Edited version of private advice

Authorisation Number: 1012636313221

Ruling

Subject : Are you carrying on a business - and entitlement to deduction for bad debts

Question 1

Are you conducting a money lending business for the purposes of section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Alternatively, are you entitled to a deduction for bad debts written off under section 8-1 of the ITAA 1997?

Answer

Not applicable.

This ruling applies for the following periods:

1 July 2008 to 30 June 2009

1 July 2009 to 30 June 2010

1 July 2010 to 30 June 2011

1 July 2011 to 30 June 2012

1 July 2012 to 30 June 2013

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You were established as a trust.

You began to function as a financier, by borrowing money from banks, commercial lenders and related parties.

You would on-loan these amounts to internal and external entities.

You are not registered as a money lender.

Your deed of settlement provides the trustee with the power to raise and loan funds.

You have loan receivables with a number of entities.

You also operate a business relating to the management of commercial premises for which you receive management fees.

All loans made to third parties are subject to written and duly executed loan agreements. The agreements generally include the following:

• Interest rate

• Interest payment terms

• Principal repayment date

• Security charge over assets

• Personal guarantees

You will sometimes demand a floating interest payment depending on the perceived risk associated with some projects.

You enter into property development projects under joint venture arrangements or development agreements with third parties.

Interest rates, repayment dates and default clauses are documented either within the agreement or in a separately executed loan agreement. These agreements include your security over the loan.

From when you began to function as a financier until some later time you charged commercial rates of interest on all of these loans.

Interest charged to the economic entities was calculated by reference to the expected interest costs and fees incurred on amounts borrowed by you plus a small additional profit margin.

When you had repaid all of your external debt you ceased charging interest on many of your internal loans.

You have a standard loan process for the approval of loans. The loan process varies depending on the nature of the borrower for internal and external entities.

For internal entities that are substantially profitable, there are minimal risks of default in contrast with a more rigorous process for entities that undertake new property developments and commercial activities.

All approved loans are monitored given their value to the group. The monitoring process between internal and external loans is similar.

The status and balance of internal loans are monitored regularly and included in formal monthly board reports. These reports are presented for review and consideration by a committee as part of the monitoring process.

You have a credit recovery process in place. The credit recovery process is generally a standard process where applicable. However, as part of this process, the committee considers both internal and external borrowings to determine whether credit recovery procedures will be pursued in the event of loan defaults as dependent on the specific circumstances.

Defaults are treated consistently in that the recoverability of the loans depends on the security of the loan. External advisors are engaged to ascertain recoverability on a case by case basis.

Reasons for decision

Question 1

Summary

You are conducting a money lending business for the purposes of section 25-35 of the ITAA 1997.

Detailed reasoning

Section 8-1 of the ITAA 1997 deals with general deductions and provides the circumstances where you may deduct from your assessable income, certain losses or outgoings. This section states that you may deduct losses or outgoings to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

However, certain exclusions exist to prevent you from deducting a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your *exempt income; or

(d) a provision of this Act prevents you from deducting it.

Section 8-10 of the ITAA 1997 indicates that if more than one provision applies, the most appropriate provision should be used. If there is a more specific section, it would be the section most appropriate.

Division 12 of the ITAA 1997 sets out particular types of deductions that are dealt with by a specific provision of either the Income Tax Assessment Act 1936 (ITAA 1936) or the ITAA 1997. In particular, Division 12 lists that the rules in relation to deduction of general bad debts are provided for by section 25-35 of the ITAA 1997.

Subsection 25-35(1) of the ITAA 1997 provides the circumstances that must exist so that you can deduct a bad debt that you have written off in an income year. These circumstances are:

(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.

Note: If a bad debt is in respect of a payment that is required to be made under a qualifying security (within the meaning of Division 16E of Part III of the Income Tax Assessment Act 1936): see subsection 63(1A) of that Act.

In order to claim a bad debt under paragraph 25-35(1)(b) of the ITAA 1997 it is necessary to demonstrate that the entity is carrying on a business as a moneylender and that the bad debt claimed related to money which was lent in the ordinary course of that business.

Carrying on a business as a moneylender

Generally, the requirements to be considered to be carrying on a business as a moneylender are similar to those required for carrying on of a business.

Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling TR 97/11 provides the Commissioners view of the factors used to determine if you are in business for tax purposes.

In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

• whether the activity has a significant commercial purpose or character

• whether the taxpayer has more than just an intention to engage in business

• whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

• whether there is regularity and repetition of the activity

• whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

• whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

• the size, scale and permanency of the activity, and

• whether the activity is better described as a hobby, a form of recreation or sporting activity.

No one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression.

