Edited version of your private ruling

Authorisation Number: 1012513893777

Ruling

Subject: Capital Losses

Question 1

Can a capital loss incurred as a consequence of the settlement of a legal claim be allowed to be offset against future capital gains in terms of Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, participants are entitled to capital losses incurred from their participation in the investment ventures. In calculating the amount of the capital loss, only the funds personally contributed to the ventures will form part of the cost base.

This ruling applies for the following periods:

1 July 2011 to 30 June 2012

The scheme commenced:

During the year ended 30 June 2000

Relevant facts and circumstances

The entities who are rulees for this ruling were participants in investment ventures in previous financial years.

The participants entered into either a joint venture agreement or a partnership agreement for the purposes of that joint venture or partnership entering into the investment ventures involving the manufacture and sale of a product. Copies of the joint venture agreement and the partnership agreements have been provided.

To enter the investment ventures, the participants, as joint venturers or as partners, entered into a Management Agreement with a company (the Manager), completed a Finance Agreement with another company (the Financier) and made a cash, contribution, of a proportion of the initial cost. The Management Agreements were for the purpose of appointing the Manager to arrange for the manufacture, store and sale of the product on behalf of the participants.

Further outlays were made by the participants, in the initial and later years, in respect of Management and Production fees, insurance and storage fees for the product which was held in storage. These amounts were paid to the Manager.

The participants entered into an agreement to surrender and forego any right, title, or interest in the product or the proceeds of its sale (the Agreement).

Relevant legislative provisions

Income Tax Assessment Act 1997  section 102-5

Income Tax Assessment Act 1997  subsection 102-15(3)

Income Tax Assessment Act 1997  subsection 104-25(1)

Income Tax Assessment Act 1997  subsection 104-25(2)

Income Tax Assessment Act 1997  subsection 104-25(3)

Income Tax Assessment Act 1997  section 108-5

Income Tax Assessment Act 1997  subsection 116-30(1)

Income Tax Assessment Act 1997  Division 110

Reasons for decision

Summary

Participants are entitled to capital losses incurred from their participation in the investment ventures. In calculating the amount of the capital loss, only the funds personally contributed to the ventures will form part of the cost base.

Detailed reasoning

An entity can make a capital gain or capital loss only if a CGT event happens to a CGT asset.

Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property or a legal or equitable right that is not property.

After reviewing the Management Agreements between the participants and the management companies we consider that upon entering into the investment ventures, the participants acquired an intangible CGT asset, being the legal or equitable right to receive the profits from the eventual sale of the product, rather than the product itself.

Under subsection 104-25(1) of the ITAA 1997, CGT event C2 'Cancellation, surrender and similar endings' happens if a taxpayer's ownership of an intangible CGT asset ends by the asset being redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, forfeited or expiring.

When the participants entered into the Agreement to surrender and forego any right to receive the profits from the sale of the product came to an end. The ending of this CGT asset constituted a CGT event C2.

The time of the event for the purposes of subsection 104-25(2) of the ITAA 1997 was when the Agreement was entered into.

Subsection 104-25(3) of the ITAA 1997 provides that a capital gain is made if the capital proceeds from the ending are more than the asset's cost base, while a capital loss is made if those capital proceeds are less than the asset's reduced cost base.

To establish whether the participants have made a capital loss in respect of this CGT event, it is necessary to subtract the capital proceeds the participants received from surrendering their right to the profits from the eventual product sales, from the reduced cost base of that right.

Applying the cost base provisions in Division 110 of the ITAA 1997, the reduced cost base of the right, as at the time of the CGT event, would comprise the cash outlay contributed by the participants (not including the funds borrowed), together with other expenses incurred in connection with the Management Agreement, such as insurance, storage fees and commissions paid.

The funds borrowed under the Finance Agreement do not form part of the cost base since the Commissioner is of the view that the finance obtained it was in substance a non-recourse loan. The Commissioner considers that although the participants formally assumed a liability, they were at no risk of commercial risk in respect of the repayment of the outstanding loan liability due to the terms and conditions upon which the loan was made and the arrangements entered into by the management companies to secure the sales of the product.

Although the participants have not received any money in respect of the ending of the CGT asset, the participants would be deemed to have received capital proceeds equivalent to the market value of the rights, worked out as at the time of the event, pursuant to subsection 116-30(1) of the ITAA 1997.

It may be that the market value of the CGT asset as at the time of its ending was nil but the Commissioner is not in a position to determine this. To determine the market value of the rights the participants can choose to obtain a valuation from a qualified valuer or compute their own valuation based on reasonably objective and supportable data.

Capital losses that a taxpayer makes in an income year are offset against any capital gains made during the income year (section 102-5 of the ITAA 1997). If the capital losses are not absorbed in this way, they are carried forward to future income years, to be offset against future capital gains (subsection 102-15(3) of the ITAA 1997).