Edited version of private ruling

Authorisation Number: 1011607555723

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: Loss from share sales

Question 1

Is the loss that the taxpayer made on the sale of shares deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2009

The scheme commences on:

Date X

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.

The taxpayer resigned as an employee of Company A and on ceasing employment, held share options in that company.

The taxpayer discussed with a financial adviser what to do regarding the options and was provided the following choices:

a. not to exercise the options; or

b. exercise the options with a view to hold the shares acquired as long term capital assets; or

c. exercise the options with a view to quickly selling the shares after the announcement of their results.

The taxpayer chose option c because the taxpayer expected that the share price would rise.

The acquisition was financed through a margin loan arrangement.

The share price did not rise and fell below the price they were acquired for.

The shares were held onto beyond the date of the original plan and eventually sold resulting in a loss.

It is the taxpayer's view that the above scheme is an isolated transaction and that the loss should be deductible in accordance with Taxation Ruling TR 92/4 Income tax: whether losses on isolated transactions are deductible.

No evidence was provided to suggest that the taxpayer was engaged in a business of share trading.

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.

Summary

Subsection 8-1(1) of the ITAA 1997 allows a taxpayer to deduct from their assessable income any loss or outgoing that is incurred in gaining or producing assessable income.

It also allows for a deduction where the loss or outgoing was necessarily incurred in carrying on a business for the purpose of gaining, or producing assessable income.

However under subsection 8-1(2) of the ITAA 1997 a deduction cannot be claimed if the loss or outgoing is a loss or outgoing of capital or of a capital nature.

It is the taxpayer's view that the loss is deductible under subsection 8-1(1) of the ITAA 1997 as an isolated transaction.

In looking at TR 92/4 and isolated transactions to be able to claim a deduction there has to be:

§ an intention or purpose of making a profit from the transaction; and

§ the transaction was entered into, and the profit (if any) was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

In this case there was an intent to make a profit. The taxpayer purchased the shares in the belief that the share price would rise and the taxpayer could then sell them and make a profit from the sale.

What needs to be decided is whether the transaction, being the buying and then selling of shares, is in the course of carrying on a business or in carrying out a business operation or commercial transaction.

As stated in paragraph 3 of TR 92/4, TR 92/4 should be read in conjunction with Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income. In effect if the profits are assessable as ordinary income then a deduction will be allowed.

TR 92/3 was issued to set out the Commissioners view on that application of the decision of the Full Court of the High Court of Australia in FC of T v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693. In respect of carrying out a business operation or commercial transaction paragraph 13 of TR 92/3 provides a list of factors that that should be considered. These being:

§ the nature of the entity undertaking the operation or transaction;

§ the nature and scale of other activities undertaken by the taxpayer;

§ the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained;

§ the nature, scale and complexity of the operation or transaction;

§ the manner in which the operation or transaction was entered into or carried out;

§ the nature of any connection between the relevant taxpayer and any other party to the operation or transaction;

§ if the transaction involves the acquisition and disposal of property, the nature of that property; and

§ the timing of the transaction or the various steps in the transaction

In this case the plan was to purchase the shares and then sell them when the interim results was announced the same month. This did not happen and what we need to do look at what actually happened

If we look at what happened in more detail step 3 did not take place as the share price fell rather than rising as predicted. Rather than selling them the taxpayer chose to hold onto them. When they were eventually sold they were sold for a loss.

The only 'income' the taxpayer could expect to receive from this scheme is the gain when the shares were sold.

In respect of a profit-making purpose the facts of this case are similar to those outlined in example 1 in TR 92/3. This example states:

Ms Donovan, a public servant, purchased 10,000 shares in a listed public company at a price of $1 each and sold them 18 months later for $2 each. During that period, the company paid one small dividend. Donovan was not carrying on a business of trading in shares. A significant purpose of Donovan in acquiring the shares was to make a profit from an increase in the value of the shares.

The profit made on the sale of the shares is not income. The transaction was merely an investment, not a business operation or commercial transaction.

A similar example is also provided in example 2 of TR 92/4 which states:

In 1987 Mr Lyon bought 20,000 shares at $1 each in a large public company from an arm's length seller. Mr Lyon was not carrying on a business of trading in shares . He principally bought the shares to derive dividend income although a significant purpose was to benefit from an increase in the value of the shares. In 1992 Mr Lyon sold the 20,000 shares at $0.80 each.

Mr Lyon's loss is a capital loss and not deductible under subsection 51(1). If the sale of shares had returned a profit, that profit would not have been income because the transaction was merely an investment, not a business operation or commercial transaction.

Although under the plan the taxpayer was to hold the shares for less time than those shown in both example the reasoning remains the same.

In addition paragraph 11 of TR 92/4 states:

If an isolated transaction was expected to produce a capital profit, a loss incurred in that transaction is not deductible under subsection 51(1). Such a loss is expressly excluded from deduction as being a loss of capital or of a capital nature, regardless of whether the transaction also produced, or was expected to produce, income

Although withdrawn and issued in respect of disposal of land, ATO Interpretative Decision ATO ID 2002/483 looked at a loss incurred on an isolated sale of property and whether it was deductible under subsection 51(1) of the Income Tax Assessment Act 1936 (this subsection has was replaced with section 8-1 of the ITAA 1997)

In this case a taxpayer purchased land with the intent to redevelop it cut after exchanging contracts determined that the project was going to be unprofitable so sold the land without making any improvements to it. The conclusion made was that the loss was a capital loss and not deductible. The reason provided were:

A loss from an isolated transaction is deductible under subsection 51(1) (ITAA 1936) if:

(a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable; and

(b) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

(See Taxation Ruling 92/3 and Taxation Ruling 92/4.)

