Edited version of your written advice

Authorisation Number: 1013121257695

Date of advice: 9 November 2016

Ruling

Subject: Money Lending and Bad Debts

Question 1

Are you conducting a business of lending money for the purposes of paragraph 230-180(3)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) and entitled to a deduction under subsection 230-15(2) of the ITAA 1997 for bad debts written off?

Answer

Yes

Question 2

Are you conducting a business of lending money for the purposes of paragraph 25-35(1)(b) of the ITAA 1997 and entitled to a deduction under subsection 25-35(1) of the ITAA 1997 for bad debts written off?

Answer

Not required to be considered.

Question 3

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

Answer

Not required to be considered.

This ruling applies for the following periods:

Year ended 30 June 201X

Year ended 30 June 201X

Year ended 30 June 201X

Year ended 30 June 201X

Year ended 30 June 201X

The scheme commences on:

01 July 201X

Relevant facts and circumstances

You are an incorporated company.

You form part of a group of entities which hold property assets and various other investments and commercial interests.

You are not registered as a money lender.

You were established as a dedicated entity to conduct a business of lending money on commercial terms to borrowers unrelated to your group of entities. It is not proposed that you will lend money internally within the group.

The service of an individual with specialist lending experience was employed to act as an Administrator.

Your operations have only commenced relatively recently.

Since its establishment, you have operated exclusively as a moneylending/financing entity, with your operations being funded by other group entities.

In a recent year, the loan funding provided to you from other group entities to fund your operations was made available on an interest free basis. Commencing this year, the loan funding provided to you will be on strict commercial terms .At this stage, it is understood that funding to be provided to you will be capped.

Your primary source of income is interest income.

Lending procedures

The Administrator has the responsibility of identifying any new opportunities. A written submission in relation to the opportunity is made to a Relevant Committee (“RC”) for their consideration. This submission will set out the relevant details relating to the loan opportunity, which would include the proposed amount of the loan, the expected return, security, repayment terms and an assessment of the risk profile of the relevant loan.

It is noted that guidelines have been established in relation to lending. The guidelines provided would appear to be appropriate for this line of business.

However, one guideline refers to the possibility of an equity stake. In particular property development projects is also contemplated under the guidelines although no such investment has yet been made on this basis.

The holding of equity stakes in particular development projects is certainly not the main focus but may be considered from time to time and so has been referred to in this application for completeness.

The RC plays a key role in assessing and approving funding of new loans. The RC consists of independent consultants.

For new loans proposed the RC will undertake a detailed commercial assessment of the proposed loan in order to assess whether it is appropriate to make the relevant loan investment. This assessment will, of course, have regard to the nature of the project, the forecast returns, security offered and LVR (loan to valuation ratio), along with relevant risk factors. If the conclusion is that risk of the proposed loan is too high relative to the return offered, unless the metrics of the project can be improved in other ways (e.g. with improved security such as guarantees), the proposed loan will be rejected by the RC and no loan funding will be provided.

When a loan is approved by the RC, loan documentation will be prepared by external legal advisers and a final approval process will be followed, including a review by internal legal counsel, sign-off by the Group Officer 1 and Group Officer 2 and evidence of the approvals will be provided to the Officer 1 so that that the approved funding amount can be advanced.

All loans made are closely monitored. The process is outlined below:

● the loan assets are closely monitored by the Administrator, in conjunction with the Officer 1;

● an accountant is specifically assigned to monitoring and managing loan drawdowns, interest calculations and repayments; and

● repayment arrangements are monitored regularly to ensure repayments are received in accordance with the terms of the loan agreement.

If the meeting of required conditions, including timing of interest and principal payments or other loan covenants are not met, the identification of any breach will result in the instigation of steps to maximise the prospects of recovery and to protect the position and rights of you as lender. Such steps would include enforcing security under the loan and instigating legal proceedings for recovery.

No bad debts were written off within your entity in the 201X or 201X years of income.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-35

Income Tax Assessment Act 1997 Subsection 25-35(1)

Income Tax Assessment Act 1997 paragraph 25-35(1)(b)

Income Tax Assessment Act 1997 Subsection 25-35(5)

Income Tax Assessment Act 1997 Division 230

Income Tax Assessment Act 1997 Subsection 230-15(2)

Income Tax Assessment Act 1997 Subsection 230-20(4)

Income Tax Assessment Act 1997 Subsection 230-180(3)

Income Tax Assessment Act 1997 paragraph 230-180(3)(b)

Income Tax Assessment Act 1997 Subsection 230-180(4)

Income Tax Assessment Act 1997 paragraph 230-180(5)(b)

Income Tax Assessment Act 1997 section 701-1

Income Tax Assessment Act 1997 section 701-5

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Are you conducting a business of lending money for the purposes of paragraph 230-180(3)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) and entitled to a deduction under subsection 230-15(2) of the ITAA 1997 for bad debts written off?

