Edited version of private ruling

Authorisation Number: 1011913862059

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Ruling

Subject: Capital gains tax

Questions and answers

Question 1: Does the Commissioner consider that the requirements of CGT event G3, as set out in subsection 104-145(1) of the Income Tax Assessment Act 1997 (the ITAA 1997), are satisfied in respect of the circumstances surrounding the promissory notes issued to the Head Company by the Overseas Entity?

Answer 1: No. The Commissioner does not consider that the requirements of CGT event G3, as set out in subsection 104-145(1) of the ITAA 1997, are satisfied in respect of the circumstances surrounding the promissory notes issued to the Head Company.

Question 1A: Whether the Overseas Entity is a 'corporate limited partnership' and thus a 'company' pursuant to section 94J of the Income Tax Assessment Act 1936 (the ITAA 1936)?

Answer 1A: Because Question 1D has been answered in the negative, it is not necessary to deal with this question.

Question 1B: Whether the promissory notes can be regarded as 'issued by', 'created by' or 'in relation to' the Overseas Entity for the purpose of subsection 104-145(1) of the ITAA 1997?

Answer 1B: Because Question 1D has been answered in the negative, it is not necessary to deal with this question.

Question 1C: Is the foreign insolvency practitioner, a 'liquidator or administrator' for the purpose of section 104-145 of the ITAA 1997?

Answer 1C: Because Question 1D has been answered in the negative, it is not necessary to deal with this question.

Question 1D: Do the Disclosure Statements constitute a declaration made in writing for the purpose of section 104-145 of the ITAA 1997?

Answer 1D: No. The Disclosure Statements do not constitute a declaration made in writing for the purpose of section 104-145 of the ITAA 1997.

Question 1E: Do the declarations made by the foreign insolvency practitioner in the Disclosure Statements evidence that the foreign insolvency practitioner had reasonable grounds to believe (as at the time of making the Disclosure Statements) that the promissory notes were of no or negligible value in terms of subsection 104-145(1) of the ITAA 1997?

Answer 1E: Because Question 1D has been answered in the negative, it is not necessary to deal with this question.

Question 2: Does a capital loss arise to the Head Company, pursuant to CGT event G3, in the year ended 31 December 2010 (the 2010 calendar year)?

Answer 2: No. A capital loss does not arise to the Head Company, pursuant to CGT event G3, in the 2010 calendar year.

Note: these answers only apply to the 2010 calendar year and not to the 2011 calendar year.

This ruling applies for the following period:

Year ended 31 December 2010

Relevant facts and circumstances

The Head Company and the other entities in the consolidated group are all Australian entities.

The Overseas Entity is registered overseas as a 'limited partnership'. The partnership is between a limited partner and a general partner.

In 200X, the Overseas Entity issued promissory notes (the notes) to a member of the Head Company's consolidated group.

The notes are not revenue assets.

Repayment of the notes was not made on the stipulated date and the notes continue to be carried forward on the same terms.

The Overseas Entity became subject to foreign bankruptcy proceedings.

The effect of the debt subordination agreements was that the Head Company would not receive any repayment on the notes, whether in bankruptcy or otherwise, unless and until the consortium of secured lenders (the Secured Lenders), were repaid in full.

The foreign insolvency practitioner was appointed as an insolvency practitioner of the Overseas Entity in accordance with the overseas country's bankruptcy law.

The 1^st Disclosure Statement was served upon the Head Company amongst others. The 1^st Disclosure Statement is signed by the attorney for the foreign insolvency practitioner and by attorneys for the creditors.

In the 1^st Disclosure Statement it is stated that all financial information in the Disclosure Statement has been prepared by the foreign insolvency practitioner and that the payments to the creditors represent the foreign insolvency practitioner's best estimates.

In the 1^st Disclosure Statement it is stated that the purpose of the Disclosure Statement was to enable creditors to make an informed judgment about the proposed bankruptcy plan.

In the 1^st Disclosure Statement it is stated that the Secured Lenders were owed $X and that the Head Company is owed certain amounts, but, those amounts are subordinated until the Secured Lenders are paid in full and it is confirmed that the proposed bankruptcy plan preserves the subordination rights. In the 1^st Disclosure Statement it is stated that the foreign insolvency practitioner does not believe that there will be sufficient funds to pay unsecured non-priority claim holders in full. In the 1^st Disclosure Statement it is confirmed that Secured Lenders' claims are impaired.

The 1^st Disclosure Statement indicates that the high level of recovery by the Secured Lenders is less than half of $X.

The 2^nd Disclosure Statement is in the form of a declaration by the foreign insolvency practitioner and is signed by the foreign insolvency practitioner.

The proposed settlement agreement is an attachment to the 2^nd Disclosure Statement. It is subject to approval by the Secured Lenders and by the foreign bankruptcy court. It provides that the Secured Lenders will be paid significantly less than $X based on the highest recovery estimates.

The Disclosure Statements follow extensive negotiations between representatives of the various classes of creditors, but, they predate the court approval of the proposed bankruptcy plan.

Overall, in the Disclosure Statements, the foreign insolvency practitioner can be regarded as having stated that the Secured Lenders' debts totalled a certain amount and that the highest expected recovery was much less than that amount and that various creditors have agreed that the subordination agreement will be maintained.

It would necessarily follow from the Disclosure Statements that the Secured Lenders would not be paid in full. As a result of the subordination agreement, it necessarily followed that the Head Company would not be paid any amount.

