Private ruling: Capital gains tax cost base
Date of advice: 26 June 2015
Published: June 2015
Ruling period: Year ending 30 June 2015. | Year ending 30 June 2016.
Date scheme commenced: 1 July 2014.

Ruling: Q1: Does the cost base of your share include the loan and bank guarantee given at the same time as acquisition of your share? | A1: No.

Relevant facts and circumstances: Over 20 years ago, several people (friends) formed a company to purchase a business and property. Your venture was risky as it relied on being able to introduce machines into the business in the future, however at the time of purchase; these machines were not legal in your state. You, as trustee of the ABC Family Trust (the trust), purchased one share in the company for $X amount. There was no formal documentation drawn up for the issuing of the share. You, as shareholder, also had to contribute $X amount as a loan and obtain a bank guarantee for around $X amount. Of the $X amount of the loan, three quarters was emergency funding due to planned finance falling through. There was no formal loan agreement put in place for the loan. The company took out a loan for approximately $X amount and you and each of the other shareholders had to obtain a bank guarantee of one fifth of the loan - around $X amount. There were never any fees or charges associated with the bank guarantee. The bank guarantee never had to be used, and it is still currently in place. You were not a Director of the company when it was first formed. You are not a Director of the company now; however you did take on the role of Director for a brief period at some point in between. After several years, the business started to achieve some success and interest was repaid on the loan ad hoc, by resolution of the shareholders. Principle amounts of the loan have also been paid ad hoc and there is currently approximately $X of the principal loan amount outstanding to you. At the time, the venture had substantial risk attached to it. All the funds, about $X per person were at risk and would have been lost should the venture have failed.

Relevant legislative provisions: Income Tax Assessment Tax 1997 section 110-25.

Reasons for decision: Detailed Reasoning - Cost base: The cost base of a capital gains tax (CGT) asset is generally the cost of the asset when you acquired it. However, it also includes certain other costs associated with acquiring, holding and disposing of the asset. Section 110-25 of the Income Tax Assessment Act 1997 (ITAA 1997) sets out items that can be included in the cost base of a CGT asset. Upon disposal of a post-CGT asset, the cost base is made up of five elements: 1. The first element is made up of the money paid or required to be paid to acquire the CGT asset. 2. The second element will include incidental costs of acquiring the asset, or costs in relation to the CGT event. Examples are agent's commission, advertising to find a seller or buyer, fees paid to an accountant. 3. The third element consists of non-capital costs incurred in connection with their ownership of a CGT asset. Examples are interest, rates, repairs and insurance premiums. An individual can include non-capital costs of ownership only in the cost base of assets acquired after 21 August 1991. 4. The fourth element includes capital expenditure the individual incurs for the purpose or the expected effect of increasing or preserving the assets' value or that relates to installing or removing the asset. 5. The fifth element includes capital expenditure the individual incurs to preserve or defend their title or rights to the asset. | Detailed Reasoning - Company loans: Generally, companies borrow money by issuing debt securities commonly known as 'debentures' or 'bonds'. Bonds can be bought and sold in the stock market in the same way as shares. Usually the company pays back the money borrowed after a period of time. Sometimes the holder of a bond is given the right to exchange the bond for shares in the borrowing company or another company. Company bonds that can be exchanged for shares are referred to as 'convertible notes'. A company bond or debenture is a promise made by a company to pay back money that it previously borrowed. In addition, the company pays interest until the money it borrowed is paid back. Interest you receive as the holder of a company bond or debenture is included in your tax return as interest income at 'L' item 10 'Gross interest'. If you sell a company bond to someone else before the company repays the money that it borrowed and you make a profit, that profit should be included on your tax return (supplementary section) at item 24 'Other income'. That profit is not treated as a capital gain. | Detailed Reasoning - Application to your circumstances: In your case, you were required to loan the company $X as a shareholder. Although there was no formal loan agreement in place, you have now been repaid the majority of the principal amount as well as interest on an ad hoc basis over the years. It is considered that your arrangement is commensurate to that of a company loan. Furthermore it is considered the loan was not consideration given to acquire the share, but instead was a separate shareholder agreement and therefore does not form part of the cost base of your share. Subsequently the interest you have received over the years is classified as assessable income which would be in your income tax return as interest income. Due to the success of your venture, the bank guarantee you have in place has never been used. The bank guarantee is still in place today. No fees, charges or expenses have ever been paid in relation to the bank guarantee you hold. Although there was considerable risk attached at the time of obtaining the bank guarantee, no money has ever been spent in respect of the bank guarantee. Consequently as no actual costs have been incurred or paid to date, the bank guarantee does not form part of the cost base of your share. Note that regardless if the bank guarantee is used in the future, it is not considered a part of the cost base of your share, as it was not consideration given in order to acquire the share, but instead was a separate shareholder agreement.