Edited version of your private ruling

Authorisation Number: 1012508112518

Ruling

Subject: taxation implications on receipt of payments

Question 1

Will the payments received from Mr A be considered a repayment of the loan you made to Company A, with interest?

Answer: Yes

Question 2

Will the payments received, over and above the principal amount of the loan, be assessable on revenue account as interest income?

Answer: Yes

Question 3

Are you eligible to apply the capital gains tax concessions for small business to the amount received from Mr A?

Answer: No

Question 4

Will the payments received be assessable in the financial years in which they are received?

Answer: Yes

Question 5

Can you claim GST on the sale proceeds?

Answer: Not applicable

This ruling applies for the following period(s)

Year ended 30 June 2013

The scheme commences on

1 July 2010

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· your application for private ruling

· copy of debt forgiveness deed

· copy of part of the share purchase agreement

· copy of a deed of agreement

You loaned Company A a sum on money.

All the shares in Company A were sold.

You did not hold any shares in Company A.

After the sale of the shares, you entered into a deed of agreement with Mr A and Mr B. The deed was to record certain factual matters and agreements between the parties in relation to Company A.

Also, after the sale of the shares, you entered into a deed of forgiveness with the new owners of Company A, where you agreed to forgive the loan you gave to Company A.

In line with the deed of agreement you received your 1^st payment in the 2010-11 financial year. The 2^nd payment was received in the 2011-12 financial year.

You state that it was agreed between the parties, at the time of the incorporation of Company A that you would have an entitlement to 25% of the value of the company.

You state that there was no formal agreement in place between the parties on incorporation of Company A. The deed of agreement was the first formal agreement between the parties. You state that there was only a gentlemen's agreement (or informal agreement) prior to this.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 6-5(1)

Income Tax Assessment Act 1997 Subsection 6-5(2)

Income Tax Assessment Act 1997 Subsection 6-5(4)

Reasons for decision

Detailed reasoning

Character of payment

Whether an item is ordinary income is determined by examining the whole circumstances of a particular case, having regard to the propositions and indicia developed or recognised by the courts.

In many instances, there can be no dispute as to the character of a receipt. Salary and wages, fees received by professional persons and business receipts from sales are clearly income according to ordinary concepts. Similarly, interest paid on a loan is income of the lender, although the loan itself is not income of the borrower and repayments of principal are not income of the lender.

In all cases, the initial and most important enquiry is to determine the character of the item in the recipient's hands: McLaurin v FCT (1961) 104 CLR 381.

Subsection 6-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) defines ordinary income as income 'according to ordinary concepts'. Under subsection 6-5(2) of the ITAA 1997, the assessable income of an Australian resident includes the ordinary income derived directly or indirectly from all sources during the income year.

The courts accept that ordinary income generally arises in 3 ways:

· as a reward for rendering personal services (eg salary and wages and professional fees);

· as profits from carrying on a business, including profits from unusual or isolated business transactions; and

· as a return on an investment (eg rent, interest and dividends).

Interest income is defined as income consisting of interest, or a payment in the nature of interest, in respect of:

· a loan, advance or deposit of money

· credit given, or

· any other kind of debt or liability.

Interest is generally, if not always, of an income nature and is therefore income according to ordinary concepts. Ordinary income is included in a taxpayer's assessable income in the income year in which it is derived by the taxpayer.

Subsection 6-5(4) of the ITAA 1997 provides that in working out whether you have derived an amount of ordinary income, and (if so) when you derived it, you are taken to have received the amount as soon as it is applied or dealt with in any way on your behalf or as you direct.

Application to your circumstances

You loaned an amount of money, to Company A. On that date, the sole shareholder in Company A, Mr A, sold all the shares in Company A. Importantly, you did not hold any shares in Company A, nor is there any indication that the sole shareholder in Company A held any part of his shareholding on trust for you, or any other entity.

You have provided a deed of agreement, stating that it was agreed between the parties at the time of incorporation of Company A that you would have an entitlement to 25% of the value of Company A, however, you have advised that no formal agreement was put in place at that time.

You then entered into a deed of forgiveness with the new owners of Company A providing that the loan you gave to Company A will be forgiven.

In line with the deed of agreement, you received, from Mr A, your 1^st payment in the 2010-11 financial year. The 2^nd payment of was received in the 2011-12 financial year.

Based on the information provided, you did not hold an equity interest in Company A. There was no agreement in place at the incorporation of Company A, nor was there any agreement in place at the time of the sale of the Company A shares that would indicate you held any interest in the company.

Instead, we consider that you loaned Company A an amount of money and the payments received from Mr A are a return of the principal of the loan, including an interest component. This is despite a deed of forgiveness of the loan being signed, as the fact remains that the character of the payments from Mr A are that of the repayment of the loan.

Therefore, in the absence of any further evidence to the contrary, the amount of money received from Mr A, over and above the amount of the principal initially loaned to Company A, will be considered interest income.

As interest income is considered ordinary income, it will be assessed under section 6-5 of the ITAA 1997, and will not be assessed under the capital gains tax provisions.

Accordingly, you are taken to have derived the income in the financial year in which it was received, or applied or dealt with in any way on your behalf or as you direct. This means your 1^st payment was derived in the 2010-11 financial year and, the 2^nd payment was derived in the 2011-12 financial year. This is the case even though the money was required to be kept in a term deposit as part of the conditions of the relative agreements for a further two years. This is because it was at your direction that the money be held, or dealt with in that particular way.

Capital gains tax concessions for small business

As the payments received are considered a repayment of the loan you made to Company A, with interest, the profit made on the transaction is considered ordinary income. Therefore no capital gain will arise from the receipt of the payments and no capital gains tax concessions will be available to be applied.

GST on the sale proceeds

As the payments received are considered a repayment of the loan you made to Company A, with interest, there are no GST implications on the transaction.