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Edited version of your private ruling
Authorisation Number: 1012444218886
Ruling
Subject: Bad debt deduction
Question
Is Entity A, a beneficiary of the Trust, entitled to a deduction under section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997) for unpaid present entitlement amounts that have been written off as bad debts?
Answer
No
This ruling applies for the following period
Year ended 30 June 2012
The scheme commenced on
1 July 2011
Relevant facts
In prior years, Entity A was credited with income distributions from the Trust however the distributions were not paid.
These distributions remain unpaid in the relevant year at which time a formal demand was made for payment.
The Trust has no net assets and was unable to repay the amount owing.
Legal advice was obtained that any enforcement action would be unsuccessful.
Accordingly the amount owing was written off as irrecoverable in the relevant year.
Relevant legislative provisions
Income Tax Assessment Act 1936 Section 97
Income Tax Assessment Act 1936 Division 6 of Part III
Income Tax Assessment Act 1997 Section 25-35
Income Tax Assessment Act 1997 Paragraph 25-35(1)(a)
Reasons for decision
A deduction for a bad debt may be claimed under section 25-35 of the ITAA 1997 if the requisite conditions are satisfied.
Paragraph 25-35(1)(a) provides that:
You can deduct a debt or part of a debt that you write off as bad in the income year if:
(a) it was included in your assessable income for the income year or for an earlier income year; or
(b) it is in respect of money that you lent in the ordinary course of your business of lending money.
Taxation Ruling TR 2010/3 states in part:
When a beneficiary is presently entitled to an amount from a trust estate, it has an equitable right to that amount. That is, the beneficiary has rights in equity and not, without more, as a result of any debtor-creditor relationship
Whilst the rights arising from a present entitlement can, in some circumstances, become, or crystallise into an equitable debt (for example, upon calling for payment of that entitlement), the right that arises on the creation of a present entitlement is not a debt.
Moreover, the amount included in the taxpayer's assessable income is not the amount of the present entitlement. Rather it includes in its assessable income its proportionate share of the trust's 'net income' calculated by reference to the proportionate share of the income of the trust to which the taxpayer is presently entitled. That is, the amount assessed to the taxpayer may be a very different amount than the amount to which it was entitled to receive from the trust.
As Entity A has not brought a debt into account as assessable income and does not carry on a business of lending money, the bad debt cannot be claimed as a deduction under section 25-35 of the ITAA 1997.