ATO ID 2008/58: Capital gains tax: CGT event C2 - unsecured note
Date of decision: 25 February 2008
Year of income: Year ended 30 June 2008
Business line: Public Groups and International

Issue
Does CGT event C2 in section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) happen on maturity of an unsecured note if the company that issued the note defaults on repayment of the amount the note represents?

Decision
No. CGT event C2 in section 104-25 of the ITAA 1997 does not happen on maturity of an unsecured note if the company that issued the note defaults on repayment of the amount the note represents.

Facts
A company raised capital by issuing unsecured notes for various terms. The taxpayer deposited an amount in return for an unsecured note for a certain period. Before the taxpayer's note matured the company was placed in voluntary administration and the taxpayer was no longer able to receive quarterly interest payments. The company did not repay the amount deposited (or any interest reinvested or accrued up to the date of entering administration) at the maturity date and the rights to redeem or cancel notes prior to, at or after maturity were suspended. The company was later placed in liquidation. The liquidator advised that a proportion of every dollar of the total amount accrued up to the date when the company was placed in administration would be returned to the taxpayer via instalments. The liquidation of the company has not been completed.

Reasons for decision
Summary: If a taxpayer deposits funds with a company raising capital in return for an unsecured note, the relevant CGT asset of the taxpayer is the debt owing to the taxpayer by the company which the note represents. A debt is an intangible CGT asset and is specifically listed as an example of a CGT asset in Note 1 to subsection 108-5(2) of the ITAA 1997. 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 time of the event is when a taxpayer enters into the contract that results in the asset ending. If there is no contract, the time of the event is when the asset ends (subsection 104-25(2) of the ITAA 1997). The taxpayer's ownership of the underlying debt which the note represents does not end when the note matures if the company defaults on repayment. Nor does it end if the company is placed in administration or liquidation whether this is before or after the note matures. The debt continues in existence. Per Emmett J stated in Federal Commissioner of Taxation v. Macquarie Health Corporation Limited & Ors (1998) 88 FCR 451 at 472; 98 ATC 5214 at 5230; (1998) 40 ATR 349 at 366: There is no doubt that the effect of winding up and of sequestration is that there is a restriction imposed on the capacity of a creditor to enforce payment of a debt without the leave of the Court. A creditor will not be entitled to payment from the debtor and if the creditor receives payment, he will be required to repay the amount to the liquidator or trustee in bankruptcy. In that sense, the creditor's remedies are converted into a right to prove in winding up or in the bankruptcy. However, it does not follow, in my view, that the debt ceases to exist. The right to enforce payment is restricted. Nevertheless, the right to prove in the winding up or bankruptcy is a right to prove in respect of the debt which continues to exist. In following the above decision, the Full Federal Court, observing the relevant consequences of the making of a winding up order, in Federal Commissioner of Taxation v. Linter Textiles Australia Ltd (in Liq) (2003) 129 FCR 42 at 51; [2003] FCAFC 63 at [26]: 2003 ATC 445 at 4465; (2003) 52 ATR 502 at 509 noted that: The rights of creditors cease to be rights in personam (although their debts are not released prior to dissolution or deregistration); ... Therefore, as the debt continues in existence after the note matures, the taxpayer's ownership of the debt does not end in one of the ways contemplated by subsection 104-25(1) of the ITAA 1997, regardless of whether the company is in administration or liquidation. Accordingly, CGT event C2 in section 104-25 of the ITAA 1997 has not happened in relation to the debt. CGT event C2 in section 104-25 of the ITAA 1997 may happen if:

Legislative references: Income Tax Assessment Act 1997 subsection 108-5(2) section 104-25 subsection 104-25(1) subsection 104-25(2)
Case references: Federal Commissioner of Taxation v. Macquarie Health Corporation Limited & Ors (1998) 88 FCR 451 98 ATC 5214 (1998) 40 ATR 349
Related ATO interpretative decisions: ATO ID 2003/948
Subject references: Capital gains tax CGT assets CGT events CGT events C1-C3 - end of a CGT asset