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Edited version of your written advice
Authorisation Number: 1013023714313
Date of advice: 1 June 2016
Ruling
Subject: Capital Losses
Question 1
Are you entitled to claim a capital loss on convertible notes issued by a company?
Answer
No
This ruling applies for the following period:
Year ended 30 June 2016
The scheme commences on:
1 July 2015
Relevant facts and circumstances
In 200X, you and your partner purchased Convertible Notes in a company.
The company went in to Administration in 20XX.
The company is now in liquidation.
You wish to now claim a capital loss on these notes.
Relevant legislative provisions
Income Tax Assessment Act 1997 section 102-20
Income Tax Assessment Act 1936 section 70B
Income Tax Assessment Act 1936 subsection 70B(2)
Income Tax Assessment Act 1936 provisions 26BB
Reasons for decision
Capital gains tax (CGT) is the tax you pay on certain gains you make. You make a capital gain or capital loss as a result of a CGT event (section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997)).
Unsecured convertible notes are classed as a 'traditional security' under the provisions 26BB of the Income Tax Assessment Act 1936 (ITAA 1936).
For a capital or revenue loss to be recognised for tax purposes, there are four possible events that may apply to convertible notes issued by a company that is now in liquidation. These are:
• Disposal - where the owner of the convertible notes sells or gives them to another person (there are conditions on this event, see the notes below).
• Surrender - where the owner of the notes enters a deed surrendering their entitlement to repayment of principle and interest on the notes.
• Cancellation of the notes at the end of the liquidation process.
• Redemption.
Where none of the events outlined above have occurred, the owner of the convertible notes issued by a company in liquidation cannot claim a loss on those notes.
In your case, none of the events listed above have occurred so you cannot claim a loss on your convertible notes.
Sale or Redemption
Where you dispose of a traditional security or it is redeemed, the amount of any loss on the disposal or redemption is allowable as a deduction against your assessable income in the year of income in when the disposal or redemption takes place (section 70B of the ITAA 1936).
In assessing whether or not a loss in relation to a traditional security is deductible, the concept of disposal is critical.
In considering whether a security has been disposed of, the disposal must have been an action of the individual who held the security. Where 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 individual (subsection 70B(2) of the ITAA 1936).
Taxation Ruling TR 96/14 (paragraph 64) acknowledges that 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 consider that in such circumstances the holder has not disposed of the security, in the sense required by subsection 70B(2) of the ITAA 1936.
At this stage, you have not sold your notes and the company has not redeemed them. As there has been no disposal of the notes, no deduction for their loss of value is available to you.
Surrender or cancellation
If all rights under a security are legally and irrevocably surrendered, released or cancelled then a CGT event C2 has occurred (section 104-25 of the ITAA 1997). CGT event C2 occurs when:
• the holder of the note executes a Deed of Release in favour of the company, or
• the notes are cancelled by the company.
A Deed of Release must unconditionally release the liquidator from any obligation to pay interest or principle on the notes.
The time of the CGT event is when you enter into a contract that results in the asset ending, or when the note is cancelled. A capital loss can be claimed in the year of the event.
You should note that a capital loss may only be used to offset a capital gain and carries forward indefinitely until you have a capital gain. A capital loss may not be offset against ordinary income.
In your case, you have not entered into a Deed of Release, nor have the notes been cancelled by the company. Therefore, you cannot claim a capital loss at this time.