Private ruling: Losses – capital vs revenue
Date of advice: 27 April 2018
Published: July 2018
Ruling period: Income year ended 30 June 20XX.
Date scheme commenced: 22 November 20XX.

Ruling: Q1: Are the losses made by Company A on investments in Company B accounted for as a revenue loss? | A1: No. | Q2: Are the losses made by Company A on investments in Company B accounted for as a capital loss? | A2: Yes.

Relevant facts and circumstances: Company A began operations in approximately 10 years ago as a tech accessory start-up. A few years later, Company A became an investment company focused tech start-ups. Generally, the Company’s return is generated from those investments. Subsequently, Company A commenced undertaking some consulting work within financial and investment services, most often with companies that it invests in. The majority of Company A’s capital resources are used in investing in other companies. Over a period of a few months, the Company A made a number of investments in Company B. Company B was a start-up digital media business. The investments were made up of both equity and convertible notes. The investments were part of a larger capital raising exercise by Company B, with shares to be issued once the entire sum has been raised, with all investments converted into share equity. One of the investments made was initially a short-term loan, and later changed into a convertible note. It became apparent that Company B was trading while insolvent. Fund were being syphoned away from Company B by individuals involved in that company. The Company A’s investments in Company B were not converted into shares. More recently, Company B was put into liquidation and subsequently deregistered. The Company A wrote off its investment in Company B once it became apparent that it was unlikely that any returns would be forthcoming from the liquidation. The Company A has not recovered any of the funds invested in Company B. The Company A has since made investments in other start-ups. The Company A does not carry on a business of trading in shares and other securities.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1. | Income Tax Assessment Act 1997 Part 3-1. | Income Tax Assessment Act 1997 Part 3-3. | Income Tax Assessment Act 1936 Section 26BB. | Income Tax Assessment Act 1936 Section 70B.

Reasons for decision: Summary: The loss incurred on Company A’s investment in Company B is of capital nature and subject to the capital gains tax (CGT) provisions. | Detailed Reasoning - Capital vs revenue: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer may deduct from their assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income. However, a taxpayer cannot deduct a loss or outgoing to the extent that the loss or outgoing is of capital, or capital nature. | Detailed Reasoning - Application to your circumstances: In this case, Company A is involved in investing in start-ups, however does not carry on a business of trading in shares and other securities. The investments made in Company B were of capital nature. | Detailed Reasoning - Traditional securities: The traditional securities provisions, sections 26BB and 70B of the Income Tax Assessment Act 1936 (ITAA 1936), include in assessable income or allowable deductions, gains or losses made on the disposal or redemption of certain securities. The word dispose is defined in subsection 26BB(1) of the ITAA 1936 as follows: Dispose, in relation to a security, means sell, transfer, assign or dispose of in any way the security or the right to receive payment of the amount or amounts payable under the security. In assessing whether or not a loss in relation to a traditional security is deductible, the concept of disposal is critical. In considering whether a security has been disposed of, the disposal must have been an action of the individual who held the security. Where a particular security might ultimately cease to exist or become worthless because of the liquidation or dissolution of the issuer company, neither of those consequences means that there has been any act of disposal (for the purposes of subsection 70B(2)) which has been taken by the individual. Furthermore, Taxation Ruling TR 96/14 Income tax: traditional securities considers the operation of sections 26BB and 70B of the ITAA 1936 and provides that a traditional security issued by a company that has gone into liquidation is not disposed of when the liquidator has made a final payment to the holder of the security or where no payments are to be made by the liquidator. | Detailed Reasoning - Application to your circumstances: As Company A has not acted to dispose its investments there has been no disposal for the purposes of subsection 70B(2) and, no deduction for loss is available to under 70B of the ITAA 1936. | Detailed Reasoning - Capital loss: A failure to satisfy the tests of disposal or redemption in the traditional security provisions will not prohibit a loss under the capital gains provisions. ATO Interpretative Decision ATO ID 2008/58 Income Tax Capital gains tax: CGT event C2 - unsecured note provides that CGT event C2 in section 104-25 of the ITAA 1997 may happen if: ● the taxpayer executes a deed of release in favour of the company so that the taxpayer is legally barred from collecting the debt, or ● the company is deregistered. In this case, the liquidation of Company B has occurred and Company B has been deregistered. It is considered that Company A’s interests (convertible notes and equity investments) have been cancelled and ceased to exist following the completion of the liquidation and deregistration of Company B. Therefore CGT event C2 has occurred. The time of the CGT event is when Company B is deregistered and capital loss can be claimed in the relevant income year.