Edited version of private advice

Authorisation Number: 1051910252404

Date of advice: 18 October 2021

Ruling

Subject: Capital loss

Question 1

Has a capital gains tax event occurred for entity A and entity B in relation to the money lent to entity C (the company)?

Answer

No.

Question 2

Is there a capital loss in relation to the loan to the company?

Answer

No.

Question 3

Can a capital loss be deducted from your assessable income?

Answer

No.

Question 4

Are you entitled to a deduction for a bad debt?

Answer

No.

This ruling applies for the following periods

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on

I July 20XX

Relevant facts

Entity C (the company) was set up on xxxx as a business.

The shareholder of the company is entity D, with primary beneficiaries as entity A and entity B.

Entity A is also the Director of the company.

In xxxx income year the company encountered a loss of approximately $xxxx.

The trading in the company was supported by two loans from entity A and entity B.

Entity A and entity B entered into a loan agreement on xxxx with the company for $xxxx.

Another joint loan was entered into with the company on xxxx for $xxxx.

Both loan agreements stated an annual interest rate of x% on the balance of the loan.

Entity A and entity B used their own funds to lend to the company.

The loan agreements show entity A and entity B as shareholders.

There was no security on the shareholder loans.

The loan agreements were provided showing full details including the payment clause.

No loan repayments have been made by the company.

Entity A and entity B have not provided the company with written notice of demand for the loan moneys.

Entity A and entity B have used their profits in xxxx income year to support the loss from the company.

The company is not in the business of lending money.

Entity A or entity B are not in the business of lending money.

The company still exists, however has not currently done any trading in the xxxx income year.

The above situation has put a financial burden on the parties.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25-35

Income Tax Assessment Act 1997 Section 102-10

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

Reasons for decision

Capital gains tax provisions

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a capital gain or capital loss is made only if a CGT event happens. The gain or loss is made at the time of the CGT event.

A debt owed to you is a capital gains tax (CGT) asset (section 108-5 of the ITAA 1997).

When a debt owed to you ends, CGT event C2 happens (section 104-25 of the ITAA 1997).

The time of a CGT event C2 in relation to a debt owed to you will occur when you enter into the contract that results in the asset ending (for example, a settlement deed) or, if there is no contract, when the asset ends (for example, when it becomes irrecoverable at law).

For a loan to be irrecoverable at law, genuine attempts to obtain the outstanding debt need to be made.

Where the terms of the loan are not enforced, it is questionable whether the loan is a commercial loan or more of a private arrangement between related parties.

In this case, only a short amount of time has passed since the loans were made and no debt recovery action has been taken. Entity A and entity B have not provided the company with written notice of demand for the loan moneys. The loan agreement with the company had no security and there was no set date for repayments.

As the company still exists and has not been wound up, it cannot be said that the company will not pay the outstanding debt to you. The fact that the company encountered a loss in the xxxx income year does not mean that the loan is irrecoverable at law for CGT event C2 purposes.

As there is no settlement deed or other relevant documents to show that the debt has ended, a CGT C2 event or capital loss has not occurred. Therefore, you are not entitled to a capital loss.

There is no other CGT event or other relevant provision that allows a capital loss in these circumstances. As no CGT event has occurred, you are unable to claim a capital loss.

Bad debts and deduction

Section 25-35 of the ITAA 1997 allows a deduction for bad debts in certain circumstances. To qualify for a bad debt deduction under section 25-35, the written off bad debt must be:

•         included in your assessable income for the income year or for an earlier income year, or

•         in respect of money that you lent in the ordinary course of your business of lending money.

In this case, the requirements under section 25-35 of the ITAA 1997 have not been satisfied, therefore no deduction for a bad debt deduction is allowed.

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

As the money lent by entity A and entity B is capital in nature, no deduction is allowable under section 8-1 of the ITAA 1997.

We acknowledge your financial position, however, the legislation does not allow a capital loss or deduction in relation to the loan under the specific circumstances.

Other information - capital loss

As stated in subsection 102-10(2) of the ITAA 1997, you cannot deduct from your assessable income a net capital loss for any income year. That is a net capital loss is not deductible from your assessable income.

However, to the extent that a net capital loss cannot be used to offset capital gains in an income year, it can be carried forward to a later income year.

In your case, no capital loss has occurred.