Edited version of private advice

Authorisation Number: 1052368143608

Date of advice: 19 March 2025

Ruling

Subject: Capital loss

Question 1

Did a capital loss arise in respect to the loans to the trusts for the executors in their capacity as executors of the Estate under section 100-35 of the Income Tax Assessment Act 1997 on liquidation of the trustee companies in the income year ended 30 June 20XX.

Answer 1

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The deceased prior to their death, was involved in running a business.

The Deceased was owed amounts from two discretionary trusts (the related trusts) which had corporate trustees.

At all times until their death, the Deceased was the sole director and shareholder of both trustee companies.

The Deceased loaned funds in multiple tranches to the related trusts to provide working capital for the business (the Loans)

No written loan documents were prepared; however, the intention was that:

•                Interest would be paid on the Loans, and these would be repaid in full when funds became available; and

•                The Loans would assist the business to operate profitably and generate profit, and therefore generate trust distributions back to the deceased.

The Loans were for two purposes:

•                Initial loans to support external borrowings financing the original purchase of the business, and

•                Subsequent short-term loans to support working capital requirements of the business.

The Loans were presented in the annual balance sheets of the related trusts in the 20XX financial reports.

Additional funds were loaned to the business in the next income year preceding the death of the deceased.

The business did not operate successfully, and following the death of the deceased, the assets of the related trusts were sold pursuant to contracts entered into prior to the death of the deceased.

The proceeds from the sale of the assets enabled part payment of the first registered secured creditor only.

Both trustee companies were placed into liquidation as there were insufficient trust assets to repay the outstanding debts and liquidation costs.

The liquidator confirmed the outstanding amount of the loans owing to the deceased estate.

The liquidator also advised the executor via email that, once the assets of the trust are realised, the trust becomes dormant. Any claim that the estate had in respect of monies advanced to the trust, are a claim against the company in liquidation. The liquidator understood that the deregistration of the company should give rise to the estate's ability to claim a capital loss in respect of the monies not recovered.

Prior to 30 June 20XX, the liquidator notified ASIC that administration of both companies had been completed.

The trustee companies were deregistered early in the next income year.

No return was paid to the deceased estate from either loan by the liquidator.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 100-35

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 116-20(1)

Income Tax Assessment Act 1997 subsection 116-30(3A)

Income Tax Assessment Act 1997 section 128-15

Reasons for decision

Detailed reasoning

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997).

Section 108-5 states that a CGT asset is any kind or property, or a legal or equitable right that is not property.

A debt owed to a lender is a CGT asset for the purposes of section 108-5.

Subsection 104-25(1) provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited. The time of the event is:

a)             when you enter into the contract that results in the asset ending; or

b)             if there is no contract - when the asset ends.

You make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-25(3)).

Whether a lender makes a capital gain or capital loss from CGT event C2 happening in respect to a debt will depend on the consideration received for the CGT event and the appropriate cost base of the asset which is the debt.

Section 108-20 provides that any capital loss made from a personal use asset is disregarded. In broad terms, personal use assets include CGT assets used or kept mainly for personal use or enjoyment, certain options or rights, and certain debts arising from CGT assets for personal use or enjoyment or otherwise than in the course of gaining or producing assessable income or from carrying on of a business.

Taxation Determination TD 2000/7 Income tax: capital gains: when does a CGT event happen to shares in a company, for the purposes of Part 3-1 and Part 3-3 of the Income Tax Assessment Act 1997 (TD 2000/7), if the company is deregistered under the Corporations Law? states that CGT event C2 usually happens in respect to a member's shares when a company is deregistered in accordance with the Corporations law.

Capital proceeds

Under subsection 116-20(1), the capital proceeds from a CGT event are the total of the money you have received, or are entitled to receive, in respect of the event happening; and the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

The market value substitution rules contained in subsection 116-30(1) will apply if no capital proceeds are received from a CGT event, under which you are taken to have received the market value of the CGT asset that is the subject of the event.

Under subsection 116-30(3A), the market value of a debt that is the subject of CGT event C2 is worked out as if the CGT event had not happened and was never proposed to happen.

Taxation Ruling TR 2001/9 Income Tax: agency development loans (TR 2001/9) discusses the taxation treatment of agency development loans in the circumstances where the loans are forgiven or written-off. Paragraph 45 states that:

The market value of the debt will be greater of the excess of expected recoverable funds over expected recovery expenses, or nil. This will depend upon the facts of each individual case. Where the debt is written off by reason of the suspected insolvency of the debtor, the market value of the debt is expected to be less than its full face value. If the debt is released or cancelled because it is worthless, then the market value will be nil, despite subsection

116-30(3A) of the [ITAA 1997]..... as the disposal itself is not considered to affect the market value.

Application of the law

In the present case, the loans the deceased provided to the trusts were CGT assets to the deceased within the meaning of the term in section 108-5.

Further, the executors of the estate of the deceased were taken to have acquired the loans owed to the deceased by the trusts for the cost base or reduced cost base of the CGT assets on the day the deceased died.

The loans were not personal use assets within the meaning of the term in section 108-20, because the loans were made in the course of a commercial transaction and had the potential to derive assessable income for the deceased.

Following the liquidation of the assets held by the related trusts, the liquidator advised ASIC prior to 30 June 20XX that the liquidation process in relation to the trustee companies had been completed. However, the companies were not deregistered until early in the next income year.

From the above, it is considered that CGT event C2 happened in respect to the loans when the companies were deregistered in the next income year, as per the ATO view in TD 2000/7. Any recourse to obtain any return on the loans formally ended at that time.

When CGT event C2 happened, the estate received no consideration from the borrower in respect to the loans. As a result, the estate is taken to have received an amount equal to the market value of the loans at the time of the CGT event.

The market value of the loans at the time of the event is worked out as if the CGT event had not happened and was never proposed to happen. In this case, it is evident that the loans were not recoverable and had become worthless due to the insolvency of the borrower. Therefore, the market value of the loans was nil at the time CGT event C2 happened despite subsection 116-30(3A). This is the case because the deregistration of the companies is not considered to have affected the market value of the loans, pursuant to the view expressed in TR 2001/9.