Edited version of your private ruling

Authorisation Number: 1012102628115

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Subject: Capital gains tax - capital loss on investment

Question:

Will you be entitled to claim a capital loss in respect of the forgiveness of a loan to a private company?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You formed a partnership ('the partnership'). The purpose of the partnership was building construction, property development and property ownership.

The partnership developed a property.

You subsequently, invested an amount of money in two companies (company A) and (company B)

You obtained the funds to invest in company A and company B as an unsecured creditor by liquidating some assets.

The property development continued for a number of years and you did not receive any return on your investment.

The only director and shareholder of the two companies is your spouse.

Company A was wound up, by order of a Supreme Court.

Company B has had official liquidators appointed and a declaration made by them that 'there are insufficient funds in the liquidation to enable a dividend distribution to be paid to the company's creditors'

You have signed two deeds of forgiveness in which you have forgiven the total amount of your investment in company A and company B. At this time the companies had no capacity to repay.

You have provided a number of documents, which form part of and should be read in conjunction with this private ruling:

Relevant Legislative provisions

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Paragraph 104-25(1)(b)

Income Tax Assessment Act 1997 Subsection 104-25(3)

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Paragraph 108-20(2)(d)

Income Tax Assessment Act 1997 Subsection 116-30(1)

Reasons for decision

Capital gains tax (CGT) is the tax you pay when a CGT event happens to a CGT asset.

A CGT asset can be any kind of property, or legal equitable right that is not property, for example a debt owed to you (section 108-5 of the Income Tax Assessment Act 1997). A debt or right to repayment is an asset for CGT purposes

Forgiven debt

The debt owed to you by company 'A' and Company 'B' or the right to repayment is an intangible asset. They are CGT assets under section 108-5 of ITAA 1997.

Paragraph 104-25(1)(b) of the ITAA 1997 provides that CGT event C2 happens if the ownership of an intangible asset ends by the asset being released, discharged or satisfied. The forgiveness of the debt by you will therefore trigger CGT event C2 and the time of the event will be when you forgive the debt and release the debtor from its obligations.

If you make a capital loss on the forgiveness of the debt under subsection 104-25(3) of the ITAA 1997, then you will be entitled to claim the capital loss under section 102-5 of the ITAA 1997 if the debt is not a personal use asset.

Under paragraph 108-20(2)(d) of the ITAA 1997, a personal use asset is a debt arising other than:

· in the course of gaining or producing assessable income ; or

· from the carrying on a business.

Paragraph 47 of Taxation Ruling TR 96/23 provides that the test of what is a personal use asset requires a finding that the debt came to be owed for a primary purpose other than gaining or producing income or in the carrying on of a business.

Therefore, if the debt which came to be owed with the expectation of promoting and enhancing the income-earning activity or came to be owed in the carrying on of the business, then this debt would not be a personal use asset and a capital loss would be allowed.

In this case, the investment was not made as part of the carrying on a business by you. As you are not in the business of lending money, you invested money in private companies.

You invested the money with the expectation of receiving interest and that you would be repaid all funds invested in the companies. Therefore, the connection with the gaining or producing of income is considered to be established at the time the debt came to be owed in this case.

Accordingly, the debt owed to you by the two companies is not a personal use asset and as such you are entitled to claim the capital loss on the forgiveness of the debt.

Note 1

The debt forgiveness rules do not apply given the fact that when the loan was forgiven the companies had no capacity to repay.

Note 2

While a capital loss was made when the deed of forgiveness was signed you will need to maintain adequate evidence to verify the quantum of the loss made.