Private ruling: Trusts losses
Published: December 2012
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 1995

Ruling: Q1: Will the appointment of a receiver manager to the incorporated trustee of the family trust extinguish the prior year trust tax losses? | A1: No | Q2: Are you entitled to claim a deduction for pre-receivership tax losses against income earned since the discharge from receivership? | A2: Yes | Q3: Will the income received, and expenses incurred, from trading by the receiver manager constitute assessable income and deductible expenses? | A3: Yes | Q4: Will the sale of the produce by the receiver manager (but for which he was not paid) constitute assessable income in the year it was sold? | A4: Yes | Q5: Will the recovery of the debt that constitutes the value of the produce sale constitute assessable income in the year it was sold? | A5: Yes | Q6: Will the cost of making recovery of the debt that constitutes the value of the produce be a valid deductible expense? | A6: Yes | Q7: Are you entitled to claim a deduction for a bad debt for $xxxx (which is the difference between the value of the produce sale of $xxxx less the $xxxx received in the settlement)? | A7: No | Q8: Will the sale of most, but not all, of the fixed and floating assets of the trust by the receiver manager or controller constitute a complete vesting or winding up of the trust? | A8: No | Q9: Will the recouped depreciation and provisions in respect to asset sales by the receive controller constitute assessable income that should be applied in the tax returns for the years the disposals took place? | A9: Yes

Relevant facts and circumstances: A Trust is a discretionary trust with a family trust election in place pre-1996. Company A is the trustee for the A Trust. The share structure of Company A consists of two ordinary shares: · 1x held by X · 1x held by X and X as executors of the Estate of X The shares have voting rights, but no right to capital or income of the company. Company A was placed in receivership during the late 1990's. Company A was also placed under controllership during the late 1990's. A receiver was appointed by the bank and the bank appointed itself as controller. The business of A Trust was principally that of producer. Commonly, A Trust contracted to sell all or most of its produce to a trader/manufacturer. It had delivered on its contract immediately prior to and immediately after the external administration appointments. A Trust delivered (or committed to deliver) all of its produce in a particular year to the trader/manufacturer. The value of the produce was $xxx. The sum of $xxxx was income to A Trust in the late 1990's. However, this was not paid as a result of breach of contract by the trader/manufacturer (with receiver and manager appointed). The received and manager of the trader/manufacturer alleged the produce was unfit for sale. You believe that the allegation was a fabrication, which you believe was intended to deprive the A Trust of income. A Trust brought proceedings against the receiver and manager in relation to their conduct of breaching the business plan/contract. It was further alleged that that the receiver manager acted on the advice of his appointer (the controller) The proceedings settled out of court in the late 2000's, with a payment of $xxxx. A Trust has applied the $xxxx settlement as a payment satisfying in part a recoverable debt carried forward from the late 1990's. A Trust intends to write off $xxxx (the value of the sale, less the settlement payment) as a bad debt. You state that the trustee of A Trust was not liquidated and at all material times it held assets, there were either the chose in action, or plant and equipment or both or cash on hand. The trustee submits that the accruals method of accounting applies to the value of the produce. You state that Hurworth Nominees Pty Ltd was not liquidated and at all material times it held assets that were either the chose in action or plant and equipment, or both, or cash on hand. The trustee submits that the ownership tests in section 125-60 of the ITAA 1997 (about ownership interests for demerger relief), section 94G of the ITAA 1936 (about continuity of ownership for corporate limited partnerships) and schedule 2F of the ITAA 1936 (about trust losses) has been passed by the entity. The trust deed has not been amended.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 165-208 | Income Tax Assessment Act 1936 Schedule 2F | Income Tax Assessment Act 1936 Division 270 of Schedule 2F | Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Subsection 40-285(1) | Income Tax Assessment Act 1997 Section 25-35

Reasons for decision: Summary: The appointment of a receiver manager to the incorporated trustee of the trust will not extinguish prior year trust tax losses. In addition, as you pass the necessary trust loss tests you may claim a deduction for prior year tax losses against income earned since the discharge from receivership. The income earned by the trust from its business operations while under receivership is ordinary assessable income. The expenses necessarily incurred while carrying on the business operation to earn assessable income will be deductible expenses, which will include legal expenses incurred in recovering the value of the sale of the produce. However, you will not be entitled to claim a deduction for the 'bad debt' as the debt ceased to exist once the deed of settlement was entered into to extinguish the debt. As the trust utilises the earnings (accrual) based method of accounting, all income is derived when a recoverable debt is created, not when payment has been received. As there are still assets remaining in the trust, the trust continues to trade, the beneficiaries of the trust have not changed and there has been no amendment to the trust deed, it is reasonable to conclude that the trust still exists for tax purposes. The recouped depreciation and provisions in relation to the asset sales by the receiver manager, will constitute assessable income by the extent that the termination value of the assets are more than the book value of the assets. | Detailed Reasoning - Will the appointment of a receiver manager to the incorporated trustee of the family trust extinguish the prior year trust tax