Edited version of private ruling

Authorisation Number: 1011711500930

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Ruling

Subject: Carrying on a business of lending money

Question

Is XYZ Fund carrying on a business of lending money for the purpose of section 230-180 and section 230-195 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2011.

The scheme commenced on

1 July 2010.

Relevant facts

XYZ Fund is a managed investment scheme under the Corporations Act 2001. XYZ Fund raises all its funds by issuing units to the investment schemes.

XYZ Fund uses funds obtained from its unit holders to lend money in the form of mortgage loans to arms length borrowers. XYZ Fund focuses on commercial property lending in the major Australian capital cities and loans are predominantly sourced from specialist commercial mortgage originators, finance brokers and financial advisers.

At 30 June 2010, XYZ Fund assets as set out in its audited financial statements comprised:

· Loans backed by mortgages

· A relatively small amount of cash and receivables, fixed and floating interest rate securities, other unit trusts and derivative contracts.

Loans are originated by mortgage originators and financial brokers who prepare and submit a credit submission.

Each loan application is assessed based on specific lending criteria.

Once appropriate valuations are undertaken by an appointed external valuer (with the requisite level of qualifications and experience) and various other checks conducted (e.g. geographical, sectoral and other limitations that apply to each loan), the credit proposal is submitted to a delegated authority for approval. Following approval, a letter of offer will be issued to the borrower detailing all terms and conditions relating to the loan.

Interest rates on the mortgage loans are written at a specific margin above the relevant reference rate (being the 90 day bank bill rate for variable loans and the swap rate applicable to the loan period being fixed in the case of a fixed loan) and as determined by a designated senior executive. The margins may be varied subject to individual credit risk assessments and market competition for similar loans.

The ongoing administration, monitoring and management of the mortgage portfolio are outsourced. The outsourced administrator administers all aspects of the mortgage portfolio (i.e. collections, arrears) settlements, discharges, consents to leases, etc.) and monthly portfolio and management reports on all mortgage investments are prepared and circulated to a number of stakeholders, including the credit committee.

There are policies in place to monitor and action loan defaults. If the default cannot be satisfactorily rectified, the outsourced administrator can take recovery action against the borrowers and/or guarantors.

A designated senior executive or the Board can approval a write off of the loan depending on the quantum involved.

Assumptions

The Commissioner assumes that:

· the trustee will elect on behalf of the trust that Division 230 applies to all financial arrangements that the trust holds at the time that the operation of the Division Commences for the trust (1 July 2010);

· none of the elective tax timing methods will be chosen by the trustee on behalf of the trust; and

· the trust will not derive any exempt or non assessable non exempt income during the income years covered by this ruling request.

Relevant legislative provisions

section 25-35

subsection 25-35(1)

paragraph 25-35(1)(b)

Division 230

section 230-180

subsection 230-180(3)

paragraph 230-190(6)(a)

section 230-195

Reasons for decision

Division 230 of the ITAA 1997 is about the tax treatment of any gains or losses from your financial arrangements.

Section 230-180 of the ITAA 1997 operates where the realisation method applies to a financial arrangement.

Section 230-195 of the ITAA 1997 operates where the accruals method applies to a financial arrangement, you re-estimate the gain or loss from the financial arrangement and you make a fresh allocation of the gain or loss from the financial arrangement on the basis referred to in paragraph 230-190(6)(a) of the ITAA 1997.

In determining whether you make a loss from a financial arrangement from writing off as a bad debt, a right to a financial benefit, these sections require you to determine whether or not you are in the business of money lending.

Paragraph 4.204 of the Explanatory Memorandum to the Taxation Laws Amendment (Taxation of Financial Arrangements) Bills 2008 explains that "A bad debt for the purposes of Division 230 is intended to be the same concept as that encompassed in section 25-35 of the ITAA 1997."

To claim a bad debt under paragraph 25-35(1)(b) of the ITAA 1997 it is necessary to demonstrate that the entity is carrying on a business of lending money and that the bad debt claimed related to money which was lent in the ordinary course of that business.

The question of whether a business is being carried on is a question of fact and degree. Taxation Ruling TR 97/11 provides the Commissioners view of the factors used to determine if you are in business for tax purposes, including commercial purpose or character; regularity and repetition of the activity; businesslike manner, purpose and prospect of profits etc.

The indicators must be considered in combination and as a whole. No one indicator is decisive.

Taxation Ruling TR 92/18 provides the Commissioner's view in relation to the deductibility of bad debts. It reiterates that the question of whether a business of money lending is being carried on is a question of fact. It also indicates that in assessing the facts a money lender may not necessarily need to be willing to lend to the public or a wide class of borrowers. Further, the taxpayer may lend to only certain classes however this must be done in a business like manner with a view to yielding a profit from that activity.

The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Bowen CJ in FC of T v. Marshall and Brougham Pty Ltd 87 ATC 4522: 18 ATR 859 made the following observations regarding a business of money mending:

It is generally accepted that in order to be regarded as carrying on a business one must demonstrate continuity and system in ones dealings. In the case of money lending it has been said that a person must hold himself out as willing to lend money generally to all and sundry (subject to credit-worthiness): see Litchfield v. Dreyfus [1906] 1 KB 584. It is not decisive whether the lender is a registered money-lender or not, although this will be a factor to take into account. It should be mentioned that it need not be the only business or the principal business of the taxpayer. It will be insufficient, however, if it is merely ancillary or incidental to the primary business. In the end, it will be a question of fact for the court to decide by looking at all the circumstances involved: see Newton v. Pyke (1908) 25 TLR 127.

In Litchfield v. Dreyfus [1906] 1 KB 584 at p. 589, Farwell J stated that:

Speaking generally, a man who carries on a money-lending business is one who is ready and willing to lend to all and sundry, provided that they are from his point of view eligible.

Further, in the case of Richard Walter Pty Ltd v FC of T 95 ATC 4440 Tamberlin J stated that:

…it is not enough merely to show that a person has on several occasions lent money at remunerative rates of interest; there must be a certain degree of continuity and system about the transactions. The activity should be capable of being described as business operations intended to yield a profit.

Accordingly, it may be sufficient if the taxpayer lends money to certain classes of borrowers, provided the taxpayer does so in a businesslike manner with a view to yielding a profit from that activity.

You provide loans to your borrowers through specialist commercial mortgage originators, finance brokers and financial advisers, which were backed by mortgages, and were predominantly over commercial and industrial property.

You assess each loan application in relation to specific lending criteria. You obtain a valuation from an external valuer and conduct other checks that may include studies of geographical location, sectoral and other limitations that apply to each loan. The credit proposal is then submitted to a delegated authority for approval.

Interest rates on the mortgage loans are written at a specific margin above the relevant reference rate, typically the 90 day bank bill rate for variable loans and the swap rate applicable to the loan period being fixed in the case of a fixed loan. The margins may be varied subject to individual credit risk assessments and market competition for similar loans.

The administration, monitoring and management of the mortgage portfolio is carried out by an administrator and includes collections, arrears settlements, discharges and consents to leases in addition to monthly portfolio and management reports for stakeholders.

In examining your lending activity it can be seen that you are conducting that activity in a structured and systematic way that demonstrates a commercial purpose. You are conducting your activity in a business like manner with a degree of repetition and regularity. In addition, the scale of your lending is significant such that your money lending activity is not ancillary or incidental to another part of your business. Further, it is apparent that you are conducting your money lending activity with a view to profit.

Therefore, on the balance of facts presented, it is considered that you are carrying on a business of lending money for the purposes of section 230-180 and 230-195 of the ITAA 1997.