Edited version of your written advice

Authorisation Number: 1013023709494

Date of advice: 25 May 2016

Ruling

Subject: Bad debt deduction

Question 1

Is the written off debt of the Trust, deductible to the Trust as a bad debt under section 25-35 of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following periods

Year ended 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

The Trust made a loan to a related Company.

The loan was not secured.

Interest was charged on the loan.

The Company subsequently went into liquidation.

The Trust lodged a Proof of Debt with the liquidator.

The liquidator advised the Trust that there would be insufficient funds to cover the debt.

The trustee of the Trust passed a resolution writing the loan of as a bad debt.

The Trust had previously entered loans with related parties. The loans were not commercial.

The Trust has subsequently entered loans with related parties

Relevant legislative provisions

Section 25-35 of the Income Tax Assessment Act 1997

Reasons for decision

Subsection 25-35(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides the following:

You can deduct a debt (or part of a debt) that you write off as bad in the income year if:

(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.

Debt you write off as bad

Taxation Ruling TR 92/18 Income tax: bad debts (TR 92/18), states the Commissioner view on the operation of the former bad debt provision, section 63 of the Income Tax Assessment Act 1936. Section 63 was the precursor to subsection 25-35 (1) of the ITAA 1997 (the two provisions are expressed in the same way) and the ruling covers the requirements of subsection 25-35(1). TR 92/18 provides the following on when a debt is bad:

What constitutes a 'debt' for section 63?

25. A debt may be defined as a sum of money due from one person to another. As a general rule where a taxpayer is entitled to receive a sum of money from another either at law or in equity, it is accepted that a debt exists for the purposes of section 63. There is a debt for the purposes of section 63 where a taxpayer has merely an equitable entitlement to the debt (G.E. Crane Sales Pty Ltd v. F.C. of T. (1971) 126 CLR 177, 71 ATC 4268, 2 ATR 692).

When will a debt be bad?

26. Whether a debt is bad depends upon an objective consideration of all the relevant circumstances of each case. Strictly speaking, in the case of an individual debtor, a debt is not 'bad' until the debtor has died without assets, or has become insolvent and his estate has been distributed, or the debt has become statute barred. In the case of a corporate debtor a similar situation would arise on receipt of the liquidator's final distribution or when the company is completely wound up.

27. However, because subsection 63(3) contemplates that an amount may subsequently be received in respect of a debt previously written off as bad, it is considered that, for the purposes of section 63, the debt need not necessarily be 'bad' in the strict sense as indicated in paragraph 26 above.

…

30. Although the debt need not be bad in the strict sense it must nonetheless be more than merely doubtful. For example, a debt will not be accepted as bad merely because a certain set period of time for payment (e.g. 180 days or 270 days) has elapsed with no payment or contact having been made by the debtor.

31. A debt may be considered to have become bad in any of the following circumstances:

(a) the debtor has died leaving no, or insufficient, assets out of which the debt may be satisfied;

(b) the debtor cannot be traced and the creditor has been unable to ascertain the existence of, or whereabouts of, any assets against which action could be taken;

(c) where the debt has become statute barred and the debtor is relying on this defence (or it is reasonable to assume that the debtor will do so) for non-payment;

(d) if the debtor is a company, it is in liquidation or receivership and there are insufficient funds to pay the whole debt, or the part claimed as a bad debt;

(e) where, on an objective view of all the facts or on the probabilities existing at the time the debt, or a part of the debt, is alleged to have become bad, there is little or no likelihood of the debt, or the part of the debt, being recovered.

32. While individual cases may vary, as a practical guide a debt will be accepted as bad under category (e) above where, depending on the particular facts of the case, a taxpayer has taken the appropriate steps in an attempt to recover the debt and not simply written it off as bad. Generally speaking such steps would include some or all of the following, although the steps undertaken will vary depending upon the size of the debt and the resources available to the creditor to pursue the debt:

(i) reminder notices issued and telephone/mail contact is attempted;

(ii) a reasonable period of time has elapsed since the original due date for payment of the debt. This will of necessity vary depending upon the amount of the debt outstanding and the taxpayers' credit arrangements (e.g. 90, 120 or 150 days overdue);

(iii) formal demand notice is served;

(iv) issue of, and service of, a summons;

(v) judgment entered against the delinquent debtor;

(vi) execution proceedings to enforce judgment;

(vii) the calculation and charging of interest is ceased and the account is closed, (a tracing file may be kept open; also, in the case of a partial debt write-off, the account may remain open);

(viii) valuation of any security held against the debt;

(ix) sale of any seized or repossessed assets.

