Edited version of private ruling

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Ruling

Subject: Income & Outgoings

Question 1

When are expenses incurred for the purposes of section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

You can claim a deduction under section 8-1 of the ITAA 1997 for a loss or outgoing in the year of income in which the liability was incurred.

Question 2

When is income derived for the purposes of subsection 6-5(2) of the ITAA 1997?

Answer

Any profits or gains from the transactions are considered to have been derived in the year(s) in which they were received by you.

Question 3

Will the provisions of Division 245 of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) apply to the debt owed by you?

Answer

The debt forgiveness provisions of Schedule 2C to the ITAA 1936 will not apply to your circumstances.

Question 4

Will Subdivision 36-B of the ITAA 1997 deny a deduction for tax losses incurred?

Answer

You will not be able to deduct tax losses (if any) incurred before your bankruptcy in the 2010 and later years of income.

Facts

A transaction involving the exercise of xxx,xxx exchange traded call options took place. The transaction/s was included and comprised part of the partnership return for the 2007/2008 tax year.

A dispute subsequently occurred between sharebroker and the partnership regarding the brokerage rates and the execution of the trades. The dispute escalated and continued into the following year which culminated in civil action. The court awarded in favour of sharebroker and a further protracted process followed as the partnership attempted to make payment arrangements to settle the outstanding debt.

The matter was still unresolved by early 2009 and as such sharebroker was successful in declaring one of the partners bankrupt.

The transactions relating to the dispute were subsequently reversed out (included in taxable income for the 2008-09 income year) in the partnership return for the financial year ended 2008-09 thereby effectively cancelling the trades for taxation purposes.

Reasons for decision

Question 1

To be deductible in a particular year under section 8-1 of the ITAA 1997, a loss or outgoing must generally have been 'incurred' in that year. There is no statutory definition of the term 'incurred'. In general terms, an outgoing is incurred at the time a taxpayer owes a present money debt that the taxpayer cannot escape. A liability will be a loss or outgoing 'incurred' under section 8-1 of the ITAA 1997 even though it remains unpaid, provided that the taxpayer is 'definitively committed', or has 'completely subjected' itself to the liability (see FC of T v. James Flood Pty Ltd (1953) 10 ATD 240; (1953) 88 CLR 492).

However, a liability will not be considered to have been incurred if the liability is merely contingent or no more than pending, threatened or expected, no matter how certain it is in the year of income that the loss or outgoing will be incurred in the future. It must be a presently existing liability to pay a pecuniary sum.

In some situations it is not possible for a taxpayer to precisely determine the pecuniary liability that has arisen at the end of the year. Provided the expenditure represents a pecuniary liability encountered in the year of income and is capable of reasonable estimation, the expenditure is incurred and the taxpayer will be entitled to a deduction in the year the liability arose. The amount is not incurred in the year in which the precise quantum of the liability is ascertained (see Texas Company (Australasia) Ltd. v. FC of T (1940) 63 CLR 382 at pp. 465-7 per Dixon J).

Application to your circumstances

You can claim a deduction under section 8-1 of the ITAA 1997 for a loss or outgoing in the year of income in which the liability was incurred.

Question 2

Subsection 6-5(2) of the ITAA 1997 states that assessable income includes ordinary income 'derived" by the taxpayer during the income year.

As a general rule, the income derived by a taxpayer is to be determined using a method of tax accounting which, in the circumstances, is "calculated to give a substantially correct reflex of the taxpayer's income" (CT v. Executor & Trustee Agency Co of South Australia (1938) 63 CLR 108).

There are two basic methods of tax accounting - the 'receipts' or 'cash' basis and the 'accruals' or 'earnings' basis. Whether a particular method is appropriate to account for the income derived is a conclusion to be reached from all the circumstances relevant to the taxpayer and the income.

Taxation Ruling TR 98/1 sets out the Commissioner's views on which tax accounting method is likely to provide a substantially correct reflex of income in a relevant year. The Commissioner considers that the 'receipts" method is likely to be appropriate to determine:

· Income derived by an employee

· Non-business income derived from the provision of knowledge or the exercise of skill

· Business income derived from the provision of knowledge or the exercise of skill in the provision of services

· Income from investments; or

· Rent or royalties

Application to your circumstances

We consider that the 'receipts' method is the most appropriate to your circumstances. The relevant transactions were entered into during the 2006-07 income year. Accordingly, any profits or gains which you derived from the transactions during the period 1 July 2006 to 30 June 2007 should be reflected in your return of income for the year ended 30 June 2007.

Any gains or profits realised in the subsequent 12 months should be included in your return of income for the year ended 30 June 2008.

Question 3

Where commercial debts owed by an individual are forgiven, the total net forgiven amount for a particular income year must be applied in accordance with the commercial debt forgiveness provisions of Schedule 2C to the ITAA 1997 successively reduce the individual's deductible revenue losses, deductible net capital losses, deductible expenditure and the cost base of certain CGT assets.

A debt is a commercial debt under Division 245 of Schedule 2C to the ITAA 1936 if the whole or any part of the interest payable on the debt is, was, or will be an allowable deduction to the debtor.

However paragraph 245-40(a) of Schedule 2C to the ITAA 1936 provides that Schedule 2C does not apply where the forgiveness is effected under an Act relating to bankruptcy. It is not necessary for the debtor to be made a bankrupt for paragraph 245-40(a) of Schedule 2C to the ITAA 1936 to apply.

Application to your circumstances

The debt forgiveness provisions of Schedule 2C to the ITAA 1936 will not apply to you as you have stated that there has not been a forgiveness of the debt. Also these provisions will not apply if the forgiveness of the debt is effected under an Act relating to bankruptcy.

Question 4

Subdivision 36-B of the ITAA 1997 deals with the effects of bankruptcy.

Section 36-35 of the ITAA 1997 applies where a taxpayer has incurred a tax loss before becoming bankrupt. The section relevantly states:

"36-35(1) If:

(a) you became bankrupt; or

(b) you were released from a debt by the operation of an Act relating to bankruptcy;

before the income year, you cannot deduct a tax loss that you incurred before the day on which you either became bankrupt or were released"

The section provides that such a tax loss cannot be deducted in any income year subsequent to the bankruptcy or release. The rationale for this provision is that a taxpayer should not be able to claim a deduction for debts which the taxpayer is no longer obliged to pay. The following example explains how section 36-35 of the ITAA 1997 operates:

Sally was declared bankrupt on 1 January 2008. She has not made any payments towards the debts. Losses available as at 30 June 2007 were $200,000. Between January 2008 and 30 June 2008 she derived income of $50,000 from a new job.

The loss from the 2007 year can be deducted against the $50,000 post-bankruptcy income in the 2008 year. She cannot claim a deduction for the balance of the loss ($150,000) in the 2009 or later years.

Application to your circumstances

As you were made bankrupt on X, you can deduct any available tax losses in your return of income for the year ended 30 June 2009. However you cannot deduct losses (if any) incurred before your bankruptcy in the 2010 and later years of income.