ATO ID 2001/301: Deductions and expenses: Bad Debt (Loan by beneficiary to trust)
Date of decision: 1 August 2001
Business line: Private Groups and High Wealth Individuals

Issue
Is the taxpayer, a beneficiary of a trust, entitled to a deduction under section 25-35 or section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for a loan made to the trust that will not be repaid.

Decision
No, the taxpayer, a beneficiary of a trust, is not entitled to a deduction under section 25-35 or section 8-1 of the ITAA 1997 for the loan made to the trust that will not be repaid.

Facts
The taxpayer, who is a beneficiary of a discretionary trust, lent an amount of money to the trust for use in a business venture being carried on by the trust. The loan was to be repaid with interest. As a beneficiary of the trust, the taxpayer is to receive distributions from the trust. The business venture is unsuccessful and the loan is not repaid to the taxpayer. The taxpayer has not brought the debt into account as assessable income and does not carry on a business of lending money.

Reasons for decision
Summary: A deduction for a bad debt may be claimed under section 25-35 or section 8-1 of the ITAA 1997. To qualify for a bad debt deduction under section 25-35 of the ITAA 1997, the debt, in addition to being bad, must satisfy two criteria: As the taxpayer has not brought the debt into account as assessable income and does not carry on a business of lending money, the bad debt cannot be claimed as a deduction under section 25-35 of the ITAA 1997. To qualify for a deduction under section 8-1 of the ITAA 1997, the loan must be incurred in gaining or producing assessable income, or in carrying on a business for the purpose of gaining or producing assessable income. In addition, the loss must not be of a capital, private or domestic nature. If the loss is an ordinary incident of the taxpayer's income earning activities then the loss will be on revenue account. For example, a bad debt loss incurred by a financial institution would generally be expected to be a revenue loss (Taxation Ruling TR 92/18). If the loan has been made in a private capacity (i.e., not business), the bad debt will not be deductible under section 8-1 of the ITAA 1997. The loan will not be regarded as an ordinary incident of the taxpayer's income earning activities, and will also be excluded from deductibility under the capital exclusion under paragraph 8-1(2)(a) of the ITAA 1997. Whilst not deductible as a bad debt, a capital loss may arise under subsection 104-25(3) of the ITAA 1997 if the taxpayer releases the trust from the debt owed (CGT event C2).

Legislative references: Income Tax Assessment Act 1997 section 8-1 paragraph 8-1(2)(a) section 25-35 section 102-20 subsection 104-25(1)
Related public rulings and determinations: TR 92/18
Subject references: Capital losses Trusts Trust beneficiaries Discretionary trusts Borrowing's & loans Deductions & expenses Bad debts