Edited version of your written advice

Authorisation Number: 1051264377903

Date of advice: 8 August 2017

Ruling

Subject: Capital Gains Tax: capital loss for loan to company in liquidation

Question 1

Will the unrecoverable net amounts invested in the company trigger a capital loss under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997), CGT event A1, in the year ended 30 June 2015?

Answer

No

Question 2

Will the unrecoverable net amounts invested in the company trigger a capital loss under section 104-145 of the Income Tax Assessment Act 1997 (ITAA 1997), CGT event G3, in the year ended 30 June 2015?

Answer

No

Question 3

Will the unrecoverable net amounts invested in the company trigger a capital loss under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997), CGT event C2, in the year ended 30 June 2016?

Answer

Yes

This ruling applies for the following period:

1July 2014 to 30 June 2016

The scheme commenced on:

During the income year ended 30 June 2015

Relevant facts and circumstances

You invested various amounts in the company. During this time, you owned all the shares issued by the company.

When the funds were initially advanced, you and the company entered into an unsecured loan agreement. Under the terms of the agreement, the company should have paid interest by the end of each month, unless the lender agreed not to charge such interest.

The funds were injected in the company to keep the company viable. The source of these funds were drawn-down on your home loan and your personal line of credit. The funds were utilised to buy stock and to fund the working capital requirements of the company.

In mid-2015 the company filed for creditors voluntary liquidation, and a liquidator was appointed. You lodged a proof of debt with the liquidator to prove your investment in the company.

No interest was charged for the 2014 and 2015 income years.

It is assumed that all the transactions recorded in the profit and loss statement of the company were at market value and conducted at arm’s length.

A loan owing to the director was still outstanding as at 30 June 2015.

The company was deregistered on DDMMYY. The loan owing to you remained outstanding. No liquidator’s distribution was made to any of the creditors.

Relevant legislative provisions

Section 104-10 of the Income Tax Assessment Act 1997

Section 104-25 of the Income Tax Assessment Act 1997

Section 104-145 of the Income Tax Assessment Act 1997

Section 108-5 of the Income Tax Assessment Act 1997

Section 108-20 of the Income Tax Assessment Act 1997

Section 116-20 of the Income Tax Assessment Act 1997

Section 116-30 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

Summary

CGT event A1 occurs when there is a disposal of a CGT asset. The appointment of a liquidator did not alter your ownership in the asset, therefore CGT event A1 did not occur.

Detailed reasoning

Capital loss

Pursuant to s 108-5 of the Income Tax Assessment Act 1997 (ITAA 1997) a capital gains tax (CGT) asset can be any kind of property, or legal or equitable right that is not property. A debt or a right to repayment is a CGT asset.

Section 108-20 of ITAA 1997 provides that a capital loss made from a personal use asset is disregarded.

A personal use asset is a debt arising other than:

(a) In the course of gaining or producing assessable income;

(b) From you carrying on a business.

Taxation Ruling TR 96/23 at paragraph 47 states that:

47. The test of what is a 'personal-use asset' in terms of subparagraph (b)(ii) of the definition in subsection 160B(1) requires a finding that the debt came to be owed for a primary purpose other than that of gaining or producing income or in the carrying on of a business. Therefore, if the debt which came to be owed as a consequence of entering the contract of guarantee, was expected to promote and enhance the income-earning activity of the guarantor, or came to be owed in the carrying on of the business, the debt would not be a personal-use asset and a capital loss would be allowed.

It follows that the 'test’ on whether the debt is a personal-use asset is whether the debt came to be owed otherwise than in the course of gaining or producing your assessable income, or in carrying on a business.

An example of a 'personal-use’ asset is provided by CG Determination Number 2 TD 2 at paragraph 4:

A father lends his son money to buy a house. If the son is later not able to repay the loan and the father waives the debt, the father is not allowed a capital loss for the disposal of the debt.

If a shareholder in a company makes a loan to the company to assist the company to continue the business, and thus to earn profits and to distribute dividends to the shareholder, the debt would not be a personal use asset.

When determining whether the loan you made to the company is a personal use asset or not, consideration has to be given to the effective use of the funds. Only funds applied for the acquisition of stock and to fund working capital requirements are excluded from the definition of personal use assets and can give rise to a capital loss.

