Private ruling: Investment losses
Published: August 2011
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you entitled to claim a deduction for your investment loss? | A1: No.

Relevant facts and circumstances: You are involved with property development as an employee. You were approached by a friend to invest in a property development project. During the 2007-08 financial year you entered an agreement with your friend whereby: · you would provide them with a loan · the funds were to be used in the development of the property · you would not be liable for any further costs associated with the financing and development of the property, and · within 12 months after signing the agreement, your friend will guarantee you the full amount of the loan funds plus interest. Your friend handled the day to day operation of the property deal. You had no direct involvement with the property deal. The property development did not proceed as your friend was unable to obtain funds to finalise the settlement of the property. Your friend was declared bankrupt. You have not received any interest, a return of your capital or a distribution from your friend's liquidator. You have not undertaken any previous property development on your own account. All your property development activities have been as an employee. You are not in the business of investing in property development by making loans to property developers.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 25-35

Reasons for decision: Summary: You are not entitled to claim a deduction against your assessable income for the loss of the loan principal as this loss is considered to be a capital loss. You may be entitled to offset the loss against capital gains earned in this or future years. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows you to deduct from your assessable income any loss or outgoing to the extent that: · it is incurred in gaining or producing your assessable income, or · it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income. No deduction is allowable if the loss is of capital, private or domestic nature or relates to the earning of exempt income or a provision of the taxation legislation excludes it. You have made a loss from an investment related to property development. We will need to determine whether the loss: · is deductible under section 8-1 of the ITAA 1997 against your other assessable income as you were carrying on a business of property development · is deductible under section 8-1 of the ITAA 1997 against your other assessable income as you conducted an isolated transaction with a view to profit · is deductible under section 25-35 of the ITAA 1997 as a bad debt, or · is considered to be a capital loss. | Detailed Reasoning - Carrying on a business of property development: The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts provided. Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. Indicators include commercial significance or character, regularity and repetition, organisation, size, scale and permanency. No one factor is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression. Whilst you earn your salary and wage income by providing building development services, your involvement with this building development project is merely providing a loan. You did not have any involvement in the day to day operations of the property deal. You are not considered to have been carrying on a business of property development as your involvement was passive in nature. Nor are you considered to be in the business of making loans as this was your first loan activity for property development. Accordingly, the loss is not considered to have been made in the course of carrying on a property development or money lending business. | Detailed Reasoning - Isolated transactions: Taxation Ruling TR 92/4 discusses whether losses on isolated transactions are deductible. TR 92/4 should be read in conjunction with Taxation Ruling TR 92/3 which deals with whether profits from isolated transactions are income and therefore assessable under section 6-5 of the ITAA 1997. An isolated transaction refers to those transactions outside the ordinary course of business of a taxpayer carrying on a business and those transactions entered into by non-business taxpayers. A loss from an isolated transaction is generally deductible under section 8-1 of the ITAA 1997 if: (a) in entering into the transaction the taxpayer intended or expected to derive a profit which would have been assessable income, and (b) the transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character ( Federal Commissioner of Taxation v. Whitfords Beach Pty Ltd (1982) 150 CLR 355, 82 ATC 4031, 12 ATR 692). Whether a particular transaction has a business or commercial character depends on the circumstances of the transaction. In determining whether an isolated transaction amounts to a business operation or commercial transaction, paragraph 13 of TR 92/3 outlines a number of factors that must be considered, as follows: · the nature of the entity undertaking the operation or transaction. For example, if the taxpayer is a corporation with substantial assets rather than an individual, that may be an indication that the operation or transaction was commercial in nature · the nature and scale of other activities undertaken by the taxpayer · the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained · the manner in which the operation or transaction was entered into or carried out · the nature of any connection between the relevant taxpayer and any other party to the operation or transaction · if the transaction involves the acquisition and disposal of property, the nature of that property, and · the timing of the transaction or the various steps in the transaction. For example, if the relevant transaction consists of the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not business or commercial in nature. In your case, · you conducted the transaction as an individual · this was your first investment loan · the amount of money involved was significant · you provided funds to your friend as a loan · whilst you have significant experience in property development as an employee, you were not involved in the proposed property development process for this property · the proposed development did not go ahead as your friend was unable to secure funding to acquire the property, and · the period of the loan was short-term as under the agreement you expected to receive the full capital amount plus interest 12 months after signing the agreement. Your intention in entering the transaction was to receive interest on the investment loan. You were not involved in the proposed development of the property other than providing short-term funds to the developer. In our view, we do not consider there was a transaction to which TR 92/4 can apply. You simply provided a short-term loan to a property developer. The funds would have been insufficient to cover the full development costs and the loan was only for a short term - less than the likely development period. We consider the arrangement is in the nature of a passive investment rather than a business operation or commercial transaction. As such the principal amount invested is considered to be a capital amount and not deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Bad debts: Where a deduction for a bad debt is not allowable under section 8-1 of the ITAA 1997, a deduction may be allowable under section 25-35 of the ITAA 1997. Section 25-35 of the ITAA 1997 states a bad debt is deductible where: · it was included in your assessable income for the income year or an earlier income year, or · it is in respect of money that you lent in the ordinary course of your business of lending money. As you are not in the business of lending money and the principal amount has never formed part of your assessable income, you are not entitled to a deduction under section 25-35 of the ITAA 1997. | Detailed Reasoning - Conclusion: You are not entitled to claim a deduction against your other assessable income for the loss of the loan principal as it is considered to be a capital amount and not deductible under section 8-1 or 25-35 of the ITAA 1997.

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