Edited version of private ruling

Authorisation Number: 1011797075763

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Ruling

Subject: Loan to a company

Question 1

Will you make a capital loss as a result of capital gains tax (CGT) event C2 under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) happening in relation to a loan to a private company which has been deregistered?

Advice/Answers

Yes.

Question 2

If CGT event C2 has happened in relation to the loan, will the time of the event be the date on which the company was deregistered?

Advice/Answers

Yes.

Question 3

Will the commercial debt forgiveness provisions in Division 245 of ITAA 1997 apply to you in relation to the loan?

Advice/Answers

No.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You were a shareholder in a small proprietary limited company.

The company carried on a business.

You and your spouse owned one ordinary share each in the company.

The other shareholders were your business partner and their spouse.

You obtained a loan from a financial institution at commercial rates. You subsequently on-lent this money to the company as a loan to the company for working capital.

Your business partner also obtained a loan from a financial institution and on-lent it to the company as working capital in the same manner.

Your intention, along with your business partner, was for the company to become profitable as soon as possible and eventually pay assessable dividends and other income to the shareholders.

You and your partner also drew wages from the company for principal work performed.

Initially, there were no formal written loan agreements in place. The loans were shown as a liability in the company's accounts as shareholders loans.

By agreement, the company paid for the exact amount of regular interest that the financial institution charged you. The company claimed the interest as a deduction. You did not claim a deduction for the interest. Your business partner's situation was identical.

You and your business partner then each borrowed further amounts from the same financial institutions at commercial rates and again you both on-lent this money to the company for working capital, in an attempt to assist the company to become profitable. The company continued to regularly pay the exact interest cost that the financial institution charged you and your partner.

In addition to paying the regular interest charge on the loan, the company also began repaying principal repayments. The principal repayments were made directly to the financial institutions by the company on behalf of you and your partner.

The company struggled with cash flow and profitability, and the company was eventually put into voluntary liquidation by creditors.

The winding up of the company by the liquidator commenced, and the company was subsequently deregistered.

At the time that the company was placed into liquidation, there was a loan amount owing to you by the company. You were classed as an unsecured creditor.

You did not receive any dividend or return from the company in liquidation, and the debt was otherwise extinguished when the company was wound up and deregistered.

The loan to the financial institution remained and you are servicing this loan from other sources of income.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 108-20

Income Tax Assessment Act 1997 Division 245

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Question 1

CGT event C2 in section 104-25 of the ITAA 1997 happens if ownership of an intangible CGT asset ends by the asset:

· being redeemed or cancelled

· being released, discharged or satisfied

· expiring or

· being abandoned, surrendered or forfeited.

A debt owed to you is a CGT asset under section 108-5 of the ITAA 1997. A debt expires when a company is deregistered.

You will make a capital gain if the capital proceeds from the ending are more than the debt's cost base, and you will make a capital loss if those capital proceeds are less than the debt's reduced cost base.

As no capital proceeds were received by you for the purposes of subsection 104-25(3) of the ITAA 1997 before the company was deregistered, that is, you did not receive any return from the company, you will make a capital loss in relation to the expiry of the debt.

Subsection 108-20(1) of the ITAA 1997 states, however, that in working out a taxpayer's net capital gain or loss for an income year, any capital loss made from a personal use asset is disregarded.

Paragraph 108-20(2)(d) of the ITAA 1997 defines personal use assets to include a debt owed to you that arose other than in the course of gaining or producing your assessable income or from you carrying on a business.

You were a shareholder of the company, and you drew wages from the company for principal work performed. You also intended to receive dividends and other income from the company.

In these circumstances, it is accepted that your primary purpose in the loaning of the money to the company was to gain assessable income as a shareholder of the company. Therefore, the capital loss will not be disregarded by subsection 108-20(1) of the ITAA 1997.

Question 2

Subsection 104-25(2) of the ITAA 1997 states that the time of CGT event C2 is:

· when you enter into the contract that results in the asset ending or

· if there is no contract - when the asset ends.

In your case, CGT event C2 happened to the debt owed to you by the company on the date that the company was deregistered.

Question 3

Division 245 of the ITAA 1997 relates to the forgiveness of commercial debts. This Division offsets the forgiven amount against amounts that could otherwise reduce the taxable income of the debtor in the same or later income year.

As you are not the debtor in this case, Division 245 of the ITAA 1997 will not apply to you.

Note

The company, being the debtor in this case, may apply for a private ruling on whether Division 245 of the ITAA 1997 will apply to it in relation to the loan.