ATO ID 2013/64: Capital gains tax: cost base: limited recourse loan
Date of decision: 26 November 2013
Year of income: Year ending 30 June 2014
Business line: Small Business / Individual Taxpayers

Issue
Does the taxpayer need to reduce the cost base and reduced cost base of a capital gains tax (CGT) asset by the amount of the shortfall between the loaned amount used to acquire the CGT asset and the market value of the CGT asset in accordance with subsections 110-45(3) and 110-55(6) of the Income Tax Assessment Act 1997 (ITAA 1997) if:

Decision
Yes, the taxpayer will need to reduce the cost base and the reduced cost base of the CGT asset by the amount of the shortfall in accordance with subsections 110-45(3) and 110-55(6) of the ITAA 1997.

Facts
The taxpayer and lender entered into a limited recourse loan. The loaned amount is used by the taxpayer to purchase a CGT asset. Under the terms of the limited recourse loan, if the taxpayer does not repay the loan by the agreed date, the lender's rights are limited to the proceeds from the disposal of the particular CGT asset. The taxpayer does not repay the loan by the agreed date. The lender sells the CGT asset. The market value of the CGT proceeds received is less than the outstanding balance of the limited recourse loan ('the shortfall amount'). Under the terms of the limited recourse loan, the lender accepts the proceeds from the disposal of the asset as full satisfaction of the loan.

Reasons for decision
Summary: Money paid to acquire a CGT asset falls within the first element of its cost base and reduced cost base (paragraph 110-25(2)(a) and subsection 110-55(2) of the ITAA 1997). However, expenditure does not form part of any element of the cost base or reduced cost base to the extent of any amount received as 'recoupment' of it, except so far as the amount is included in the taxpayer's assessable income (subsections 110-45(3) and 110-55(6) of the ITAA 1997). Section 995-1 of the ITAA 1997 provides that 'recoupment' has the meaning given by section 20-25 of the ITAA 1997. Section 20-25 of the ITAA 1997 defines a 'recoupment' of a loss or outgoing as including '...any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however described'. The ordinary meaning of the term 'recoup' is provided in The Macquarie Dictionary [Multimedia], version 5.0.0, 01/10/01 (Macquarie Dictionary) and includes '...to obtain an equivalent for; compensate for: to recoup one's losses', '...to regain or recover' and '...to reimburse or indemnify: to recoup a person for expenses'. Where a taxpayer borrows funds under a limited recourse loan and does not repay the loan by the agreed date, either by defaulting or otherwise, the taxpayer obtains an economic gain equivalent to the shortfall amount. That is, notwithstanding that the proceeds from the disposal of the underlying asset are insufficient to repay the loan in full, the taxpayer is not required to repay the shortfall amount to the lender. Therefore, the shortfall amount is regarded as having been indirectly received by the taxpayer as a reduction of the loaned amount. This economic gain is within the meaning of 'recoup' because the taxpayer has received an amount to compensate their loss as a result of the loan being discharged in full by an asset that is worth less than the loaned amount. Accordingly, the shortfall amount is a recoupment in accordance with the definition in section 20-25 of the ITAA 1997. In the alternative, the shortfall amount is a recoupment in accordance with the definition in section 20-25 of the ITAA 1997 because it is an indemnity. The ordinary meaning for the term 'indemnity' is provided in the Macquarie Dictionary as including '...compensation for damage or loss sustained'. A limited recourse loan protects the borrower from any potential economic loss caused by the reduction in value of the CGT asset. In this circumstance, by accepting the value of an asset that is worth less than the loaned amount as full satisfaction of the loan, the lender has compensated the taxpayer for any loss incurred as a result of the decrease in market value of the asset. Accordingly, the shortfall amount is a 'recoupment' and therefore, will not form part of the asset's cost base or reduced cost base in calculating any capital gain or capital loss under subsections 110-45(3) and 110-55(6) of the ITAA 1997.

Legislative references: Income Tax Assessment Act 1997 section 20-25 paragraph 110-25(2)(a) subsection 110-45(3) subsection 110-55(6) section 995-1
Related public rulings and determinations: PR 2007/55 | PR 2007/73 | PR 2008/40 | PR 2008/41 | PR 2008/49 | PR 2008/58 | PR 2011/5 | PR 2012/2 | PR 2013/15
Subject references: CGT CGT cost base recouped expenses CGT reduced cost base shortfalls