Private ruling: Bad debt deductions
Published: February 2014
Ruling period: Year ended 30 June 2013
Date scheme commenced: 2011

Ruling: Q1: Is the Taxpayer entitled to claim a bad debt deduction in the amount of $Z under section 25-35 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the year ended 30 June 2013? | A1: Yes

Relevant facts and circumstances: The taxpayer carries on a business of manufacturing goods. There has been no change in the majority ownership of the taxpayer since its establishment. The taxpayer is not the member of a consolidated group or MEC group. A Pty Ltd was a customer of the taxpayer. The taxpayer had a minority ownership interest in A Pty Ltd. In 20XX the taxpayer's ownership interest in A Pty Ltd was increased to give it a majority interest. The taxpayer advised that the acquisition arose when the taxpayer agreed to purchase the shares of minority shareholders who wanted to sell their shares. In 20YY the taxpayer increased its ownership interest in A Pty Ltd. The taxpayer advised that the purpose was a further capital injection to assist with liquidity of the A Pty Ltd's business. The taxpayer advised that it supplied goods to A Pty Ltd on the usual commercial terms of trade that the taxpayer requires with all its customers. Pricing with A Pty Ltd was on similar commercial terms as between the taxpayer and its customers. Between 20XX and 20YY the taxpayer supplied goods to A Pty Ltd totalling $X. The taxpayer included in its income tax return for the year ended 30 June 20YY the assessable income from the sales to A Pty Ltd in that year. The taxpayer has advised that it will include in its income tax return for the year ended 30 June 20ZZ the assessable income from the sales to A Pty Ltd in that year. In 20YY A Pty Ltd was placed into administration. An amount of $X remained unpaid to the taxpayer at this time (the debt). Prior to A Pty Ltd being placed into administration, the taxpayer's directors undertook endeavours to recover the debt owing from A Pty Ltd, including: · They chased payment of outstanding invoices on a regular basis and where possible requested cash of delivery; · The taxpayer only supplied stock to A Pty Ltd which was required by it in order to fulfil orders; and · When A Pty Ltd was placed into administration the taxpayer's directors engaged legal representation in order to outline the amount unpaid and state their retention of title security interests over the stock the taxpayer had supplied. In 20ZZ the assets of A Pty Ltd were sold by the administrator for an amount which was less the amounts owing to the secured creditor. The taxpayer has advised that litigation proceedings were in progress in relation to retention of title priority claims with the secured creditor. In 20ZZ A Pty Ltd was placed into liquidation. The directors of the taxpayer formed the view that they would not receive 100% of the debt due to insufficient funds subsequent to the sale of the assets to satisfy the liabilities of the secured creditors. In 20ZZ the directors of the taxpayer resolved to write off X% of the A Pty Lt debt as a bad debt (the written off debt). A provision was made for the balance of the debt as doubtful debts. The debt was not forgiven by the taxpayer. Later in 20ZZ the taxpayer collected $Y in relation to the debt. The taxpayer has advised that it will recognise an amount (being the difference between the amount collected and the written off debt) as assessable income in its income tax return for the year ended 30 June 20VV and the remaining amount recovered will be recognised as a reversal of the provision of doubtful debts.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1, and | Income Tax Assessment Act 1997 section 25-35, and | Income Tax Assessment Act 1997 subdivision 165-C

