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Ruling

Subject: Bad debts

Questions and Answers:

Question:

Can you claim a deduction for unpaid commissions?

Answer:

No

Question:

Can you include unpaid commissions as a capital loss in the year when it becomes certain the commission will never be paid to you?

Answer:

Yes

Question:

If you renegotiate a commission contract in order to recover some amount of payment, will you incur a capital loss during the year the contract is renegotiated?

Answer:

No

This ruling applies for the following periods

Year ending 30 June 2012

Year ending 30 June 2013

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You work on a commission basis and account for your income on a cash basis. You have concerns about your employer's financial position and believe they may go into liquidation and not pay you some commissions owed to you.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-35

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Section 108-5

Reasons for decision

Section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997) is about deductions for bad debts. 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 included in your assessable income for the income year or for an earlier income year (unless you were in the business of lending money).

Section 108-5 of the ITAA 1997 is about capital gains tax (CGT) assets and includes debts owed to you as CGT assets.

When an entity creates a contractual right or other legal or equitable right in you, CGT event D1 happens under section104-35 of the ITAA 1997. When a debt owed to you ends, CGT event C2 in section 104-25 of the ITAA 1997 happens.

Subsection 104-25(3) of the ITAA 1997 states you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

However, ATO Interpretative Decision ATO ID 2005/211 states the first element of the cost base and reduced cost base of a debt that arose from the provision of services to a debtor is nil. In other words, the provision of services which results in the acquisition of a CGT asset (such as a contractual right) does not involve the giving of money or other property, which forms the first element of a CGT cost base.

The time of CGT event C2 in relation to a debt owed to you will occur when you enter into the contract that results in the asset ending (e.g., a settlement deed) or, if there is no contract, when the asset ends (e.g., it becomes irrecoverable at law).

Paragraph 4 of Taxation Ruling TR 92/18, which is about bad debts, states where a trustee in bankruptcy, receiver or liquidator advises a creditor of the amount expected to be paid in respect of the debt (i.e. the extent to which the amount likely to be received is less than the debt) is accepted as bad when the advice is given.

In your case, given you account for your income on a cash basis, any unpaid commissions will not be included in your assessable income. Also, as you are not in the business of lending money, section 25-35 of the ITAA 1997 will prevent you from claiming a deduction for any unpaid commissions.

However, given unpaid commissions will represent debts owned to you, a CGT loss will arise in the financial year where a trustee in bankruptcy, receiver or liquidator advises you of the amount you will not recover.

However, in respect to renegotiating a commission contract in order to recover some amount of payment, the CGT cost base of the original contract will be nil. It follows a CGT loss will not arise when you end the original contract by negotiating a new contract of payment because you will not lose any money or other property used to acquire the original contract.