 104-10(2) of the ITAA 1997….There has been a change of ownership from the taxpayer to the State by operation of law….As the property was compulsorily acquired by an entity under a power conferred by a State law, the time of the disposal is determined by subsection 104-10(6) of the ITAA 1997. (ATO Interpretative Decision ATO ID 2002/67)

The close-out of an option position is not the same as the sale of an asset. When an option position is closed out, there is no transfer of rights between two parties. CGT event A1 therefore cannot happen when an option position is closed out, there being no change in ownership of the asset from one entity to another as required by subsection 104-10(2) of the ITAA 1997. (ATO Interpretative Decision ATO ID 2005/164)

The word 'lost' in subsection 104-20(1) is wide enough to cover some situations where an asset is confiscated. However, other situations involving confiscation may amount to forfeiture (CGT event C2 - about cancellation, surrender and similar endings - in section 104-25) or a change of ownership (CGT event A1 - about disposals of CGT assets - in section 104-10), so that the circumstances of each case determine the relevant CGT event. (Taxation Determination TD 1999/79)

In your case, similar to a property compulsorily acquired by an entity under a power conferred by a State law, the relevant CGT asset, namely, the debt owed to you, did not end when the assignment occurred. Instead, a change of ownership occurred from you to another entity. It follows CGT event A1 is the most specific event is to be used when the debt owed to you was assigned (rather than CGT event C2).

Question 4

Item 1 of subsection 128-15(4) of the ITAA 1997 provides if a deceased person acquired an asset on or after 20 September 1985, their legal personal representative is taken to have acquired it at the cost base of the asset on the day of the deceased person's death.

Section 116-30 of the ITAA 1997 states if you received no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset that is the subject of the event. (The market value is worked out as at the time of the event.)

Section 116-25 of the ITAA 1997 provides this market value substitution rules applies to CGT events A1 and C2 (apart from paragraph 116-30(3)(a), which would not apply to your case if CGT C2 actually happened).

In your case, you would only make a capital loss in relation to the assignment if the recoverability of all or any part the debt (due to the financial position/solvency of the debtor) affected and reduced its market value. Otherwise, if the debt was wholly recoverable by any owner of the debt, at the time you disposed of it, no capital loss would happen.

Question 5

The forgiveness of commercial debts provisions in Division 245 of the ITAA 1997 are about when a creditor forgives a commercial debt you owe. Thus this Division offsets the forgiven amount against amounts that could otherwise reduce your taxable income in the same or a later income year.

In your case, you did not forgive the debts owed to you. Further, the forgiveness of commercial debts provisions apply to the debtor rather than to the creditor. It follows your question about the forgiveness of commercial debts provisions is not applicable to you.

Question 6

As previously explained: (i) subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident taxpayer includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year; and (ii) interest is generally derived when it is received or credited.

In your case, the interest received by or credited to you prior to that date of the Deed is assessable to you as ordinary income.

The accrued interest not paid or credited to you was capitalised as a debt owed to you and was included in the settlement sum paid to the claimants (the settlement sum comprising the company loans and interest owing to you). The interest amount that was capitalised is not assessable as ordinary income to you and becomes part of a capital amount paid by you in order to end the claimants' right to receive compensation from you.

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