Edited version of private advice

Authorisation Number: 1051936305120

Date of advice: 22 December 2021

Ruling

Subject: Sale of business - deduction for loss on sale of shares

Question

Is the loss on the sale of the shares you received for the sale of your business deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Period Ending 30 June 20XX

The scheme commences on:

31 October 20XX

Relevant facts and circumstances

You are an Australian resident taxpayer.

You have operated a timber and hardware wholesale business since 20XX.

The business as a business brand has been in operation for over XX years.

The business was part of a wider business group controlled by Person A.

Person A through multiple structures concurrently operated a carpentry, plastering and building and more recently has engaged in property development.

On 31 October 20XX you sold the business operated by the trust (Goodwill, Stock & PPE) to Company B.

For the sale of your business, you received cash of a specified amount and a specified amount of shares in Company B valued at a specified amount.

You did not have an option to receive more cash instead of shares for the sale of the business.

The shares had restrictions imposed on them where you were required to hold the shares for a period of 12 months from the date of completion as stated in your letter of offer from Company B dated a specified date.

On a specified date you received the shares from Company B.

Your intention was to sell the shares as soon as the restrictions were lifted where you would pay off your debts with the money from the sale of the shares.

You sold the shares via Commsec for a specified amount between 5 February 20XX and 11 June 20XX.

You had no intention of holding the XXXX shares as a long-term investment as you planned to dispose of the shares as soon as contractually possible.

Contentions

Profit making intention was established pre 20XX and maintained through the operation of the businesses.

The shares were received by the taxpayer as part consideration for the sale of the business, this was a non-negotiable "take it, or leave it" offer from Company B and the opportunity to receive more cash was not possible.

The taxpayer further states in an email dated a specified date that he has achieved his profit-making goals by way of dividends and notes the deterioration of the share price.

Selling due to the severe deterioration of the share price does not designate the absence of a profit-making intention but rather a business aptitude to maintain as much value as possible by pre-emptively making arrangements to sell the shares as quickly as possible.

Selling the shares due to the avoidance of further loss does not mean a profit was not intended.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Section 8-1 relates to general deductions and provides:

8-1(1)

You can deduct from your assessable income any loss or outgoing 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.

8-1(2)

However, you cannot deduct 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 your *non-assessable non-exempt income; or

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

8-1(3)

A loss or outgoing that you can deduct under this section is called a general deduction.

The courts have held that for there to be a deduction under section 8-1 there must be sufficient connection between the loss or outgoing and the production of assessable income. The loss or outgoing must be incidental and relevant to the earning of assessable income (Ronpibon Tin NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 8 ATD 431; (1949) 4 AITR 236).

In Federal Commissioner of Taxation v Myer Emporium Limited (1987) 163 CLR 199 ('Myer'), the High Court considered the concepts of 'capital' and 'revenue' in reference to charactering a profit or gain from an isolated transaction outside the ordinary course of a taxpayers business. The High Court also considered the characterisation of a profit or gain made in the ordinary course of a business.

Taxation Ruling TR 92/3 Income Tax: whether profits on isolated transactions are income ('TR 92/3) sets out the Commissioner's view as to the application of the decision of the High Court in Myer.

Taxation Ruling TR 92/4 Income Tax: whether losses on isolated transactions are deductible ('TR 92/4') provides the Commissioner's view on whether losses from isolated transactions are deductible under section 8-1 of the ITAA 1997. TR 92/4 should be read in conjunction with TR 92/3 (see paragraph 3 of TR 92/4).

Paragraph 15 of TR 92/3 sets out that where a taxpayer carrying on a business makes a profit from a transaction or operation, that profit is income if the transaction of operation:

(a)  is it the ordinary course of the taxpayer's business (see paragraph 32 for an explanation of the circumstances in which a transaction is in the ordinary course of the business) - provided that any gross receipt from the transaction or operation is not income; or

(b)  is in the course of the taxpayer's business, although not with the ordinary course of that business, and the taxpayer entered the transaction or operation with the intention or purpose of making a profit; or

(c)   is not in the course of the taxpayer's business, but

(i)    the intention or purpose of the taxpayer in entering into the transaction or operation was to make a profit or gain; and

(ii)   the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

Isolated Transactions

TR 92/3 provides guidance on the Commissioner's views in regards to isolated transactions. Paragraph 1 of TR 92/3 provides that the term 'isolated transactions' refers to:

(a)  those transactions outside the ordinary course of business of a taxpayer carrying on a business; and

(b)  those transactions entered into by non-business taxpayers.

In this case, it is accepted that the shares that you received for the sale of your business is outside the ordinary course of your business and therefore considered to be an isolated transaction.

