Edited version of private advice

Authorisation Number: 1051965021235

Date of advice: 29 March 2022

Ruling

Subject: CGT - capital loss

Question 1

Are you entitled to a capital loss for the unpaid loan to the Company for the 20XX-XX income year?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Person 1 and Person 2 (you) are partners in the Partnership (the partnership).

The partnership does not carry on a business of money lending.

You loaned the total amount of $X to Company A (the Company) in the 20XX-XX income year.

The loan was provided to the Company in two separate instalments, $X on XX October 20XX and $X on XX November 20XX.

The sole Director of the Company, Person 3, is a close relative of Person 1 and Person 2.

The Company carried on a business since its incorporation in April 20XX.

The Company was experiencing difficult trading conditions which resulted in cash flow challenges.

The intention of both parties was that once the Company emerged from these cash flow difficulties, the funds loaned to the Company would be repaid in full.

There was no interest charged on the loan.

There was no loan contract entered into.

The trading conditions deteriorated further and the director of the Company, Person 3 decided to place the Company into Voluntary Administration on XX July 20XX.

The company was liquidated on XX June 20XX.

At the time the Company was placed in Voluntary Administration there had been no repayment of any of the loaned amount.

You did not receive any payment from the liquidator in relation to the loaned amount, upon liquidation of the Company.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-25(2)

Income Tax Assessment Act 1997 subsection 108-20(1)

Income Tax Assessment Act 1997 subsection 108-20(2)

Income Tax Assessment Act 1997 paragraph 108-20(2)(d)

Reasons for decision

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 (section 102-20 of the Income Tax Assessment Act 1997 (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 are considered personal use assets.

In your case, a partnership is not a separate legal entity and the loan will be considered to be from you, the partners individually. This follows that the CGT asset (the loan) is also held by you, the partners individually.

You loaned money to your close relative's company to assist with cash flow difficulties in their business (the Company). 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.

The loan arrangement was not entered into in the course of gaining or producing your assessable income and you do not carry on a business of money lending. The loan was made for no other reason than to provide financial assistance to your close relative's company. Therefore, 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.