Edited version of private advice

Authorisation Number: 1051846638998

Date of advice: 23 September 2021

Ruling

Subject: Bad debt

Question 1

Are you entitled to a deduction for a bad debt for the unpaid loan provided to your Co-worker for the 20XX-XX income year?

Answer

No

Question 2

Are you entitled to a capital loss for the unpaid loan provided to your Co-worker for the 20XX-XX income year?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You loaned money to your Co-worker for 30 days.

The loan was not repaid, and your Co-worker requested an extension of time to repay the loan.

A copy of a document was provided, signed and dated by You and your Co-worker outlining an extension of time to repay the loan by X/XX/XXXX.

A copy of a Statutory Declaration was provided, signed and dated by your Co-worker outlining a further extension of time to repay the loan by X/XX/XXXX.

You provided a Statement of Claim.

Copy of emails between your Lawyer and your Co-worker were provided. Your Co-worker responded to your Lawyer by email acknowledging the debt, indicating the inability to pay at this stage, sorry for the grief caused, advising the amount owed will be repaid but not sure when will be able to do that.

You provided an extract from the Online Registry Courts and Tribunals regarding your case showing Judgments and orders

Your Lawyer was advised by the Sheriff's office that your Co-worker was now bankrupt and no longer in a position to repay the money borrowed. No documentation or evidence was provided to support this fact.

You are engaging with your Lawyer and continuing to pursue settlement of the debt. You are waiting on Trustee of the Co-worker to confirm whether you will be added to the list of creditors.

Relevant legislative provisions

Section 8-1 of the Income Tax Assessment Act 1997

Section 8-10 of the Income Tax Assessment Act 1997

Section 25-35 of the Income Tax Assessment Act 1997

Section 104-25 of the Income Tax Assessment Act 1997

Section 108-20 (1) of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

A deduction for a bad debt may be allowable under either section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997) or section 8-1 of the ITAA 1997.

Section 8-1 of the ITAA 1997 deals with general deductions and provides the circumstances where you may deduct from your assessable income, certain losses or outgoings. This section states that you may deduct losses or outgoings to the extent that:

(a) it is incurred in gaining or producing your assessable income; or

(b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income.

However, certain exclusions exist to prevent you from deducting a loss or outgoing under this section to the extent that:

(a) it is a loss or outgoing of capital, or of a capital nature; or

(b) it is a loss or outgoing of a private or domestic nature; or

(c) it is incurred in relation to gaining or producing your *exempt income; or

(d) a provision of this Act prevents you from deducting it.

Section 8-10 of the ITAA 1997 indicates that if more than one provision applies, the most appropriate provision should be used. If there is a more specific section, it would be the section most appropriate.

Division 12 of the ITAA 1997 sets out particular types of deductions that are dealt with by a specific provision of either the ITAA 1936 or the ITAA 1997. In particular, Division 12 lists that the rules in relation to deduction of general bad debts are provided for by section 25-35 of the ITAA 1997.

Subsection 25-35(1) of the ITAA 1997 provides the circumstances that must exist so that you can deduct a bad debt that you have written off in an income year. These circumstances are:

(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.

Taxation Ruling TR 92/18 Income tax: bad debts clarifies the circumstances in which a deduction for bad debts is allowable. Whilst the ruling considers this in relation to the Income Tax Assessment Act 1936 (ITAA 1936), the same principle apply in respect of the ITAA 1997.

Paragraph 6 of TR 92/18 provides that if a taxpayer is not carrying on a business of money lending a bad debt deduction is not allowable under paragraph 63(1)(a) unless the debt has been previously included in assessable income. A taxpayer who is not a money lender and returns income on the basis of cash receipts will not be entitled to a deduction for bad debts because the debts have not been bought to account by the taxpayer as assessable income.

Further, paragraph 40 of TR 92/18 states. The requirement of paragraph 63(1)(a) that the debt was previously brought to account as assessable income presupposes a non-cash basis of returning income for tax purposes. For a taxpayer who operates on a cash receipts basis and lodges returns of income on that basis the taxpayer is not entitled to a deduction for bad debts. As the outstanding amount has not been received it has never been included in the assessable income of the taxpayer. Support for this view can be found in Case P78 82 ATC 381; 26CTBR(NS)Case10 (at ATC p.385, CTBR p. 92) which states that '[s]peaking generally, it is impossible for a taxpayer to properly claim a bad debt as a deduction under sec.63 if he is conducting his business on a cash basis; the requirement of sec.63(1)(a) simply cannot operate in regard to such a business.'.