The portion of the loan that funded the receivable owing from the director could be a personal use asset unless there is a connection between the advance of funds and the purpose of gaining assessable income.

Event A1

Section 104-10 of the ITAA 1997 provides that CGT event A1 happens when there is a disposal of a CGT asset. For the disposal to occur there must be a change of ownership of the CGT asset from the taxpayer to another entity.

Pursuant to subsection 104-10(2) of the ITAA 1997, a change of ownership occurs because of some act or event or by operation of law. The change of ownership does not occur:

● If you stop being the legal owner of the asset but continue to be its beneficial owner; or

● Merely because there is a change of trustee.

The appointment of the liquidator does not have any impact on your beneficial ownership of the loan. You were the owner of the CGT asset before and after the appointment of the liquidator, and at all times in the 2015 income year.

Question 2

Summary

You can choose to realise a capital loss under event G3 when you have received a declaration in writing from the liquidator or administrator of the company. The liquidator was appointed after 30 June 2015; therefore the declaration requirement under subsection 104-145(1) was not satisfied in the 2015 income year. CGT event G3 occurred when the liquidator advised you in writing that the loan was worthless.

Detailed reasoning

In the event of the dissolution (winding up) of a company, a CGT event occurs when the company is wound up. While a company remains in administration or liquidation, the CGT event has not yet occurred and you are not able to make a capital loss or gain at that time.

However, in certain circumstances you can choose to realise a capital loss on worthless shares or financial instruments before the dissolution of a company. CGT event G3 occurs if a liquidator or administrator of a company declares in writing that they have reasonable grounds to believe that there is no likelihood that owners will receive any further distribution from the company in the course of its winding up (subsection 104-145(1) of the ITAA 1997).

If this declaration is made, the owners of the relevant asset can choose to make a capital loss at the time of the declaration (subsections 104-145(2) and 104-145(4) of the ITAA 1997).

Therefore you are entitled to claim the capital loss in an income year when either:

● the administrator makes a declaration that there is no likelihood that you will receive any further distribution AND you choose to realise the capital loss at that time, OR

● when a court orders that the company be dissolved (wound up).

In your case, the company was not in liquidation during the year ended 30 June 2015, hence there would have not been any declaration made by the liquidator or administrator.

It follows that CGT event G3 did not occur during the year ended 30 June 2015.

Although CGT event G3 did not occur during the year ended 30 June 2015, you could choose to trigger event G3 during the income year in which the liquidator made a declaration in writing that the financial instrument represented by your loan owing from the company was worthless.

Question 3

Summary

You made a capital loss under CGT event C2 in relation to the unrecoverable net amounts invested in the company at the time of deregistration of the company. The capital loss is available to the extent that the funds were not a personal use asset.

Detailed reasoning

CGT event C2 happens when the ownership of a CGT asset ends by being redeemed, cancelled, or in other specified ways. As outlined above, a loan is a CGT asset.

Taxation Determination TD 2000/7 describes the Commissioner’s view on when a CGT event occurs for the purpose of Parts 3-1 and 3-3 of the ITAA 1997 when a company is deregistered. Accordingly to paragraph 1:

A CGT event happens for the purposes of Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 ('the 1997 Act'), when the company is deregistered in accordance with the Corporations Law ('C Law'). A company ceases to exist on deregistration. (However, CGT event G3 in section 104-145 of the ITAA 1997 may happen at an earlier time in respect of worthless shares in a company in liquidation or administration - see Note 1 for more details.)

The determination provides that when a company is deregistered it ceases to exist. It follows that all the company’s debt is abandoned, surrounded or forfeited for the purpose of s 104-25 of the ITAA 1997 when deregistration occurs (ATO ID 2008/58).

In this case, the company was deregistered on DDMMYY. It follows that your ownership of the loan ended at this point in time, and CGT event C2 occurred at the time of deregistration.

The general rules about capital proceeds are in section 116-20 of the ITAA 1997. The capital proceeds are modified by subsection 116-30(1) of the ITAA 1997 which provides that:

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.)

The capital proceeds in this case are equal to the market value of the assets at the time the company was deregistered. The company did not have any assets at the time of deregistration; hence the loan had a nil market value.

The amount of the capital loss is equal to the difference between the market value of the unrecovered debt and its cost base, to the extent that the loan does not represent a personal use asset.

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