Edited version of private ruling

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Ruling

Subject: CGT event C2

Question 1

Can the amounts outstanding on the loan be written off as a bad debt?

Answer

No

Question 2

Is the superannuation fund entitled to claim a capital gain or loss for the release of a debt owed to the superannuation fund?

Answer

Yes, when all the conditions are met.

Relevant facts

The superannuation fund loaned funds to a unit trust.

The superannuation fund is not carrying on a money lending business.

The superannuation fund also purchased units in the unit trust.

The superannuation fund received regular statements from the borrower outlining the interest earned on those funds, which was accrued against the loan amount. Each year, the superannuation fund reported on their income tax returns as interest income the amounts accrued.

The lender received an email from the unit trust with an attachment stating that the balances outstanding for a particular income year could be written off as a capital loss. The superannuation fund received correspondence from solicitors acting for the unit trust suggesting that the entire loan balance be written off as a capital loss. This correspondence also contained an agreement outlining the terms of a repayment plan. The superannuation fund is not party to this agreement- it is between the borrower and the creditor they on-loaned the funds to. The superannuation fund has subsequently received a number of repayments following the borrower's attempts to recover the lost funds.

Despite the advice from the borrower about the entire amounts outstanding being treated as capital losses, the superannuation fund believes that the interest accrued on the loans should be deductible as a bad debt. The original loan amounts (or part of thereof in light of the repayment agreement) would be treated as capital losses.

The superannuation fund believes that any amounts recovered from the borrower should be treated as capital receipts in the first instance and in the event that the proceeds exceed the original loan amounts, the balance would be dealt with on revenue account.

Question 1

Detailed reasoning

Section 65-260 of Income Tax Assessment Act 1997(ITAA 1997) deals particularly with when a debt can be classified as a bad debt.

A debt normally cannot be considered as a bad debt simply because it is overdue or if there is still a genuine dispute over it (Case 45/93, 93 ATC 486).

Taxation Ruling TR 92/18 shows a list of situations when a debt would be bad:

· the debtor has died, leaving insufficient assets to pay the debt

· the debtor or the debtor's assets cannot be traced

· the debt has become statute barred and it is reasonable to expect the debtor will rely on this defence

· the debtor company is in liquidation or receivership with insufficient funds to pay the debt

· an objective examination of all the facts indicates that there is little or no likelihood of recovering the debt. This will normally require that appropriate steps have been taken to attempt to recover the debt. These steps vary according to the size of the debt and the resources available to pursue it. Depending on the circumstances, the steps could include:

o issuing reminder notices and attempting telephone/mail contact

o allowing a reasonable time for payment

o serving a formal notice of demand

o issuing and serving a summons

o entering judgment

o execution proceedings to enforce judgment

o ceasing the calculation of interest and closing the account

o valuing any security held against the debt

o selling any seized or repossessed assets (Taxation Ruling TR 92/18).

To qualify for a bad debt deduction under section 25-35 of the ITAA 1997, the debt, in addition to being bad, must satisfy two criteria:

There must be a physical writing off of the debt.

The debt must have been brought into account by the taxpayer as assessable income. This condition does not apply to taxpayers in the business of lending money.

In this case, the superannuation fund has subsequently received four payments for the outstanding balances. The superannuation fund also received an agreement outlining the terms of a repayment plan from the borrower. The amount outstanding is therefore not a bad debt under section 65-260 of ITAA 1997.

Question 2

Detailed reasoning

A debt owed to the superannuation fund is an intangible asset. It is a capital gains tax (CGT) asset under section 108-5 of the ITAA 1997.

Section 104-25 of the ITAA 1997 states that CGT event C2 happens to the superannuation fund if the fund's ownership of an intangible CGT asset ends by the asset:

o being redeemed or cancelled,

o being released, discharged or satisfied,

o expiring, or

o being abandoned, surrendered or forfeited.

The event occurs at the time you enter into a contract that results in the asset ending.

ATO Interpretive Decision ATO ID 2003/215 Income Tax - Capital gains tax: CGT event C2 - debtor bankrupted considers the occurrence of a CGT event C2 in the context of a borrower becoming bankrupt. The mere writing off of a debt is insufficient to constitute a release, discharge, or satisfaction.

However, the debt may be extinguished by forgiveness under a deed of release, such that the owner of the debt is legally barred from collecting the debt.

When CGT event C2 occurs, the superannuation fund makes a capital gain if the capital proceeds received from the end of the intangible CGT asset are more than its cost base. In contrast, the superannuation fund makes a capital loss if the capital proceeds are less than the reduced cost base.