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This edited version has been archived due to the length of time since original publication.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.

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Edited version of your written advice

Authorisation Number: 1012757863046

Ruling

Subject: Deductibility of losses

Question 1

Are you entitled to a deduction for the payment made as part of a partnership business arrangement with an international party?

Answer

No.

Question 2

Did capital gains tax (CGT) C2 occur in the 20ZZ financial year?

Answer

Yes.

This ruling applies for the following period

Year ending 30 June 20YY

Year ending 30 June 20ZZ

The scheme commences on

1 July 20XX

Relevant facts and circumstances

You met an individual through a social website.

You and the individual, at first instance, agreed to form a partnership to acquire products for sale. It was intended to purchase or acquire products from an overseas location.

The individual, in accordance with the terms and representations of the partnership, indicated to you that they were in the process of acquiring products for a total sum of $x.

You arranged for various payments to the individual for the acquisition of the products.

Investigations have shown that no items were purchased or acquired by the individual and that they had perpetrated fraud.

You have made numerous demands to the individual for repayment of the monies after unsuccessfully receiving the products.

You reported the matter to the local police station. A fraud report was also simultaneously filed.

You were informed by police officers that the matter had been referred to the Australian Federal Police and Interpol by reason that the matter involved international crime.

You were subsequently informed that it was unlikely there would be any form of restitution or recovery of the monies. During the relevant financial year you were informed that it was unlikely there would be any further progress made.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 paragraph 108-5(1)(b)

Reasons for decision

Section 8-1 of the ITAA 1997 allows you to claim a deduction for a loss or outgoing that is incurred in gaining or producing your assessable income, or necessarily incurred in carrying on a business to gain or produce assessable income. These deductions are limited by the exclusion of losses or outgoings that are capital, private or domestic in nature.

When a business commences

In determining when a business commences, there are three indicators that must be present before it can be said that a business has commenced. These are:

For example, for a primary production activity involving the planting and cultivating of trees, then the planting of the trees could be seen as the commencement of that business. Alternatively, if your business activity is characterised as a trading activity, involving conducting services in return for a fee, the business would generally be considered to have commenced once you begin conducting the services for a fee.

Purpose, intention and decision

The chain of events leading to the commencement or start-up of a business activity often begins with a mere intention to establish the business activity.  This is developed by researching the proposed business and, in some instances, by experiment.  This process culminates in a final decision on whether to commence business.  However, not all businesses commence in such an orderly manner.

Acquisition of a business structure

For a business activity to commence, an appropriate business structure should be in place. As to what this structure will consist of, and its size, this will be a question of fact and degree, and depend on the nature of the business activity. It is usually a collection of capital assets. What the particular capital assets are will depend on the particular business activity.

Commencement of Business Operations

As noted by Brennan J in Inglis v. Federal Commissioner of Taxation (1979) 10 ATR 493; 80 ATC 4001, the level of activity is important in deciding whether a business is being carried on.  Brennan J stated at ATC 4004-4005; ATR 496-497 that:

In this case we do not consider you had begun ordinary business operations during the 20YY financial year. At that point in time you did not have trading stock or your product ready for sale. We consider that your activities were preliminary to the carrying on of your intended business. Therefore, the payment for the items was not incurred in the course of carrying on a business and is not deductible under section 8-1 of the ITAA 1997.

Question 2

Capital gains tax (CGT) is the tax you pay on certain gains you make. Section 102-20 of the ITAA 1997 provides that you make a capital gain or capital loss as a result of a CGT event happening to an asset in which you have an ownership interest. Under section 108-5 of the ITAA 1997 an asset for CGT purposes is any form of property or a legal or equitable right that is not property. An example of a CGT asset is a debt owed to you.

Under section 102-20 of the ITAA 1997 you make a capital gain or capital loss as a result of a CGT event.

Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if the ownership of an intangible CGT asset ends by the asset:

The time of the event is when you enter into the contract, that results in the asset ending or if there is no contract, when the asset ends.

The mere writing off of a debt (by a taxpayer) is insufficient to constitute a cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment at law or in equity.

The Commissioner takes the view that in certain circumstances contractual rights can be discharged or come to an end merely by being treated as being at an end by the parties. It will be considered that the entity made a capital gain/loss at the time the contractual rights end by being abandoned.

In this case, we consider that you acquired contractual rights upon entering into the agreement with the online party. These contractual rights are a CGT asset, as per paragraph 108-5(1)(b) of the ITAA 1997.

Your contractual rights are considered to be properly abandoned in the 20ZZ financial year as it is reasonably certain that there is no real hope of recovering any of the funds. At this time, CGT event C2 will occur and you will make a capital loss. As you will have received no capital proceeds from the CGT event, your capital loss will be equal to the cost base of the abandoned rights.

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