Private ruling: Debt forgiveness - Director loans- Deductibility tests for losses
Published: September 2011
Ruling period: Year ended 30 June 2010
Date scheme commenced: 1 July 2009

Ruling: Q1: Is a loan from a shareholder who was also a director of the corporate debtor, a commercial debt for the purposes of Section 245-25 of Schedule C of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: No | Q2: If the answer is Yes to Question 1, does Division 245 of the ITAA 1936 apply if the director is declared bankrupt and removed as director of the company and a new director is appointed? | A2: Not applicable | Q3: If the answer is Yes to Question 1, does Division 245 of the ITAA 1936 apply if the company is sold and the loan is issued as shares to the new director/shareholder? | A3: Not applicable | Q4: Will the company be able to offset the tax loss against future profits generated by trading in financial securities other than those specifically traded by the director that generated the tax losses? (ie can profits from trading options and shares, other than via futures contracts, be reduced by the carried forward tax losses?) | A4: Yes | Q5: Would the same business test for applying losses be met once the company has been sold to the purchaser and the company generates interest income from term deposits only? | A5: Yes


Relevant legislative provisions: Income Tax Assessment Act 1936 Section .245-10 | Income Tax Assessment Act 1936 Subsection 245-15(1) | Income Tax Assessment Act 1936 Section 245-25 | Income Tax Assessment Act 1936 Subsection 245-245(1) | Income Tax Assessment Act 1997 Section 165-10 | Income Tax Assessment Act 1997 Section 165-12 | Income Tax Assessment Act 1997 Section 165-13 | Income Tax Assessment Act 1997 Section 165-210

