Edited version of your written advice

Authorisation Number: 1013000526320

Date of advice: 20 April 2016

Ruling

Subject: CGT - deceased estate and debentures

Questions and answers

Are you entitled to claim a capital loss on Debentures you acquired from a deceased estate which are subject to Receivership?

No.

This ruling applies for the following period

1 July 2015 to 30 June 2016

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Your non-resident relative acquired Debentures in a company (the Company), in two tranches.

The interest was retained by the Company and compounded.

The Company went into Receivership.

A partial redemption of the principal investment was made to your non-resident relative.

Your non-resident relative held a Special Category visa which is a temporary visa.

Your non-resident relative was not an Australian Citizen or an Australian permanent resident.

Your non-resident relative moved to Australia and did not intend to return overseas.

Your non-resident relative received a further partial redemption of the principle investment.

Your non-resident relative passed away.

You are the main beneficiary of your non-resident relative's estate and hold the Debentures as an investment.

You received a partial redemption of the principle investment.

You received another partial redemption of the principle investment.

The Receivers issued a letter accompanying a partial redemption which stated that this was the final distribution and that they do not expect to recover further funds. The Receivers also stated that they anticipate finalising the Receivership in the near future.

There has been no other written declaration by the Receivers that the Debentures have no value or have only negligible value.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 26BB

Income Tax Assessment Act 1936 subsection 26BB(1)

Income Tax Assessment Act 1936 subsection 26BB(2)

Income Tax Assessment Act 1936 Section 70B

Income Tax Assessment Act 1997 Section 8-1

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

Income Tax Assessment Act 1997 section 20-25

Income Tax Assessment Act 1997 subsection 20-25(1)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-25

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

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

Income Tax Assessment Act 1997 Section 104-145

Income Tax Assessment Act 1997 subsection 104-145(2)

Income Tax Assessment Act 1997 subsection 104-145(3)

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 128-15

Income Tax Assessment Act 1997Supsection 995-1(1)

Reasons for decision

Is the investment loss an income loss or a capital loss?

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer may deduct from their assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income. However, a taxpayer cannot deduct a loss or outgoing to the extent that the loss or outgoing is of capital, or capital nature.

Under 6-5(1) of the ITAA 1997, the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). A repayment of the principal of a debt is generally a capital receipt and is not assessable as ordinary income.

Application to your circumstances

Any gain or loss on Debentures will be of capital or capital nature if the Debentures are held as an investment.

Therefore, any gain or loss on the Debentures you received from your non-resident relative's deceased estate will be of a capital nature.

Traditional securities

The traditional securities provisions, sections 26BB and 70B of the Income Tax Assessment Act 1936 (ITAA 1936), include in assessable income or allowable deductions, gains or losses made on the disposal or redemption of certain securities.

A traditional security is defined under subsection 26BB(1) of the ITAA 1936 as one that is:

• Acquired by the taxpayer after 10 May 1989;

• Not issued at a discount of more than 1.5% multiplied by the number of years in the terms of the security;

• Does not bear deferred interest;

• Is not capital indexed;

• Is not trading stock of the taxpayer.

Subsection 26BB(2) of the ITAA 1936 states:

Where a taxpayer disposes of a traditional security or a traditional security of a taxpayer is redeemed, the amount of any gain on the disposal or redemption shall be included in the assessable income of the taxpayer of the year of income in which the disposal or redemption takes place.

For the purposes of this section:

Security is defined as stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security; a deposit with a bank or other financial institution; a secured or unsecured loan; or any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not liability is secured.

The word dispose is defined in subsection 26BB(1) of the ITAA 1936 as follows:

Dispose, in relation to a security, means sell, transfer, assign or dispose of in any way the security or the right to receive payment of the amount or amounts payable under the security.

Taxation Ruling TR 96/14 deals with traditional securities. Paragraphs 63 to 65 provide guidance to the question:

Can there be a disposal where the issuer company is in liquidation?

Paragraphs 63 to 65 provide that:

Where a taxpayer disposes of a traditional security or a traditional security of a taxpayer is redeemed, subsection 70B(2) allows a deduction for any loss on the disposal or redemption of the security. When a traditional security matures and the issuer honours the obligation to pay the promised amount, the security may be said to have been redeemed by the issuer.

In some cases the issuer may not be able to redeem its securities at the time they mature. This may occur where, for example, the issuer is a company and is insolvent at the time the securities mature. We also consider that, in such circumstances, for the reasons mentioned in paragraphs 48 to 60 above, the holder has not disposed of the security, in the sense required by subsection 70B(2).

Further, in considering whether a security has been disposed of, it seems clear that the terms of subsection 70B(2) require any act of disposal to be an act of the taxpayer who held the security. While a particular security might ultimately cease to exist or become worthless because of the liquidation or dissolution of the issuer company, neither of those consequences means that there has been any act of disposal (as defined) which has been taken by the taxpayer.' (emphasis added).

Application to your circumstances

Accordingly, as the security that you held was not disposed of or redeemed, you are not entitled to a deduction under subsection 70B of the ITAA 1936.

Capital Gains Tax

Under section 104-10 of the ITAA 1997 a Capital Gain Tax (CGT) event A1 occurs when a taxpayer disposes of a CGT asset. The disposal of a CGT asset takes place if a change of ownership occurs from the taxpayer to another entity, whether because of some act or event or by operation of law.