Paragraph 7 of TR 92/18 provides Paragraph 63(1)(b) applies to taxpayers who are engaged in a money lending business. The question of whether a taxpayer is carrying on a money-lending business is a question of fact. For the purposes of paragraph 63(1)(b), 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.

If a claim fails the tests of section 25-35 of the ITAA 1997, deductibility may be considered under section 8-1 of the ITAA 1997.

To be deductible under section 8-1 of the ITAA 1997, the bad debt must have been incurred and be a loss relating to the production of assessable income, and not a loss of a capital, domestic or private nature.

Application to your circumstances

You loaned money to your Co-worker for a short-term period. The loan was provided to assist your Co-worker with a personal matter. There is no formal loan documentation to support this is a commercial loan agreement, such as obtaining security for the loan, applying interest payments and other terms and conditions.

Your Co-worker has not repaid the loan and is unable to do so. However, you have demonstrated reasonable attempts have been made to collect the debt.

It is acknowledged you entered the arrangement to assist your Co-worker and you have suffered as a result of your Co-worker not repaying the loan money. However, you have not satisfied the requirements under section 25-35 of the ITAA 1997 and no deduction for a bad debt is allowed under this provision.

Paragraph 25-35(1)(a) of the ITAA 1997 is not met as you have not brought the loan arrangement to account as assessable income on a non-cash (accruals) basis of returning income for tax purposes. As you are not in the business of conducting money lending activities you do not meet the requirements of paragraph 25-35(1)(b) of the ITAA 1997.

We also considered whether the unpaid loan could be an allowable deduction under section 8-1 of the ITAA 1997. The primary purpose was not for you to earn assessable income but to assist your co-worker for personal reasons. The loan arrangement was not entered into for income producing activities by you did not receive material benefit or advantage by way of a return. Therefore, the unpaid loan is not an allowable deduction pursuant to section 8-1 of the ITAA 1997 because there is no connection between the unpaid loan and earning assessable income.

Question 2

Another relevant exclusion in section 8-1 of the ITAA 1997 is that the loss on the loan should not be capital or of a capital nature.

Ordinarily, a taxpayer may account for losses on loan principal on revenue account if the taxpayer is carrying on a business as a banker, financier or moneylender or in the limited categories of other cases where the loans represent trading stock of the lender. Those taxpayers who do not fall within the above categories would ordinarily account for the principal of a loan as capital and any loss in relation to that capital asset is a loss on capital account.

You can only make a capital gain or capital loss if a capital gains tax (CGT) event happened to a CGT asset (Subsection 102-20 of ITAA 1997).

Subsection 108-5(1) of the ITAA 1997 defines a CGT asset to be any kind of property, or legal or equitable right that is not property. One of the examples provided in the notes to section 108-5 of the ITAA 1997 is a debt owed to the taxpayer. Thus, an unpaid loan is considered a debt that is owing to the taxpayer.

CGT event C2 in section 104-25 of the ITAA 1997 happens if a 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. The event gives rise to a capital loss to the lender.

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

However, subsection 108-20(1) of the ITAA 1997 states that a capital loss that is made from a personal use asset, is disregarded.

A 'personal use asset' is defined in subsection 108-20(2) of the ITAA 1997.

Paragraph 108-20(2)(d) of the ITAA 1997 provides that a 'debt' is a personal use asset unless the debt has arisen:

a) in the course of gaining or producing the taxpayer's assessable income; or

b) from carrying on the taxpayer's business.

Paragraph 47 of Taxation Ruling TR 96/23 Income tax: capital gains: implications of a guarantee to pay a debt provides that the test of what is a personal use asset requires a finding that the debt came to be owed for a primary purpose other than of gaining or producing income or in the carrying on of a business of the lender.

Therefore, debts arising from non-business activities that do not produce assessable income can be personal use assets.

In your situation, you did not earn any interest income during the course of the loan, you do not carry on a business of lending money and the loan was made for no other reason than to provide assistance to your co-worker. The loan is considered a personal use asset under paragraph 108-20(2)(d) of the ITAA 1997.

Any capital loss arising from a personal use asset is disregarded for CGT purposes. Such losses are not available to offset capital gains on any type of CGT asset.