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Edited version of your private ruling
Authorisation Number: 1012457626694
Ruling
Subject: Capital loss
Question 1
Is the company entitled to a deduction for the loss of funds not repaid under the loan agreement?
Answer
No.
Question 2
Is the company entitled to a deduction for a bad debt?
Answer
No.
Question 3
Is the company entitled to a capital loss in relation to the unpaid loan?
Answer
No.
This ruling applies for the following period:
Year ended 30 June 2012
The scheme commenced on:
1 July 2011
Relevant facts
The director and secretary of a company borrowed some money several years ago. These funds were on lent to the company. The company did not have a loan agreement with the director or secretary.
The company entered into a loan agreement with some borrowers. The company lent the money to the borrowers for property development. The interest rate was X% per month. The loan amount together with interest payable was to be repaid a number of months later.
The director transferred the loan money into a bank account for entity A.
It was later found that the mortgage documents were prepared for the company and never given to the other party to sign. It has also been found that the loan funds were never used by the borrowers on the building project. Entity A was later wound up.
The properties that were developed by the borrowers were sold. However, the borrowers did not repay the loan.
To date the company has not recovered any of the funds.
The company is not in the business of lending money.
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.
Reasons for decision
Allowable deductions and loan agreement
Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.
A number of significant court decisions have determined that for an expense to be an allowable deduction:
§ it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478),
§ there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and
§ it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).
In this case, the company lent funds to the borrowers. The unpaid loan principle is a one off capital sum. As the associated loss is capital in nature, no deduction is allowable under section 8-1 of the ITAA 1997.
Bad debts
Section 25-35 of the ITAA 1997 allows a deduction for bad debts in certain circumstances. To qualify for a bad debt deduction under section 25-35, the written off bad debt must be:
§ included in your assessable income for the income year or for an earlier income year, or
§ in respect of money that you lent in the ordinary course of your business of lending money.
In this case, the company has not satisfied the requirements under section 25-35 of the ITAA 1997, therefore no deduction for a bad debt is allowed.
Capital gains tax provisions
A debt owed is a capital gains tax (CGT) asset (section 108-5 of the ITAA 1997). When a debt owed to you ends, CGT event C2 happens.
The time of a 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 (for example, a settlement deed) or, if there is no contract, when the asset ends (for example, when it becomes irrecoverable at law).
In this case, the company had a loan agreement with the borrowers. There is no information to show that the borrowers are all in receivership. It can not be said that the borrowers will not pay the outstanding debt to the company. The fact that entity A is bankrupt is not directly related to the company. The company had no loan agreement with entity A. A CGT C2 event has not occurred. Therefore no capital loss is allowed.
There is no other relevant provision that allows the company a capital loss.