Reasons for decision: Summary: According to subsection 25-35 (1) of the Income Tax Assessment Act 1997 (ITAA 1997) you can deduct a debt (or part of a debt) that you write off as bad in the income year if: (a) It was included in your assessable income for the income year or for an earlier income year; or (b) It is in respect of money that you lent in the ordinary course of your business of money lending. TR 92/18 Income tax: bad debts (TR 98/18) clarifies the circumstances in which a deduction for bad debts will be allowable under the bad debts provision in section 63 of the Income Tax Assessment Act 1936 (ITAA 1936). The Commissioner's views in TR 92/18 apply to this case to the extent that the previous bad debt provisions and subsection 25-35(1) of the ITAA 1997 are materially similar. | Detailed Reasoning - Debt: A debt exists where a taxpayer is entitled to receive a sum of money from another either at law or in equity. On the evidence supplied the Commissioner accepts that there was a legal debt owed to the taxpayer by A Pty Ltd in an amount of $X representing goods supplied to A Pty Ltd by the taxpayer. | Detailed Reasoning - Bad Debt: Paragraph 3 of TR 92/18 sets out that the question of whether a debt is bad is a matter of judgment having regard to all the relevant facts. Guidelines for deciding when a debt is bad are at paragraphs 31-32. Generally provided a bone fide commercial decision is taken by a taxpayer as to the likelihood of non-recovery of a debt, it will be accepted that the debt is bad. The debt, however, must not be merely doubtful. Paragraph 31 of TR 92/18 sets out that a debt may be considered to have become bad in any of the listed circumstances. In particular, if the debtor is a company, it is in liquidation or receivership and there are insufficient funds to pay the whole debt. In this case, A Pty Ltd was placed into liquidation in 20ZZ and its assets were sold for less than the amount owing to the secured creditor. In addition, the taxpayer engaged legal representation in order to outline to the administrator the amount unpaid and state their retention of title security interests over the stock the taxpayer had supplied. It is accepted that the debt owning by A Pty Ltd was bad at the time it was written off. | Detailed Reasoning - Debt written off in the income year: By a written resolution of the directors of the taxpayer the debt was written off in 20ZZ. It is accepted that the debt was written off in the income year ended 30 June 20ZZ. | Detailed Reasoning - Debt included in assessable income: The taxpayer advised that it included in its income tax return for the year ended 30 June 20YY the assessable income from the sales to A Pty Ltd in that year. The taxpayer advised that it will include in its income tax return for the year ended 30 June 20ZZ the assessable income from the sales to A Pty Ltd in that year. Provided that the taxpayer includes the sales to A Pty Ltd for the year ended 30 June 20ZZ in its assessable income, the Commissioner considers that paragraph 25-35(1)(a) of the ITAA 1997 will be satisfied. | Detailed Reasoning - Special rules affecting deduction - subsection 25-35(5): Change in ownership or control of company Item 1 of the table in subsection 25-35(5) of the ITAA 1997 sets out that a company cannot deduct a bad debt if there has been a change in ownership or control of the company and the company has not satisfied the same business test. The taxpayer needs to only satisfy the provisions in subdivision 165-C of the ITAA 1997. The taxpayer is not a widely held or eligible Division 166 company and therefore the provisions in subdivision 166-C of the ITAA 1997 do not apply. Relevant to this case, under paragraph 165-120(1)(a) of the ITAA 1997 a company cannot deduct a debt (or part of a debt) that it writes off as bad in the current year unless it meets the conditions in section 165-123 (which is about the company maintaining the same owners). The Commissioner accepts the taxpayer's submissions that during the ownership test period there was no change in the taxpayer's voting power (subsection 165-123(2) of the ITAA 1997), right to dividends (subsection 165-123(3) of the ITAA 1997), or rights to capital distributions (subsection 165-123(4) of the ITAA 1997). The ownership test period is from the date of the first outstanding invoice in 20XX to the end of the income year, 30 June 20ZZ. Accordingly, Item 1 of the table in subsection 25-35(5) of the ITAA 1997 does not apply to affect the bad debt deduction. Trafficking of debts Item 2 of the table in subsection 25-35(5) of the ITAA 1997 sets out that a company cannot deduct a bad debt in various other cases that may involve trafficking in bad debts. The Commissioner accepts the taxpayer's advice that there has been no trafficking of debts by the taxpayer. Therefore item 2 of the table in subsection 25-35(5) of the ITAA 1997 does not apply. Debt forgiven Item 3 of the table in subsection 25-35(5) of the ITAA 1997 sets out that a deduction under this section is reduced if the debt is forgiven and the debtor and the creditor are companies under common ownership and agree for the creditor to forgo the deduction to a specified extent. The Commissioner accepts the taxpayer's advice that the debt owing by A Pty Ltd was not forgiven. Therefore item 3 of the table in subsection 25-35(5) of the ITAA 1997 does not apply. Recoupment of bad debt Item 4 of the table in subsection 25-35(5) of the ITAA 1997 sets out that if you receive an amount as a recoupment of a bad debt that you can deduct under this section, the amount may be included in your assessable income. In the income year ended 30 June 20ZZ the taxpayer did not receive a recoupment of a bad debt that it can deduct under section 23-35 of the ITAA 1997 However, the income year ending 30 June 20VV the taxpayer received a recoupment of the bad debt which it can deduct under section 25-35 of the ITAA 1997. Item 4 of the table in subsection 25-35(5) of the ITAA 1997 and subdivision 20-A of the ITAA 1997 will need to be considered by the taxpayer when preparing its tax return for the year ending 30 June 20VV. Trusts and Consolidated Group or MEC Group Items 5 and 6 of the table in subsection 25-35(5) of the ITAA 1997 sets out specific rules that apply to trusts and consolidated groups or MEC groups. These items do not apply as the taxpayer is not part of a consolidated group or MEC group and there are no trusts involved. | Detailed Reasoning - Section 8-1: Section 8-10 of the ITAA 1997 sets out that if 2 or more provisions of this Act allow you deductions in respect of the same amount (whether for the same income year or different income years) you can deduct only under the provision that is most appropriate. In this case, the most appropriate provision is section 25-35 of the ITAA 1997 and the taxpayer is not able to deduct under section 8-1 of the ITAA 1997.