The liquidator of the Head Company is well-versed in liquidation matters.

In the year ended 31 December 2010, the foreign insolvency practitioner verbally declared that no payment would be made in relation to the notes.

In the year ended 31 December 2011, the foreign insolvency practitioner reiterated the declaration in writing.

The Overseas Entity is not a VCLP, ESVCLP, an AFOF or a venture capital management partnership as referred to in the Income Tax Assessment Act 1936 (the ITAA 1936).

No Australian attributable taxpayer has an attribution percentage of greater than nil in relation to the Overseas Entity for the purposes of the controlled foreign company provisions contained in the ITAA 1936.

No Australian taxpayer had an 'interest' in the Overseas Entity for the purposes of the foreign investment fund provisions contained in the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-145.

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.

Questions 1, 1D & 2

Summary

CGT event G3 did not occur because the necessary written declaration was not made.

Detailed reasoning

Pursuant to section 104-145 of the ITAA 1997, a taxpayer can choose to make a capital loss (equal to the reduced cost base) if a liquidator or administrator of a company declares in writing that they have reasonable grounds to believe that a financial instrument owned by the taxpayer has no or negligible value.

A promissory note falls within the examples of a financial instrument under paragraph 104-145(3)(a) and the notes were issued after 20 September 1985 and the foreign insolvency practitioner's declaration was made after 21 March 2005 and the notes were not held on revenue account.

Subsection 104-145(1) refers to a declaration in writing made by a liquidator or administrator to the effect that the liquidator or administrator has reasonable grounds to believe that there is no or negligible likelihood of payment.

Subsection 104-145(2) of the ITAA 1997 provides that the time of the CGT event is when the declaration was made.

It logically follows that 'the declaration' mentioned in subsection 104-145(2) is a reference to the written declaration mentioned in subsection 104-145(1) not to some other declaration.

Assuming (without deciding the matter) that the foreign insolvency practitioner could be treated as a 'liquidator or administrator' and that all the other conditions are met, the question is whether the foreign insolvency practitioner has made a declaration in writing in the 2010 calendar year. The fact that a verbal declaration was made is not sufficient. The fact that a written declaration was made in a later year is not relevant.

The Macquarie Dictionary 5^th ed., defines 'declaration' as '1. a positive, explicit, or formal statement, announcement, etc...' The Australian Oxford Dictionary provides the following definition '2a a formal emphatic or deliberate statement or announcement...'

It is considered that, in the present context, the word 'declaration' connotes a more explicit pronouncement than the broader word 'statement'. It might be added that the legislature, even when adopting plain English wording in the drafting of the Income Tax Assessment Act 1997, did not choose to employ the plain English word 'statement' instead of the word 'declaration' which connotes something more explicit. A declaration can trigger a CGT event. The choice of the word 'declaration' (instead of the word 'statement') can be understood on the basis that the declaration has to be sufficiently explicit so that it can be clear at what point in time a taxpayer is entitled to make an election.

Taxation Determination TD 92/102 provides an example of a written declaration. The example assumes that a declaration will contain very precise explicit statements by the liquidator. The example in TD 92/102 fits within the theme of a positive, explicit, or formal, statement. It is noted in TD 92/102 that:

An oral statement by the liquidator that any distribution to shareholders is unlikely, or a statement that a written declaration will be made soon, is not sufficient

The Disclosure Statements confirm that the subordination agreement will continue to have effect so that the Head Company's rights are subordinated to the Secured Lenders' rights. The Disclosure Statements confirm that the Secured Lenders are owed $X and that, at the high end of the recovery values, they will receive much less than sum. It can be concluded from those statements that the Head Company will not receive any repayment in respect of the notes because the Secured Lenders will not be paid in full. The liquidator of the Head Company would fully understand that the conclusion which should be drawn from the statements and from the figures in the Disclosure Statements, if the proposed bankruptcy plan was agreed to by the creditors and was approved by the bankruptcy court, is that the notes are worthless.

However, it is considered that the word 'declaration' for the purposes of section 104-145 involves something more explicit than a conclusion or a necessary implication that can be pieced together from a series of figures and statements. The statements contained in the Disclosure Statements were provided for the purpose of having the parties agree to a bankruptcy plan and to obtain court approval. The Disclosure Statements did not explicitly state that the notes (or that a class of notes) were worthless. A third party who perused the Disclosure Statements could easily miss the point that the notes were worthless. Although the Head Company could ascertain the conclusion that the notes were worthless from various statements which were contained in the Disclosure Statements, this does not constitute something which is sufficiently explicit to be regarded as a 'declaration' by the foreign insolvency practitioner.

Having regard to the information identified in the Disclosure Statements, the foreign insolvency practitioner may well have possessed sufficient details to allow the foreign insolvency practitioner to make the relevant declaration if the foreign insolvency practitioner had chosen to do so. However, in the present circumstances, it is considered that the various statements and financial information contained in the written documents were not sufficiently explicit to constitute a written declaration by the foreign insolvency practitioner within the meaning of section 104-145 to the effect that the foreign insolvency practitioner held a reasonable belief that the notes were worthless.

It is considered that, because the necessary written declaration was not made in the 2010 calendar year, CGT event G3 did not occur in the 2010 calendar year.

Because there is no written declaration, it is not necessary to determine whether the other conditions in section 104-145 have been satisfied.

As the present ruling only involves the 2010 calendar year, it is not necessary to consider whether CGT event G3 may have occurred during the 2011 calendar year.