losses?: Section 165-208 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that for the purposes of the primary continuity of ownership test or the alternative continuity of ownership test, an entity is not prevented from: a) beneficially owning shares in a company; or b) having the right to exercise, controlling, or being able to control, voting power in a company; or c) having the right to receive any dividends that a company may pay; or d) having the right to receive any distribution of capital of a company; merely because: e) the company is or becomes: i. an externally-administered body corporate within the meaning of the Corporations Act 2001 ; or ii. an entity with a similar status under a foreign law to an externally-administered body corporate; or f) either: i. a provisional liquidator is appointed to the company under section 472 of the Corporations Act 2001 ; or ii. a person with a similar status under a foreign law to a provisional liquidator is appointed to the company. Accordingly, even though Company A was in receivership during the period in the late 1990's, the shareholders of the company still maintain continuity of ownership for the purposes of claiming prior year tax losses. It is a similar case with trusts, however, there are further tests that need to be passed to ensure that a trust can claim a prior year tax loss. | Detailed Reasoning - Are you entitled to claim a deduction for pre-receivership tax losses against income earned since the discharge from receivership?: Schedule 2F to the Income Tax Assessment Act 1936 (ITAA 1936) contains measures referred to as the trust loss measures. These measures are designed to restrict the recoupment of prior and current year losses and debt deductions of trusts and to prevent the transfer of the tax benefit of those losses or deductions. The tax benefit of losses is transferred where a person, who did not bear the economic loss at the time it was incurred by the trustee, obtains a benefit from a trust by being able to deduct the loss. The measures imposed to restrict the use of losses and the claiming of debt deductions generally revolve around a change in ownership or control of the trust. There are certain tests that must be satisfied if a trust wishes to deduct a tax loss and/or certain debt deductions, the tests are: · control test · 50% stake test · pattern of distributions test · income injection tests Certain tests only apply to certain types of trust. A trust will be able to deduct a tax loss and/or certain debt deductions if it satisfies the trust loss tests that apply to it. The following table summarises the tests that apply to each type of trust. | Detailed Reasoning - Income injection test: Fixed trust other than a widely held unit trust X (1) X Unlisted widely held trust X Listed widely held trust X X (2) X Unlisted very widely held trust X X Wholesale widely held trust X X Non-fixed trust X X (3) X X Family trust X (4) Excepted trust (other than a family trust) (1) An alternate test is also available in certain cases where non-fixed trusts hold fixed entitlements in the fixed trust. (2) This test can be applied if the 50% stake test is failed by a listed widely held trust. (3) This test does not apply for current-year loss purposes. (4) The income injection test does not apply where entities and individuals within a family group inject income into a family trust with losses. The A Trust is a family trust (family trust election in place) for the purposes of the trust loss tests. Accordingly, the trust is only subject to the income injection test. | Detailed Reasoning - The income injection test: Division 270 of Schedule 2F to the ITAA 1936 discusses the requirements for the income injection test. If a trust is involved in a scheme to take advantage of losses or other deductions, it may be prevented from making full use of those losses or deductions under the income injection test. Under these schemes, income is injected into trusts with losses or other deductions so that no tax is payable on the income. The income injection test will apply where an 'outsider' to the loss trust seeks to take advantage of the deduction(s). In general terms, the outsider must provide a benefit to the trust and a return benefit must be given to the outsider. Also, either of the benefits (or the income injected under the scheme), must have been provided or derived wholly or partly, but not merely incidentally, because of the deduction(s). The income injection test does not apply to income injection schemes that take place wholly within a family group. It also does not apply to complying superannuation funds, complying approved deposit funds, pooled superannuation trusts, fixed unit trusts where all direct or indirect unit holders are exempt from income tax, and deceased estates within a reasonable administration period. The income injection test applies to all trusts, including excepted trusts. For the purposes of this test, a 'scheme' takes on the same meaning as in Part IVA of the ITAA 1936. 'Scheme' means: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings, and (b) any scheme, plan, proposal, action, course of action or course of conduct. The term benefit is broadly defined and will include any benefit or advantage within the ordinary meaning of those expressions. However, it is defined to specifically include money or other property (whether tangible or intangible), rights or entitlements (whether proprietary or not), services and the extinguishment, forgiveness, release or waiver of a debt or other liability. The income injection test applies where the person who has provided, directly or indirectly a benefit to the trustee or beneficiary of the trust (or an associate), is an outsider to the trust. The meaning of 'outsider' depends on whether or not the trust is a family trust. Generally, in the case of family trusts, members of the defined 'family' or other trusts, companies or partnerships in the defined family group are not 'outsiders' for the purposes of the test. The income injection, in this case, was received as part of a settlement from the bank and the receiver. The payment was in place of income that should have been earned by the received manager for the sale of the produce in question. The settlement payment was as a