Edited version of your private ruling

Authorisation Number: 1012457703876

Ruling

Subject: Loss on investemnt

Question 1

Are you entitled to a deduction for the loss of borrowed funds on lent to entity A?

Answer

No.

Question 2

Are you entitled to a deduction for a bad debt?

Answer

No.

Question 3

Are you entitled to a capital loss for the unpaid loan?

Answer

No.

Question 4

Are you entitled to a deduction for fees paid to entity B?

Answer

No.

Question 5

Are you entitled to a capital loss for your fees paid to entity B?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts

You borrowed money from your joint line of credit account. These funds were paid to entity B for services, membership, project management, research and mentoring fees.

The fee paid to entity B provided you and your spouse with membership. You attended some meetings and one conference with entity B.

You also borrowed more money from your joint line of credit account. These additional funds were on lent to entity A. You are an office holder of entity A. You did not have a loan agreement with entity A.

Entity A entered into a loan agreement with some borrowers. Entity A lent 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 two months later.

You transferred the funds into a bank account for entity C.

You later found out that the mortgage documents were prepared for entity A and never given to the other party to sign. You have also since found out that the loan funds were never used by the borrowers on the building project. The associated company, entity C was wound up.

Entity B was also wound up.

The properties that were developed by the borrowers were sold. However, the borrowers did not repay the loan.

You engaged lawyers to assist you in the possible recovery of funds.

To date you have not recovered any of the funds.

You paid out the loan amounts in the relevant income year.

You are 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 25-55.

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).

As a general rule, a loss or outgoing will not be deductible unless it is incurred in gaining or producing the assessable income of the taxpayer who incurs it (Federal Commissioner of Taxation v Munro (1926) 38 CLR 153).

A company is a separate entity from its directors and is taxable in its own right. Therefore it is necessary to determine who incurred the various expenses in order to determine if a deduction is allowed.

Taxation Ruling TR 97/7 sets out the Commissioner's views on the meaning of incurred. Generally, a taxpayer incurs an expense at the time they owe a present money debt that they cannot escape.

Therefore, where a document, such as a loan agreement is made out in the company's name, it is considered that the company has a present existing liability to pay the specified amount and incurs the associated expense. Where such expenses are incurred for the production of assessable income, then it follows that a deduction is generally allowable under section 8-1 of the ITAA 1997 for the company.

Where expenses are incurred by the company and paid for by an office holder, a deduction is not allowable to the office holder. It is acknowledged that paying the expenses of the company will indirectly affect you. However, such expenses do not sufficiently relate to your income earning activities. They more directly belong to the company. That is the expenses belong to the company and you paid the expenditure on behalf of the company.

Office holders of a company would not ordinarily be expected to pay the company's expenses. Expenses are normally incurred by a company in relation to their operations and, thus, the earning of the company's assessable income.

In your case, you have borrowed funds and passed them on to entity A to satisfy the terms of the loan agreement for the company. You had no loan agreement with the company or the borrowers. The purpose of your action was not to directly produce any assessable income for yourself, but to earn assessable income for the company. Although you were expecting the company to pass on any profits to you, the associated expenses do not belong to you.

Therefore a deduction for paying the company's expenses is not allowable under section 8-1 of the ITAA 1997 as it relates to the company's affairs and not your assessable income.

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 your case you have 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 to you 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).

As you on lent the funds to entity A and entity A has not been wound up and still exists, it can not be said that Entity A will not pay the outstanding debt to you. The fact that entity C is bankrupt is not directly related to you. You had no loan agreement with entity C or the borrowers. As entity Ad still exists, it can not be said that a CGT C2 event has occurred for you. Therefore you are not entitled to a capital loss.

There is no other relevant provision that allows you a capital loss in your specific circumstances.

Membership fees

Section 25-55 of the ITAA 1997 allows a deduction for a payment for membership of a trade, business or professional association. The maximum amount that can be deducted under this section for the payments that a person makes in the income year to any one association is $42.

Entity B is not regarded as a trade, business or professional association. Therefore you are not entitled to a deduction under section 25-55 of the ITAA 1997.

Self education expenses

Taxation Ruling TR 98/9 discusses the circumstances under which self education expenses are allowable as a deduction. A deduction is allowable for self education expenses if a taxpayer's current income earning activities are based on the exercise of a skill or some specific knowledge and the subject of the self education enables the taxpayer to maintain or improve that skill or knowledge (Federal Commissioner of Taxation v. Finn (1961) 106 CLR 60, (1961) 12 ATD 348).

Similarly, if the study of a subject of self education objectively leads to, or is likely to lead to an increase in a taxpayer's income from his or her current income earning activities in the future, a deduction is allowable.

However, TR 98/9 states that no deduction is allowable for self education expenses if the study is to enable a taxpayer to get employment, to obtain new employment or to open up a new income earning activity (whether in business or in the taxpayer's current employment). This includes studies relating to a particular profession, occupation or field of employment in which the taxpayer is not yet engaged. The expenses are incurred at a point too soon to be regarded as incurred in gaining or producing assessable income. They are incurred in getting, not in doing, the work which produces the income (High Court decision in FC of T v. Maddalena 71 ATC 4161; (1971) 2 ATR 541).

Paragraph 42 or TR 98/9 states:

If a course of study is too general in terms of the taxpayer's current income earning activities, the necessary connection between the self education expense and the income earning activity does not exist. The cost of self-improvement or personal development courses is generally not allowable, although a deduction may be allowed in certain circumstances.

To determine whether your fees paid to entity B are deductible, the essential character and nature of the expenditure must be considered. It is necessary to determine whether there is a sufficient nexus between the expenditure and your current income-earning activities. The nature or character of the expense follows the advantage which is sought to be gained by incurring the expense. If the advantage to be gained is of a capital nature then the expense incurred in gaining the advantage will also be of a capital nature.

The fees paid to entity B covered their services, project management, research and mentoring costs. Entity B was aimed at creating wealth and to help you improve your lifestyle. Entity B was open to people from any field and offered general skills to improve your wealth. The services provided by entity B were general in nature and not sufficiently connected to your current assessable income.

Taxation Determination TD 95/60 deals with the issue of whether fees paid for obtaining investment advice are an allowable deduction for taxpayers who are not carrying on an investment business.

TD 95/60 explains that a fee for drawing up a financial plan is not deductible because it is not expenditure incurred in the course of gaining or producing the assessable income from the investments. It is too early in time to be an expense that is part of the income producing process as it is an expense that is associated with putting the income earning investments in place. Therefore the expense has an insufficient connection with earning income from the investments, and is considered capital in nature.

TD 95/60 also states that where a taxpayer has existing investments and goes to an investment advisor to draw up an investment plan, the fee paid would be a capital outlay even if some or all of the pre-existing investments were maintained as part of the plan. The character of the outgoing is not altered because the existing investments fit in with the plan. It is still an outgoing of a capital nature.

Although TR 98/9 and TD 95/60 do not directly address your circumstances, the principles outlined are relevant.

In your case the services and mentoring relates to your future investments and do not relate to servicing any existing investment. Accordingly the expenses are incurred at a point too soon to be considered as incurred in gaining or producing your assessable income. The fees paid to entity B do not have a sufficient nexus to the derivation of your current assessable income. The expense is also considered to be capital in nature. Therefore, the expenses incurred are not deductible under section 8-1 of the ITAA 1997.

Capital gains tax provisions

The fees paid to entity B for membership, services, project management, research and mentoring are not regarded as a CGT asset. As the expenses do not relate to a CGT asset, the CGT provisions do not apply. There is no other provision that allows you a capital loss for the fees paid to entity B.