Profits or losses on isolated transactions

In reference to the Myer decision, paragraph 3 of TR 92/3 provides:

...The court relied on two strands of reasoning in holding that the amount received by the taxpayer was income:

(a)  The amount in issue was a profit from a transaction which, although not within the ordinary course of the taxpayer's business, was entered into with the purpose of making a profit and in the course of the taxpayer's business.

(b)  The taxpayer sold a mere right to interest for a lump sum, that lump sum being received in exchange for, and as the present value of, the future interest it would have received. The taxpayer simply converted future income to present income.

More recently, the elements established in the Myer decision were considered in Visy Packaging Holdings Pty Ltd v Commissioner of Taxation [2012] FCA 1195 ('Visy'). In Visy, Justice Middleton stipulated at paragraph 9 that:

As is the subject of further analysis later in these reasons for judgment, these proceedings do not raise any novel or overly complex principles of law. The determination of these proceedings turns on the facts.....

Middle J further elaborated at paragraph 185 to 187 that:

185. The principle of law which is at the centre of this case is clear: if the intention or purpose of the relevant entity in entering into a transaction or upon acquiring an asset was to make a profit or gain, that profit or gain will be income, even if the transaction was extraordinary by reference to the ordinary course of the entity's business: see Westfield Ltd v Commissioner of Taxation (1991) 28 FCR 333; Commissioner of Taxation v Cooling (1990) 22 FCR 42; Federal Commissioner of Taxation v Myer Emporium Ltd (1987) 163 CLR 199; Federal Commissioner of Taxation v Whitfords Beach Pty Ltd (1982) 150 CLR 355; and Visty Industries USA Pty Ltd [2012] FCAFA 106. Similarly, if the intention or purpose was to make a profit or gain but a loss was ultimately in fact sustained, then a deduction is the amount of that loss would be permitted.

186. It is not necessary that the sole of dominant purpose of entering into the relevant transaction is to make a gain or profit. It is enough if a "not insignificant purpose" of the relevant transaction was to obtain a profit or gain: see eg. Cooling (1990) 22 FCR 42 at 56-57.

187.Accordingly, in these proceedings, if the intention or purpose of acquiring the relevant shares (in the context in which that occurred), was to make a profit or gain, then the losses ultimately incurred are deductible. If that intention or purpose did not exist, then in the circumstances of these proceedings the losses incurred would be of a capital nature for the purpose of s 8-1 of the 1997 Act, and no losses could be deducted as sought by the taxpayers.

Paragraph 6 of TR 92/3 provides the Commissioner's view regarding profit on isolated transactions:

Whether a profit from an isolated transaction is income according to the ordinary concept and usages of mankind depends very much on the circumstances of the case. However, a profit from an isolated transaction is generally income when both of the following elements are present:

(a)  the intention or purpose of the Taxpayer in entering into the transaction was to make a profit or gain; and

(b)  the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.

Accordingly, to determine whether the loss on an isolated transaction will be deductible under 8-1 of the ITAA 1997, you must have had an intention or purpose to make a profit at the time of acquiring the Company B shares and the acquisition must have been in the course of carrying on a business operation or commercial transaction.

Intention or purposes to make a profit

As established in the Myer case, and repeated in paragraph 6(a) of TR 92/3, a profit from an isolated transaction will generally be income when the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain.

Relevantly, paragraph 7 to 10 of TR 92/3 provide:

7. The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case.

8. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose.

9. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If the transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property.

10. If a transaction or operation is outside the ordinary course of a taxpayer's business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question.

When looking at the business context of the transaction, Middleton J, in Visy, stipulated at paragraph 238 that, "it is necessary to look at the whole factual matrix in which the transaction occurs".

In the current circumstances, the factual matrix to be considered is those listed in the Relevant facts and circumstances. It is the factual matrix that has been utilised to determine whether you had the requisite intention or purpose when entering into the transaction.

On consideration of the 'Relevant facts and circumstances' of this ruling, the Commissioner is not satisfied that you had the relevant intention of making a profit at the time of entering the transaction. This is because your intention for entering into the transaction was to be paid for the sale of your business and you were not given a choice to if you received cash or shares. In addition, your intention was to sell the shares as soon as contractually possible irrespective of market value.

Conclusion

Whilst you have stated that you had a profit-making intention the Commissioner is not satisfied that you did. This is because your intention for entering into the transaction was to be paid for the sale of your business and you were not given a choice to if you received cash or shares. This does not demonstrate an intention to make a profit.

Taking into consideration the Commissioner's views expressed in TR 92/3 and TR 92/4, and the application of the principles set out in Myer and Visy, the loss incurred by you on the sale of the shares in Company B will not be deductible under section 8-1 of the ITAA 1997.