result of legal action taken against the receiver manager for disposing of the produce for less than the market value. In addition, you have advised that you consider that the payment amounts to assessable income. Therefore, the trust has received an income injection from an 'outsider' of the family trust, that is the bank and the receiver. However, while there is a benefit received by the trust in that assessable income has been received, the benefit was not provided or derived wholly or partly to take advantage of the prior year tax losses as part of a scheme. The assessable income received was merely a replacement of income that should have been received on the sale of the produce in the first instance. Accordingly, the trust satisfies the income injection test, and the prior year tax losses are available as a deduction against future assessable income. | Detailed Reasoning - Will the income received (and expenses incurred) from trading by the receiver manager constitute assessable income and deductible expenses?: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). Ordinary income has generally been held to include three categories, namely, income from rendering personal services, income from property and income from carrying on a business. Therefore, income derived from the trust's business operations, is assessable under section 6-5 of the ITAA 1997. Section 8-1 of the ITAA 1997 allows a deduction for losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. A loss or outgoing is not deductible to the extent that it is of a private, capital or domestic nature. Therefore, any expenses necessarily incurred in carrying on the trust's business operations will be deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Will the sale of the produce by the receiver manager (but for which he was not paid) constitute taxable income in the year of the sale?: Taxation Ruling TR 98/1 discusses the determination of income under the receipts (cash) or earnings (accrual) methods and provides that the 'earnings' method is often referred to as the 'accruals' method. The earnings method is, in most cases, appropriate to determine business income derived from a trading or manufacturing business. Under the earnings method, income is derived when it is earned. The point of derivation occurs when a 'recoverable debt' is created. The term 'recoverable debt' is used to describe the point of time at which a taxpayer is legally entitled to an ascertainable amount as the result of having performed an agreed task. A taxpayer may have a recoverable debt even though, at the time, they cannot legally enforce recovery of the debt. Whether there is, in law, a recoverable debt is a question to be determined by reference to the contractual agreements that give rise to the legal entitlement to payment, the general law and any relevant statutory provisions. Accordingly, as you state that the accruals method applies to the value of the produce, the sale of the produce constitutes assessable income in the year when delivery of the produce was made. Will the recovery of the debt that constitutes the value of the produce sale in the 1990's (paid for in the 2000's) constitute income in the year of the sale? Under the earnings (accrual) method of accounting, the soft commodity sale made in the 1990's, should be included in assessable income in the 1990's in the year of the sale, the year it was derived. The final recovery of the debt, when the trade debtor or in this case, the receiver manager, ultimately paid the money to the trust in the 2000's, will not constitute income of the trust in the 2000's. | Detailed Reasoning - Will the cost of making recovery of the debt that constitutes the value of the produce be a valid tax deduction?: As already discussed, section 8-1 of the ITAA 1997 allows a deduction for losses and outgoings to the extent to which they are incurred in gaining or producing assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing assessable income. A loss or outgoing is not deductible to the extent that it is of a private, capital or domestic nature. In determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered ( Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. The leading Australian judgment on the distinction between capital and revenue expenditure is that of Dixon J in Sun Newspapers Ltd & Associated Newspapers Ltd v. FC of T (1939) ALR 10; 12 ALJ 411; (1938) 1 AITR 353; 1 AITR 402; (1938) 1 AITR 403; 5 ATD 23; 5 ATD 87; (1938) 61 CLR 337 ( Sun Newspapers' Case ). His Honour explained the capital revenue distinction in the following terms: The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure or organisation set up or established for the earning of profit and the process by which such an organisation operates to obtain regular returns by means of regular outlay ... In the same way expenditure and outlay upon establishing, replacing and enlarging the profit-yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue. In your case, you incurred legal expenses in order to receive appropriate consideration for the value of the produce that was sold to a debtor. The sale of the produce is in the ordinary course of earning assessable income for the business. Accordingly, the legal expenses incurred to receive the assessable income from the sale of the produce was necessarily incurred in carrying on your business and therefore the legal expenses will be deductible under section 8-1 of the ITAA 1997. Are you entitled to claim a deduction for a bad debt for $xxxx (which is the difference between the value of the produce sale of $xxxx less the $xxx received in the settlement)? Section 25-35 of the ITAA 1997 provides that you can deduct a bad 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 lending money. Taxation Ruling TR 92/18 lists the factors to be satisfied: · there must be a debt · the debt must be bad · the debt must be written off during the income year · the debt must have been brought to account as assessable income Paragraphs 37 and 38 of TR 92/18 provide that no deduction will be allowed in a year, if the debt is written off after the year's end at the time when the books of account are being prepared (i.e. as a balance day adjustment made after the close of the income year). Furthermore, it