As no assessable income was actually derived in this case, it is necessary to establish that there was an expectation to produce assessable income ( Ronpibon Tin N.L and Tongkah Compound N.L. v. FC of T (1949) 78 CLR 47). The taxpayers failed to demonstrate how their proposed property development activities would ever result in a project which would have produced assessable income. The taxpayers did not seek any advice on how to run a property development business profitably, therefore a profit motive cannot readily be drawn from the facts.

Similarly, whether or not the transaction occurred in the course of carrying on a business is to be determined on the basis of objective facts, having regard to all the circumstances of a particular case (see Magna Alloys & Research Pty Ltd v. FCT (1980) 11 ATR 276 at 285, 287; 80 ATC 4542; McCurry v. FCT (1998) 39 ATR 121 at 127; 98 ATC 4487). By itself, the taxpayer's state of mind is not something which establishes that the transaction was entered into in the course of carrying on a business.

Based on the facts, the transaction is an isolated transaction. This is because: there was an absence of a repetitive element (see Jones v. Leeming (1930) AC 415 at 430; Crow v. FCT (1988) 19 ATR 1565 at 1573; 88 ATC 4620; Ferguson v FC of T 79 ATC 4261 at 4265; 9 ATR 873); the project was simple and involved little activity from the taxpayers ( Statham & Anor v. FC of T 89 ATC 4070; 20 ATR 228) and the project was approached in a haphazard way. (See Taxation Ruling TR 97/11 and Taxation Ruling TR 92/3 for elements indicating 'significant commercial characteristics'). In these circumstances the sale of the property is a mere realisation of an asset (see FCT v. Myer Emporium Ltd 163 CLR 199 at 213; Statham & Anor v. FC of T 89 ATC 4070 at 4077; 20 ATR 228; Case W59 89 ATC 538 at paragraph 60; 20 ATR 3728). The loss is therefore not deductible under subsection 51(1) (ITAA 1936); rather, it is a capital loss that is subject to the capital gains tax provisions of Part IIIA (ITAA 1936).

Although the taxpayer entered into the scheme to make a profit, the profit could only come from selling the shares at an increased value and the entire scheme was contingent on the taxpayer being able to sell the shares for more than he acquired them for.

The plan itself is a simple one. The activities to be undertaken by the taxpayer involved 2 steps buying the shares and then selling them on a later date. The short term margin loan facility was how the scheme was financed.

Setting aside the volume of shares involved and the way in which the scheme was financed, the mechanics of this scheme is no different to one in which someone purchases a parcel of shares with the intent of making a profit from their sale at a later date. There is a profit making purpose but once the shares are purchased the ability to make a profit is reliant on factors and actions outside of the owner's control.

In this case the whole transaction relied on the taxpayer obtaining a capital gain from the transaction. There was no other way the taxpayer could have made a profit from this scheme and the nature of the property purchased meant that the taxpayer could not do anything to the property himself to increase it value.

Therefore as the taxpayer could not do anything to the actual property itself to increase it's value it has to be seen as an investment rather than a business operation or commercial enterprise in accordance with examples 1 of TR 92/3. and 2 of TR 92/4

For completeness even if this transaction was an isolated transaction as described in TR 92/3 we should also look at whether the taxpayer would be entitled to a deduction under section 25-40 of the ITAA 1997. This section looks at deductions incurred under a profit-making undertaking or plan.

The application of section 25-40 of the ITAA 1997 in respect of loss on the sale of shares acquired with a profit making intention on or after 20 September 1985 was addressed in ATO Interpretative Decision ATO ID 2002/951.

This ATO ID came to the conclusion that a the taxpayer was not entitled to a deduction under section 25-40 of the ITAA 1997 for a loss on the sale of shares acquired on or after 20 September 1985.

The facts in this ATO ID were:

The taxpayer acquired shares with the intention of making a profit on the resale of those shares. The shares were acquired on or after 20 September 1985.

The shares were not acquired with the intention of long term holding for capital appreciation or to derive assessable income as dividends or bonus share issues.

The taxpayer made a net loss from buying and selling shares.

The taxpayer is not in a business of share trading.

There facts are very similar to those in this case and therefore the reasoning behind the decision is also applicable here. These reasons were:

Subsection 25-40(1) of the ITAA 1997 allows a deduction for a loss arising from the carrying out of a profit-making undertaking if any profit from that undertaking would have been included in the taxpayer's assessable income by section 15-15 of the ITAA 1997.

However, subsection 25-40(2) of the ITAA 1997 provides that a loss from a profit-making undertaking is not an allowable deduction if the loss arises in respect of the sale of property acquired on or after 20 September 1985. The term 'property' encompasses not only physical assets but also intangible assets such as shares and securities.

As the shares constitute property acquired by the taxpayer on or after 20 September 1985, the loss on the sale of the shares is not an allowable deduction under section 25-40 of the ITAA 1997.

The loss incurred by the taxpayer is a capital loss and not deductible under section 8-1 of the ITAA 1997. This loss can only be applied against a capital gain. However it can be carried forward indefinitely and applied against a capital gain made in future years.