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Edited version of your private ruling
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Ruling
Subject: loan loss
Questions and Answers:
1. Is your $50,000 loss made in relation to a loan to the Trust a revenue loss?
No.
2. Is your $50,000 loss made in relation to a loan to the Trust a capital loss?
Yes.
3. Are your on-going interest obligations in relation to the outstanding $50,000 loan deductible?
Yes.
This ruling applies for the following periods:
Year ended 30 June 2009
The scheme commences on:
1 July 2006
Relevant facts and circumstances
You are one of six unit holders in the Trust, where each unit holder loaned an amount (on an interest free basis) to the trust so it could carry on a business of property development. You took a bank loan to fund this loan. You were not carrying on a business of money lending.
Due to financial difficulties, a settlement was made by other parties for the assets of the trust, where the unit holders would receive an amount equal to half their loan for their loaned amount. You used these funds to reduce your loan. You have an economic inability to repay the outstanding loan.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 8-1
Income Tax Assessment Act 1997 Section 25-35
Income Tax Assessment Act 1997 Section 108-5
Income Tax Assessment Act 1997 Section 104-25
Income Tax Assessment Act 1997 Section 110-55
Reasons for decision
Bad debts
A deduction for a bad debt may be claimed under section 25-35 or section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997).
To qualify for a bad debt deduction under section 25-35 of the ITAA 1997, the debt that was owed to you by the trust in addition to being bad, must have satisfied two criteria:
· There must have been a physical writing off of the debt.
· The debt must have been brought into account by you as assessable income. This condition does not apply to taxpayers in the business of lending money.
As you did not bring the debt owed to you into account as assessable income and as you did not carry on a business of lending money, the bad debt owed you cannot be claimed as a deduction under section 25-35 of the ITAA 1997.
Capital loss
Section 108-5 of the ITAA 1997, which is about capital gains tax (CGT) assets, includes debts owed to you as CGT assets.
Whilst you cannot claim a deduction for your bad debt, a capital loss does arise under subsection 104-25(3) of the ITAA 1997 in the income year you released the trust from the debt owed (CGT event C2).
When a capital loss happens under CGT event C2, subsection 104-25(3) of the ITAA 1997 specifies the capital loss is calculated by using the assets 'reduced cost base'.
The reduced cost base of a CGT asset is defined in section 110-55 of the ITAA 1997. It does not allow interest expense in its third element. It follows any interest expense incurred on borrowings in relation to the debt owed to you will not form part of the reduced cost base.
Interest deductions
Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or are necessarily incurred in carrying on a business for the purposes of gaining or producing such income, except where the outgoings are of a capital, private or domestic nature.
Taxation Ruling TR 2004/4 allows deductions for interest expenses incurred following the cessation of relevant income earning activities, when a taxpayer can demonstrate a legal or economic inability to repay is suggestive of the loan not having been kept on foot for purposes other than the former income earning activities.
In your case, you incurred and continue to incur interested expenses on amounts borrowed for the purpose of earning assessable income via income distributions from a unit trust. As long as you have an economic inability to repay your loan amount, interest deductions are available to you under section 8-1 of the ITAA 1997.