Summary

You are conducting a money lending business for the purposes of paragraph 230-180(3)(b) of the ITAA 1997 and any loss you make in respect of bad debt written off in relation to loans made in the ordinary course of that business will be deductible under subsection 230-15(2) of the ITAA 1997.

Detailed Reasoning

Paragraph 230-180(3)(b) of the ITAA 1997 provides that an entity makes a loss from a financial arrangement from writing off, as a bad debt, a right to a financial benefit (or a part of a financial benefit) if the right is one in respect of money that the entity lent in the ordinary course of their business of money lending.

In order to realise a loss under subsection 230-180(3) of the ITAA 1997 it is therefore necessary to demonstrate that the entity is carrying on a business as a moneylender and that the bad debt 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 Commissioner's view of the factors used to determine if you are in business for tax purposes. 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 Income Tax Assessment Act 1936 (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 moneylender 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 businesslike 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 lending:

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 order to demonstrate that an entity is carrying on the business of money lending, Tamberlin J stated in Richard Walter Pty Ltd v FC of T 95 ATC 4440 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.

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 (Bivona), 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), and the fact that the loans were made to related entities was not determinative.

Application of the law to your circumstances

Business purpose and character, commerciality, and profit making intention

Since the commencement in operations, you have continually undertaken significant moneylending activities. This activity shows elements of repetition and regularity in running a money lending business. The number of loans issued over the X years of operation demonstrates that no loan was a single and isolated transaction.

The scale of your lending is significant with loans being made to external parties only. As to the commerciality of the loans it is noted that in a previous year you had loans with X entities with a total value of loans outstanding of a significant amount. You have derived interest income from these loans. The figures increase significantly for the following financial year. The scale of lending is significant as such that the income derived from loans is not ancillary to another part of your business. It clearly demonstrates your intention to carry on a money lending business.

The establishment of the relevant facilities to fund loans under commercial terms, and the process undertaken by the RC to approve the provision of loans is representative of a business of money lending.

The internal procedures adopted within your company in respect of the making of new loans, and the close periodic monitoring of existing loans and credit recovery procedures, also represent the businesslike and systematic way that the lending operations are being conducted

The commercial approach to setting interest rates on these loans demonstrates your profit making intention in relation to your lending activities.

The internal processes applied to assess the basis on which loan funds are being provided and the monitoring of such loans is consistent with a profit making intention.

We note that you have been specifically established to conduct business as an external financier, with this being your sole business. All borrowers in your case are at arm's length.

Size and scale

The scale of lending activities undertaken by you is collectively considerable, both in terms of dollar amounts and also in terms of numbers of borrowers.

Other matters

You have acknowledged that you are not registered as a moneylender. However, non-registration as a moneylender is only one circumstance to be considered and is not decisive in determining whether you are not in the business of money lending.

In considering the activities of your company it is obvious you are not conducting an activity that is better described as a hobby, a form of recreation or sporting activity.

In examining the lending activities of your company it can be seen that those activities are undertaken in a structured and systematic way that demonstrates commercial purpose. You are conducting your activities in a businesslike manner with a degree of repetition and regularity. The scale of the lending is significant such that the companies money lending is not ancillary or incidental to another part of its business. It is apparent that you are conducting a money lending activity with a view to profit.

Therefore, on the balance of facts presented, it is considered that you are carrying on a business of lending money for the purposes of paragraph 230-180(3)(b) of the ITAA 1997.

As such, any loss made in respect of bad debts written off in relation to any loan made by you in the ordinary course of your money lending business will constitute a loss from a financial arrangement pursuant to subsection 230-180(3) of the ITAA 1997.

The bad debt loss will be taken to occur at the time all or part of the right to the financial benefit is written off as a bad debt (subsection 230-180(4) of the ITAA 1997), and the amount of the bad debt loss will be equal to the amount of the financial benefit which was written off as bad (paragraph 230-180(5)(b) of the ITAA 1997).

Losses made from a financial arrangement are deductible under subsection 230-15(2) of the ITAA 1997 to the extent that they're made in gaining or producing assessable income.

Subject to none of the general restrictions on the availability of deductions for bad debts (as listed in subsection 25-35(5) of the ITAA 1997) applying, as assumed for the purposes of this ruling, any bad debt losses you make in accordance with subsection 230-180(3) of the ITAA 1997 will be deductible under subsection 230-15(2) of the ITAA 1997.

Question 2

Are you conducting a business of lending money for the purposes of paragraph 25-35(1)(b) of the ITAA 1997 and entitled to a deduction under subsection 25-35(1) of the ITAA 1997 for bad debts written off?

Summary

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

Question 3

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

Summary

As any debt written off as bad by you in relation to loans you make in the ordinary course of your money lending business will be deductible under subsection 230-15(2) of the ITAA 1997, the deductibility of such amounts under section 8-1 of the ITAA 1997 is not required to be considered.