While the above factors are indicative of the circumstances in which a debt may be considered bad, ultimately the question is one of fact and will depend on all the facts and circumstances surrounding the transactions. All pertinent evidence including the value of collateral securing the debt and the financial condition of the debtor should be considered. Ultimately, the taxpayer is responsible for establishing that a debt is bad and bears the onus of proof in this regard.

…

A deduction for a bad debt is allowable in the year of income in which the debt is written off

34. It is not enough to simply make a provision for a bad debt. The debt has to be written off as a bad debt and it has to be written off before year's end. The question has often arisen as to what the term 'written off' means. In Case 33 (1941) 10 TBRD 101 the Taxation Board of Review expressed at p.103 the view that:

'... the writing off of a bad debt does not necessitate a particular form of book entry or even a book entry at all. It is sufficient, we think, if there are written particulars - there must, of course, be something in writing - which indicates that the creditor has treated the debt as bad.'

35. There is a requirement that the debt has to be physically written off…

It is accepted that the Trust has taken necessary steps to write off as a bad debt the debt owing to it by the Company.

Business of lending money

Whether a taxpayer is carrying on a business of lending money is a question of fact.

In Federal Commissioner of Taxation v Marshall and Brougham Pty Ltd 87 ATC 4522; 18 ATR 859 Bowen CJ stated the following about carrying on the business of money lending (at ATC 4528-4529):

It is generally accepted that in order to be regarded as carrying on a business one must demonstrate continuity and system in one's 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 Federal Commissioner of Taxation v Bivona Pty Ltd 90 ATC 4168 the court stated the following about carrying on the business of money lending:

Speaking generally, to find that a "taxpayer's principal business consists of the lending of money" in a year of income suggests a degree of system and continuity or repetition in the conduct of a commercial activity …

The necessity for the repetition of acts or continuity is perhaps clearer from the phrase "carries on business" than the word "business"…; but for a business to exist there must be activity of the body concerned to constitute a commercial enterprise and generally one must look for system, regularity or recurrence. (at 4172-4173)

In Fairway Estates Pty Ltd v Federal Commissioner of Taxation (1970) 123 CLR 153, Barwick CJ stated the following concerning continuity and repetition:

I do not regard the fact that there was no immediate repetition of the lending of money or that there was a considerable break before there was any continuity in the making of loans as definitive of the question whether the business of lending money was being carried on at the time of the advance…

… in my opinion , there can be a course of business although as yet there is nothing more than an intention to carry on the business and a single transaction carried out in pursuance of that intention… (at 165-166)

In TR 92/18, after quoting the above comments of Bowen CJ in Federal Commissioner of Taxation v Marshall and Brougham Pty Ltd, the Commissioner goes on to state the following about who is a money lender:

44. The frequently quoted statement of Farwell J in Litchfield v. Dreyfus [1906] 1 KB 584 at p. 589 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'

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. F.C. of T. (1970) 123 CLR 153, 70 ATC 4061, 1 ATR 726; F.C. of T. v. Marshall and Brougham Pty Ltd (supra); and F.C. of T. v. Bivona Pty Ltd 90 ATC 4168, 21 ATR 151.

45. These recent cases have highlighted the differences between the laws relating to the control of money-lenders and the laws relating to the taxing of money-lenders. In particular, the joint judgment in FCT v. Bivona Pty Ltd (supra) at ATC p.4173, ATR p.156 concluded that '[w]hether Farwell J.'s statement (in the Litchfield case) is consistent with modern authority is not a matter for us to consider because it is used in the context of moneylending legislation, whereas a different inquiry is involved in this case.'. Litchfield v. Dreyfus (supra) was a case under the Moneylenders Act 1900 (UK) and not under a taxing statute.

46. Accordingly, …, a money lender need not necessarily be ready and willing to lend moneys to the public at large or to a wide class of borrowers. It would be sufficient if the taxpayer lends moneys to certain classes of borrowers provided the taxpayer does so in a businesslike manner with a view to yielding a profit from it.

For subsection 25-35(1) of the ITAA 1997 to apply, the Trust must have been carrying on a business of lending money at the time the loan was made.

At the time of making the loan to the Company the Trust was not carrying on a business of lending money.

As such, the debt written off by the Trust is not deductible under section 25-35 of the ITAA 1997.