Reasons for decision: Summary: 1. Is a loan from a shareholder who was also a director of the corporate debtor, a commercial debt for the purposes of Section 245-25 of Schedule C of the ITAA 1936? Former Div 245 of the ITAA 1936 was enacted by Taxation Laws Amendment Act (No 2) 1996 (Act No 76 of 1996). Former Div 245 of the ITAA 1936 was repealed by Act No 79 of 2010 but remains applicable to debts forgiven in income years prior to a taxpayer's 2010/11 income year. Section 245-10 of Schedule 2C to the ITAA 1936 provides that Schedule 2C applies where a forgiveness of a commercial debt occurs after 27 June 1996. Subsection 245-15(1) of Schedule 2C to the ITAA 1936 defines a debt for the purposes of Schedule 2C as: Subject to this section, a debt is an enforceable obligation imposed by law to pay an amount to another person. Subsection 245-245(1) of Schedule 2C to the ITAA 1936 defines pay as including repay. A loan will constitute a debt where a Lender can legally enforce the terms of a loan should the Debtor default at any time. There were no formal loan agreements between the director and the company to acknowledge a 'directors loan' had been in place. Therefore a commercial debt for the purposes of Section 245-25 of Schedule C to the ITAA 1936 does not apply. 2. If the answer is Yes to Question 1, does Division 245 of the ITAA 1936 apply if the director is declared bankrupt and removed as director of the company and a new director is appointed? Not applicable as Division 245 does not apply to Question 1. 3. If the answer is Yes to Question 1, does Division 245 of the ITAA 1936 apply if the company is sold and the loan is issued as shares to the new director/shareholder? Not applicable as Division 245 does not apply to Question 1. 4. Will the company be able to offset the tax loss against future profits generated by trading in financial securities other than those specifically traded by the director that generated the tax losses? (ie can profits from trading options and shares, other than via futures contracts, be reduced by the carried forward tax losses?) Under section 165-10 of the Income Tax Assessment Act 1997 (ITAA 1997) a company cannot deduct a tax loss unless either: · It meets the conditions in section 165-12 of the ITAA 1997 (which is about the company maintaining the same owners), or · It meets the conditions in section 165-13 of the ITAA 1997 (which is about the company carrying on the same business) The continuity of ownership test requires that shares carrying more than 50% of all voting, dividend and capital rights be beneficially owned by the same persons at all times during the ownership test period. The ownership test period is the period from the start of the loss year to the end of the income year in which the loss is to be deducted Subsection 165-12(1) of the ITAA 1997. The former director is still the sole shareholder of the company, therefore the conditions in section 165-12 of the ITAA 1997 are satisfied and the company will be able to offset the tax loss against future profits generated by trading in financial securities. 5. Would the same business test for applying losses be met once the company has been sold to the purchaser and the company generates interest income from term deposits only? Where the continuity of ownership test in section 165-12 of the ITAA 1997 is not satisfied, section 165-13 of the ITAA 1997 provides an alternative Same Business Test condition. Subsections 165-210(1) and 165-210(2) of ITAA 1997 includes three tests, each of which must be satisfied by a company in order for the company to meet the requirements of section 165-13 and section 165-210 of the ITAA 1997 and thereby not be prevented by section 165-10 of the ITAA 1997 from deducting prior year losses Firstly, for a company to satisfy the same business test, the company must be able to show that it carried on at all times during the period of recoupment the same business as the business that the company carried on at the change-over subsection 165-210(1) of the ITAA 1997. Secondly, the company did not carry on any business (meaning a particular undertaking or enterprise) other than a business of a kind carried on before the test time as part of the overall business subsection 165-210(2) of the ITAA 1997; and Thirdly, it only derived income from transactions of a kind that it entered into in the course of the overall business before the test time subsection 165-210(2) of the ITAA 1997; and the anti-avoidance provisions in subsection 165-210(3) of the ITAA 1997 do not apply. For the purpose of the same business test, a company is treated as carrying on one overall business at the change-over and during the period of recoupment since the reference to 'business' in the same business test is a reference to all of the activities carried on by the company at the change-over and during the period of recoupment, irrespective of whether those activities constitute or are treated by the company as constituting separate or distinct activities, enterprises, divisions or undertakings carried on by the company. Taxation Ruling TR 1999/9 provides guidance on the operation of sections 165-13 and 165-210, paragraph 165-35(b), section 165-126 and section 165-132 of the ITAA 1997. In particular, paragraph 13 provides that In the same business test, the meaning of the word 'same' in the phrase 'same business as' imports identity and not merely similarity; the phrase 'same business as' is to be read as referring to the same business, in the sense of the identical business. However, this does not mean identical in all respects: what is required is the continuation of the actual business carried on immediately before the change-over. Nevertheless, it is not sufficient that the business carried on after the change-over meets some industry wide definition of a business of the same kind; nor would it be sufficient for there to be mere continuance of business operations from immediately before the change-over into the period of recoupment, if the business had so changed that it could no longer be described as the same business. The applicant has provided a description of the business as follows. The company was and still is an investment company. Prior investments were foreign exchange futures, interest rate futures, some shares and deposit interest. The company now is trading less, invests in term deposits, options, shares and some investment consulting work. We accept that the first test is satisfied in this instance. However, in the year of recoupment it will be necessary for the Entity to consider its business activities. It is important to note that paragraph 13 of TR 1999/9 also provides that the analysis of whether the same business continues after the change-over may give rise to questions of degree and ultimately depends on the facts of the case. In making the analysis it needs to be acknowledged that a company may expand or contract its activities without necessarily ceasing to carry on the same business. The organic growth of a business through the adoption of new compatible operations will not ordinarily cause it to fail the same business test provided the business retains its identity; nor would discarding, in the ordinary way, portions of its old operations. But, if through a process of evolution a business changes its essential character, or there is a sudden and dramatic change in the business brought about by either the acquisition or the loss of activities on a considerable scale, a company may fail the test. We accept that the second and third test referred to above will also be satisfied. The applicant has confirmed that the Entity will not carry on any business other than an investment company, and will only derive income from transactions of a kind entered into in course of investments immediately before changeover. Accordingly, the same business test under section 165-210 of ITAA will be satisfied.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | Relevant facts: You have provided the following background facts. | The sole shareholder of the company, had put their personal money into the company during the life of the company. They had been trading in financial securities, mainly in foreign exchange (FX) futures and interest rate futures, while also trading in some shares using the company's funds. Their trading activities were unsuccessful and have led to the accumulation of carried forward tax losses. | Prior to trading their own money via the company, the director had previously worked with investment banks as a professional financial trader. | There were no formal loan agreements between the director and the company to acknowledge a 'directors loan' had been in place and no interest had been charged. The only indication that a 'directors loan' is present is due to the classification of the loan as a 'directors loan' on the statement of financial positions. | The director has declared bankruptcy during the financial year ended 30 June 2007, and was removed as director of the company and their spouse has become the sole director. They are still the sole shareholder of the company.