Section 128-15 of the ITAA 1997 provides that any capital gain or capital loss that is made on the transfer of assets to a legal personal representative, or executor, or a beneficiary is disregarded.

Where a deceased person acquired an asset after 20 September 1985 (post CGT), and the deceased person was a foreign resident just before they died and an asset they owned was not taxable Australian property, the cost base and reduced cost base of that asset will be the market value of the asset on the day the deceased person died.

Application to your circumstances

Your non-resident relative was a non-resident of Australia just before death.

The Debentures you inherited from your non-resident relative are foreign Debentures. At the time, just before your non-resident relative passed, the Debentures were not taxable Australian property.

Accordingly, the cost base and reduced cost base of the Debentures will be their market value on the day your non-resident relative died.

Where the market value of an asset needs to be determined, a person can choose to obtain a detailed valuation from a qualified valuer or compute their own valuation based on reasonably objective and supportable data.

If you choose to compute your own valuation it is important to take into consideration that at the time your non-resident relative passed, the company that issued the Debentures had already been placed into receivership and this may affect the market value of the Debentures.

To be acceptable, a valuation must specify a precise figure as the value of an asset. The Australian Taxation Office may challenge valuations where appropriate.

Asset

A debt is an asset as defined in section 108-5 of the ITAA 1997, which states, in part that:

A CGT asset is:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

One of the examples given in the notes to section 108-5 of the ITAA 1997 is 'debts owed to you.' Therefore, a debt, or right to repayment, is an asset for CGT purposes.

Application to your circumstances

You inherited a debt (the Debentures) of the Company, which has been placed into Receivership. The financial instrument, or debt, owed to you by the Company is viewed as a CGT asset.

CGT event

Section 102-20 of the ITAA 1997, provides that a taxpayer makes a capital gain or capital loss if and only if a CGT event happens. The gain or loss is made at the time of the CGT event.

CGT event C2

CGT event C2 in section 104-25 of the ITAA 1997 happens if the taxpayer's ownership of an intangible CGT asset ends in certain ways, including because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited.

Under subsection 104-25(2) of the ITAA 1997 the time of the event is when the taxpayer enters into a contract that results in the asset ending. If there is no contract, the event happens when the asset ends.

A taxpayer's ownership of the underlying debt, which the Debenture represents, does not end when the Debenture matures if the company defaults on repayment. Nor does it end if the company is placed in administration or liquidation whether this is before or after the Debenture matures. The debt continues in existence. Per Emmett J in Federal Commissioner of Taxation v. Macquarie Health Corporation Limited & Ors (1998) 88 FCR 451; 98 ATC 5214; (1998) 40 ATR 349:

There is no doubt that the effect of winding up and of sequestration is that there is a restriction imposed on the capacity of a creditor to enforce payment of a debt without the leave of the Court. A creditor will not be entitled to payment from the debtor and if the creditor receives payment, he will be required to repay the amount to the liquidator or trustee in bankruptcy. In that sense, the creditor's remedies are converted into a right to prove in winding up or in the bankruptcy. However, it does not follow, in my view, that the debt ceases to exist. The right to enforce payment is restricted. Nevertheless, the right to prove in the winding up or bankruptcy is a right to prove in respect of the debt which continues to exist.

In following the above case, the Court, observing the relevant consequences of the making of a winding up order, in Federal Commissioner of Taxation v. Linter Textiles Australia Ltd (in Liq) (2003) 129 FCR 42; 2003 ATC 4458; (2003) 52 ATR 502 noted that:

The rights of creditors cease to be rights in person am (although their debts are not released prior to dissolution or deregistration); ...

Therefore, as the debt continues in existence the taxpayer's ownership of the debt does not end in one of the ways contemplated by subsection 104-25(1) of the ITAA 1997, regardless of whether the company is in administration or liquidation.

Application to your circumstances

CGT event C2 in section 104-25 of the ITAA 1997 has not happened in relation to the debt, the Company has not been deregistered, nor have you released the debt in favour of the Company.

CGT event G3

Under section 104-145 of the ITAA 1997 a CGT event G3 happens if a taxpayer owns shares in a company, or financial instruments issued by or created by or in relation to a company, and a liquidator or administrator of the company declares in writing that they have reasonable grounds to believe, as at the time of the declaration, that;

(a) for shares - there is no likelihood that shareholders in the company, or shareholders of the relevant class of shares, will receive any further distribution for their shares; or

(b) for financial instruments - the instruments, or a class of instruments that includes instruments of that kind, have no value or have only negligible value.

The time of the CGT event is when the administrator makes the declaration (subsection 104-145(2) of the ITAA 1997).

Under subsection 104-145(3) Debentures are listed as a financial instrument.

A taxpayer can choose to make a capital loss equal to the reduced cost base of their financial instrument, as at the time of the declaration. If the choice is made, the cost base and reduced cost base of the shares are reduced to nil.

There are two points in time when a taxpayer can choose to make a capital loss on worthless financial instruments:

• when the liquidator or administrator declares the financial instruments to be worthless, or

• when the financial instrument is disposed of or ceases to exist, for example when a company is wound up.

Application to your circumstances

The Company has not been deregistered. The Receivers of the Company have declared that they have made their final distribution and do not expect to recover further funds. However, the Receivers have not made a declaration that the Debentures have no value or have only negligible value.

Therefore, you are unable to make the choice to apply a capital loss as neither of the conditions listed above have been met.