Edited version of private advice

Authorisation Number: 1051566919178

Date of advice: 15 August 2019

Ruling

Subject: CGT - capital loss - loss of right to seek return of funds advanced to buy shares

Question

Has the Taxpayer made a capital loss in the 20XX-XX income year due to ceasing recovery action in respect of the investment?

Answer

Yes.

The Taxpayer's investment is a CGT asset for capital gains purposes. It may be described in many ways including as 'the right to seek compensation'. (Note: the CGT asset is not shares in a company because none were allocated to the Taxpayer.)

CGT event C2 happened due to the Taxpayer ceasing recovery actions as the Taxpayer's ownership of the investment as a CGT asset ended at that time.

The Taxpayer has made a capital loss as the capital proceeds were less than the reduced cost base of the investment as a CGT asset.

In this case:

·         The capital proceeds is the market value of the investment at the time of the CGT event, not the amount received (this is the rule for CGT event C2), and

·         The reduced cost base includes both the amount invested (first element) and the Taxpayer's legal expenses in seeking the return of the funds invested (fifth element).

None of the exemption provisions apply to this capital loss. Specifically:

·         The investment was acquired in 2016, so it is not a pre-CGT asset, and

·         The Taxpayer intended to use the investment to earn assessable income, so it is not a personal use asset.

This ruling applies for the following period:

20XX-XX income year

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Taxpayer is a professional person who owns (through associated entities) interests in various businesses.

Some XX years ago, the Taxpayer was introduced to and came to know a business person as a customer of one of the businesses owned by an associated entity.

Subsequently, the business person invited the Taxpayer to be a guest at an event and during that event the Taxpayer was introduced to a number of the business person's associates including other professional persons.

Shortly after the event the Taxpayer expressed an interest in developing a business importing certain items into Australia.

Next, the business person presented a business opportunity to the Taxpayer consisting of the following:

a.    A group of Australian investors would be collaborating to establish a business requiring a special licence via a yet to be established company in a foreign country

b.    The proposal outlined how the company would make profits. The initial target market of customers was intended to be from another foreign country

c.    The business person advised that the group of investors would be advised by the partner of the accounting firm referred to above on all matters relating to the establishment and operation of the foreign company

d.    It was presented to the Taxpayer that the Taxpayer would be an ideal participant due to the Taxpayer's connections in the second foreign country

e.    The business person purported that the company would have a significant share capital based on its projected profitability, and

f.     After numerous discussions with the business person and his associates the Taxpayer agreed to invest enough to acquire a sizeable interest in the company.

A draft letter of intent was provided to the Taxpayer that outlined the investment and steps required to form the company. The Taxpayer sought further assurances from the business person and received them in the form of a substantial written Indemnification Agreement.

The letter of intent and Indemnification Agreement was purportedly signed by a representative of a foreign company assisting in the venture (it is now suspected that the signature on the letter of intent and Indemnification Agreement was a forgery).

It was proposed that the Taxpayer would make the investment in the company in instalments.

The letter of intent set out that the company would be formed and that the Taxpayer would be the nominated person to apply for the special licence on the company's behalf.

The Taxpayer accepted the terms proposed by email to the business person.

The Taxpayer then transferred the first instalment to an account advised by the business person as part payment of the Taxpayer's capital contribution for equity in the company. The Taxpayer borrowed the funds from a Bank to make the payment.

Next, the Taxpayer transferred a further amount to the same account as a further contribution for equity.

Then, the business person requested that the Taxpayer make the balance of the capital contribution as the funds were required by the company earlier than expected. The Taxpayer did not have the immediate funds available and the business person encouraged the Taxpayer to borrow the funds from a pre-existing facility.

The Taxpayer advanced these further amounts.

Next, the Taxpayer had a first formal meeting with the accountant representing the business person. This accountant confirmed that the company would be formed and that the Taxpayer would become a shareholder. This accountant also confirmed the share capital of the company.

Later, the Taxpayer visited the offices of the Chartered Accounting firm to discuss the licence application process. During that meeting the accountant for the company advised the cost of the application and that the company would be established in 4 to 6 weeks. The accountant also suggested that the Taxpayer's shares be held by another person as trustee for the Taxpayer as beneficiary.

Then, the accountant obtained from the Taxpayer various personal details to allow the company to be formed and for the licence application. It was confirmed (again) that the Taxpayer's investment would entitle the Taxpayer to 15% of the profits of the company.

Subsequently, the Taxpayer met with the business person. The business person requested that the final instalment be accelerated. The Taxpayer advised that the Taxpayer did not have the funds and would have to borrow them. The business person advised that they would treat the advance as a loan repayable shortly. Shortly thereafter and over a period of several days the Taxpayer transferred the funds to the same account previously used.

The business person failed to repay the loan as agreed.

Shortly afterward, the accountant advised the Taxpayer that there were no investors and the company would not be formed and that the application was not commenced.

The Taxpayer sought immediate legal advice and it was ascertained that some of the documents presented by the business person were forgeries/fraudulent.

Since then, the Taxpayer engaged an investigator to attempt to trace the investment and or any alternate assets of the business person without any success.

The Taxpayer has also contacted the police and provided a detailed witness statement.

The Taxpayer has consulted with various solicitors regarding action against the promoters to recover the investment. Unfortunately, none of those advisers have been able to achieve any success in recovering the investment.

In the 20XX-XX income year the Taxpayer has received definitive legal advice that the purported investment was a fraud and that the likelihood of recovery of any of the investment is nil and any legal action to seek recovery of the funds would be fruitless.

The Taxpayer has made the decision to cease any recovery action to seek the return of the invested funds during the 20XX-XX income year and as a result no longer has any right to this investment.

Relevant legislative provisions

Income Tax Assessment Act 1997 Part 3-1