Taxation Ruling TR 92/18 provides the Commissioner's view in relation to the deductibility of bad debts. Whilst the ruling considers this in relation to the ITAA 1936, the same principles apply in respect of the ITAA 1997.

TR 92/18 reiterates that the question of whether a business of money lending is being carried on is a question of fact. It also indicates that in assessing the facts a money lender may not necessarily need to be willing to lend to the public or a wide class of borrowers. Further, the taxpayer may lend to only certain classes however this must be done in a business-like manner with a view to yielding a profit from that activity.

Relevant case law

Bowen CJ in FC of T v. Marshall and Brougham Pty Ltd 87 ATC 4522: 18 ATR 859 (Marshall and Brougham's case) made the following observations regarding a business of money mending:

It is generally accepted that in order to be regarded as carrying on a business one must demonstrate continuity and system in ones dealings. In the case of money lending it has been said that a person must hold himself out as willing to lend money generally to all and sundry (subject to credit-worthiness): see Litchfield v. Dreyfus [1906] 1 KB 584. It is not decisive whether the lender is a registered money-lender or not, although this will be a factor to take into account. It should be mentioned that it need not be the only business or the principal business of the taxpayer. It will be insufficient, however, if it is merely ancillary or incidental to the primary business. In the end, it will be a question of fact for the court to decide by looking at all the circumstances involved: see Newton v. Pyke (1908) 25 TLR 127.

In Litchfield v. Dreyfus [1906] 1 KB 584 at p. 589, Farwell J stated that:

Speaking generally, a man who carries on a money-lending business is one who is ready and willing to lend to all and sundry, provided that they are from his point of view eligible

However, this should not restrict the meaning of 'money-lender' for taxation purposes in light of the more recent Australian cases of Fairway Estates Pty Ltd v. Federal Commissioner of Taxation (1970) 123 CLR 153; (1970) 70 ATC 4061; (1970) 1 ATR 726, Marshall and Brougham's case and FC of T v. Bivona Pty Ltd 90 ATC 4168; 21 ATR 151.

These recent cases have highlighted the differences between laws relating to the control of money lenders and the laws relating to the taxing of money lenders.

Further, in the case of Richard Walter Pty Ltd v FC of T 95 ATC 4440 Tamberlin J stated that:

…it is not enough merely to show that a person has on several occasions lent money at remunerative rates of interest; there must be a certain degree of continuity and system about the transactions. The activity should be capable of being described as business operations intended to yield a profit.

Non-registration as a money lender is only one circumstance to be considered and is not decisive. In Administrators of Estate of Stewart v C of T (NSW) (1935) 3 ATD 271 it was held that, despite non-registration as a money lender, the taxpayer was carrying on a money lending business.

In Fairway Estates Pty Ltd v. Federal Commissioner of Taxation (1970) 123 CLR 153; 70 ATC 4061; (1970) 1 ATR 726, Barwick CJ said that 'provided there is an intention to carry on a money lending business, such a business can exist even though only one loan has been made'. Therefore, it is possible for an entity to carry on a money lending business with only a few borrowers.

In Federal Commissioner of Taxation v. Bivona Pty Ltd (1990) 21 FCR 562; 90 ATC 4168; (1990) 21 ATR 151, the taxpayer company was incorporated for the purpose of borrowing money overseas ($4m in Swiss francs) for use by a group of companies of which it was a member.

It was concluded that the taxpayer's principal business was money lending as approximately 83% of the taxpayer's gross income was interest received from the holding company and a further 7% was interest received from unrelated companies.

The loan to the holding company yielded a profit (that is, the interest received exceeded the interest paid to the overseas lender).

Accordingly, for the purposes of taxation law, a money lender does not have to necessarily be ready and willing to lend money to the public at large, or to a wide class of borrowers. Registration as a money lender and the number of borrowers does not conclusively determine that a business of money lending is being carried on. In addition, it is sufficient if the taxpayer lends money to certain classes of borrowers, provided the taxpayer does so in a businesslike manner with a view to yielding a profit from that activity.

Application of the law to your circumstances

In examining your lending activities, it can be seen that you are conducting those activities in a structured and systematic way that demonstrates commercial purpose. You are conducting your activities in a business-like manner with a degree of repetition and regularity. The scale of the lending is significant such that your money lending is not ancillary or incidental to another part of your business. It is apparent that you are conducting your money lending activity with a view to profit. You are not conducting an activity that is better described as a hobby, a form of recreation or sporting activity.

Therefore, on the balance of facts presented, it is considered that you are carrying on a business of lending money for the purposes of section 25-35 of the ITAA 1997.

Question 2

Summary

It has been determined at Question 1 that you are carrying on a business of money lending and therefore the loans that you make are considered to be in the ordinary course of business.