1 Will capital gains tax event C2 occur in relation to the lent funds on the date the Company was deregistered?
1 Yes. Question 2 Is any capital gain or loss you made from the capital gains tax event C2 occurring on the deregistration of the Company disregarded? Answer 2 Yes. This ruling applies for the following period : Year ending 30 June 20XX The scheme commenced on: 1 July 20XX
A company (the Company) was registered several years ago of which you are the director and public officer. The Company was established to carry on a business of providing specified services which involved the use of an online platform on the Company's web site. The Company had several shareholders (the Shareholders) which included a discretionary trust (the Trust) with you being one of its eligible beneficiaries, with the other eligible beneficiaries being family members. The trustee of the Trust is a corporate trustee. The funding of the Company was provided via related party loans, with you being one of the lenders. The plan was for the Company to trade profitably and return a profit to its shareholders by way of franked dividends. You contemplated formalising a lending agreement with the Company in a written and signed document on commercial terms, which would include charging interest. However, a formal agreement was not prepared due to resistance by the trustee of the Company's other shareholder. You expected:
• The Company to generate income from providing the specified services and that the Company would use cash generated from profits to repay the lent funds; and • That if the Company became profitable and paid dividends to the Shareholders, then the Trust would be a recipient of dividends, which would become income of the Trust in the income year the dividend was received. It was anticipated that the Trust would distribute its income to you as a presently entitled beneficiary. The services of Company X were engaged to build web pages for the Company through which it would conduct most sales. The Company started making sales several months after it was registered. You made several payments to Company X for their services provided to the Company. The Shareholders had a disagreement about the Company's business activities with the engagement of Company X's services ended, with the Company's website being decommissioned. The Company had not made any further sales and had become unable to cover its costs. As a result the following had occurred: • You paid an accounting fee invoice issued to the Company.
• You paid the Company's amended quarterly Business Activity Statement (BAS); and • You personally collected the refund amount for one of the Company's quarterly BAS. As the Company had ceased its trading activities, and had a lack of assets, it was unable to be liquidated to obtain funds to repay the borrowed funds it owed to you. Due to the Company's lack of profitability, and the unlikelihood that it will be profitable, a decision was made to deregister the Company. On XX XX 20XX, the Company was deregistered.
Income Tax Assessment Act 1997 section 102-20 Income Tax Assessment Act 1997 section 104-25 Income Tax Assessment Act 1997 section 108-5 Income Tax Assessment Act 1997 section 108-20
Question 1: Will capital gains tax event C2 occur in relation to the lent funds on the date the Company was deregistered? Capital gains tax event C2 A capital gains tax (CGT) asset can be any kind of property or a legal or equitable right that is not property under section 108-5 of the ITAA 1997. An intangible asset is one that lacks a physical presence and includes a debt owed to a lender. CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being redeemed or cancelled; or expiring; or being abandoned, surrendered, or forfeited under subsection 104-25(1) of the ITAA 1997. The time of the C2 event is when you enter into the contract that results in the asset ending, or if there is no contract - when the asset ends under subsection 104-25(2) of the ITAA 1997. When a company is deregistered, it ceases to exist. At that time, its debts, if any, are abandoned, surrendered or forfeited for the purposes of section 104-25 of the ITAA 1997, and CGT event C2 will happen with any recourse to obtain any return on the debts/loans formally ending at that time.
You make a capital loss if the capital proceeds are less than the assets reduced cost base under subsection 104-25(3) of the ITAA 1997. Application to your situation You lent funds to the Company which had not repaid in full when the Company was deregistered. For CGT purposes you had a CGT asset, being the debt owed to you by the Company. Your CGT asset was abandoned, surrendered or forfeited for the purposes of section 104-25 of the ITAA 1997 when the Company was deregistered. You may make a capital gain or loss as a result of the CGT event C2 occurring. Question 2 : Is any capital gain or loss you made from the capital gains tax event C2 occurring on the deregistration of the Company disregarded? Personal use assets When calculating your net capital gain or net capital loss for the income year, any capital loss you make from a personal use asset is disregarded under subsection 108-20(1) of the ITAA 1997. Paragraph 108-20(2)(d) of the ITAA 1997 states a personal use asset includes a debt arising other than in the course of gaining or producing your assessable income. Taxation Ruling IT 2385 Income Tax: expenses incurred by beneficiaries of discretionary trusts (Withdrawn)
is about expenses incurred by beneficiaries of discretionary trusts. It states that beneficiaries of discretionary trusts are unable to show a sufficient nexus between their activities and the receipt of assessable income from a discretionary trust because, at its highest, the beneficiary of a discretionary trust has the mere expectancy of receiving income from the trust. While IT 2385 has been withdrawn because it was replaced by a new Taxation Determination which articulates the same principles, the principles contained in IT 2385 can still be applied when determining whether a sufficient nexus has been shown between a beneficiary's assessable income and a discretionary trust. It is stated in paragraph 13 of Taxation Determination TD 2018/9 Income tax: deductibility of interest expenses incurred by a beneficiary of a discretionary trust on borrowings on-lent interest-free to the trustee that a beneficiary of a discretionary trust is only presently entitled to income if they have: a) an interest in the income which is both vested in interest and vested in possession; and
b) a present legal right to demand and receive payment of the income, whether or not the precise entitlement can be ascertained before the end of the relevant year of income and whether or not the trustee has the funds available for immediate payment. This is distinguishable from a shareholder of a company or a beneficiary of a fixed trust, who have an absolute interest in the company or trust income. Application to your situation You lent the funds to the Company to help fund its activities. You had not received repayment of all the lent funds prior to the Company being deregistered. It had been contemplated by you to formalise your lending of funds to the Company with a signed written document on commercial terms, which would include interest payments on the lent funds. However, that had not occurred.
Based on the information provided there is no evidence to support that the lending of the funds were undertaken under a commercial arrangement, such as an interest-bearing loan. Nothing has been provided in relation to you receiving any interest payment/s from the Company and/or any terms and conditions of any lending arrangement. It appears that there may not have been an agreement for the payment of any interest on the funds lent to the Company because it was intended that the Company's profits would be paid to the Shareholders. You expected to the Company to pay dividends to the Shareholders when it became profitable, which would involve the Trust receiving dividends and that it would then distribute trust income to you as a presently entitled beneficiary. However, as outlined above it cannot be viewed that you would be presently entitled to any of the Trust income as you are only one of the beneficiaries of a discretionary trust until the conditions outlined above had occurred. You only had a mere expectancy of receiving income from the Trust.
Debts arising from non-business activities that do not produce assessable income are considered personal use assets. You lent the funds to provide financial assistance to the Company. Nothing has been provided to support that the lending of the funds was entered into in the course of gaining or producing your assessable income, or that you were carrying on a business of money lending. Therefore, any capital loss arising as a result of the CGT event C2 occurring in relation to the funds you lent to the Company will be disregarded for CGT purposes under section 108-20 of the ITAA 1997.