is essential that a debt be in existence in order that it may be written off as bad. A debt cannot be written off after it has been settled, compromised, otherwise extinguished or assigned. In your case, the debt in question no longer exists as you have reached a settlement with the parties in question that effectively extinguishes the debt that should have been brought to account as assessable income in the 1990's. Accordingly, as the debt no longer exists, you do not satisfy the necessary factors to deduct an amount for the 'bad debt'. Will the sale of most, but not all, of the fixed and floating assets of the trust by the receiver manager or controller constitute a complete vesting or winding up of the trust (including any un-recouped tax losses)? On 21 January 2011, the Full Federal Court (Edmonds and Gordon JJ, Dowsett J dissenting) handed down its judgment in Commissioner of Taxation v. David Clark ; Commissioner of Taxation v. Helen Clark [2011] FCAFC 5; 2011 ATC 20-236; (2011) 79 ATR 550 ( Clark ). That case raised squarely for consideration the circumstances in which the nature of a trust has so changed that it might be concluded that the trust that originally incurred capital losses is not the same trust for income tax purposes as that which has derived gains against which the losses are sought to be recouped. Clark was decided adversely to the Commissioner. Special leave sought by the Commissioner to appeal the decision to the High Court was rejected on 2 September 2011. In light of this, the Commissioner issued Taxation Determination TD 2012/21 in which he explains his view on the administrative impact of the Court's decision in the following terms: The Commissioner considers that the decision of the Full Federal Court in Clark does not change the basic proposition that, based on the authority in Commercial Nominees , the relevant focus is on whether continuity of the trust estate has been maintained. That this is so is confirmed by the High Court's language in disposing of the Commissioner's application for special leave where the High Court noted that the decision of the Full Federal Court involved 'characterisation and evaluation of the continuity of the trust estate'. As decided by the High Court in Commercial Nominees , the Commissioner considers that the test to be applied looks to whether changes to one or more of the trust's constituent documents, the trust property, and the identity of those with a beneficial interest in the trust property are such as to terminate the existence of the trust. To the extent that the High Court in Commercial Nominees left open the possibility that there might be a loss of continuity in circumstances short of the existence of the trust having come to an end, the Commissioner acknowledges that in Clark there were significant changes to the property, membership and operation of the [the relevant trust in that case] without any finding by the courts that there was a loss of continuity such as to deny the trust access to the losses being carried forward. Relevantly, in disposing of the Commissioner's special leave application, the High Court noted that the application raised the question: Whether a trustee of a unit trust could set-off, against capital gains, capital losses incurred some years before under a different trustee with different unit holders, with an intervening excess of liabilities over assets, subsequent recapitalisation of the trust and a waiver by the original trustee of its right to be indemnified from the assets of the trust. Accordingly, following Clark, there will not be a loss of continuity sufficient to deny a trustee access to any capital losses being carried forward without a termination of the existence of the trust estate. It is clear following Clark that, at least in the context of recoupment of losses, continuity of a trust estate will be maintained so long as the trust is not terminated for trust law purposes. As such, in the absence of termination, tax losses being carried forward by a trustee will as a general rule remain available to be recouped against relevant trust income derived in future years of income. In your case, · not all of the assets of the trust were disposed of by the receiver manager · the trust continues to trade · the beneficiaries of the trust remain the same, and · there have been no amendments to the trust deed Accordingly, it is reasonable to conclude that there has been no loss of continuity of the trust estate and therefore, the trust still exists for income tax purposes. Will the recouped depreciation and provisions in respect to asset sales by the receive controller constitute assessable income that should be applied in the tax returns for the years the disposals took place? If you cease to hold or use a depreciating asset, a balancing adjustment event may occur. If there is a balancing adjustment event, you need to calculate a balancing adjustment amount to include in your assessable income or to claim as a deduction. A balancing adjustment event occurs for a depreciating asset when: · you stop holding it, for example, if the asset is sold, lost or destroyed · you stop using it and expect never to use it again · you stop having it installed ready for use and you expect never to install it ready for use · you have not used it and decide never to use it, or · a change occurs in the holding or interests in an asset which was or is to become a partnership asset. Subsection 40-285(1) of the ITAA 1997 provides that an amount is included in your assessable income if: a) a balancing adjustment event occurs for a depreciating asset you held and: i. whose decline in value you worked out under Subdivision 40-B; or ii. whose decline in value you would have worked out under that Subdivision if you had used the asset; and b) the asset's termination value is more than its adjustable value just before the event occurred. The amount included is the difference between those amounts, and it is included for the income year in which the balancing adjustment event occurred. Accordingly, if the termination value of the asset is more than the book value of the asset (adjusted for depreciation), the difference in value will need to be returned as assessable income.

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