Case X47

Members:
KL Beddoe SM

Tribunal:
Administrative Appeals Tribunal

Decision date: 1 May 1990.

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K.L. Beddoe (Senior Member)

The question at issue in these proceedings is whether losses incurred by the applicant in trading in United States Treasury Bonds futures transactions are allowable deductions within the terms of sec. 51(1) of the Income Tax Assessment Act 1936 (``the Act'').

2. The relevant statutory provision is sec. 51(1) which provides, so far as is relevant, that losses incurred in the course of gaining or producing assessable income shall be an allowable deduction except for those losses which are of capital or of a capital nature. Part IIIA of the Act was also raised in the course of proceedings. I will refer to those provisions later in these reasons.

3. The applicant is a medical practitioner who also seeks to derive income from sources outside his medical practice. The relevant income tax return for the year of income ended 30 June 1986 disclosed investment income in the nature of interest, rents and profits on sale of shares. The return also disclosed sale of some shares held as a long-term investment on which the profit was not assessed and that the applicant had invested $8,000 with Lincoln Hunt Australia Pty. Ltd. for the purpose of trading in relation to United States Treasury Bonds. This investment was made on 14 November 1985 and by 17 December 1985 all of the funds were said to have been lost, due it was said to changes in United States policy. The applicant claimed a deduction for a loss incurred of $8,000 and enclosed in the return of income a substantial amount of information in relation to the nature of the transactions and the details of the applicant's account with Lincoln Hunt Australia Pty. Ltd. The respondent

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refused to allow the deduction of $8,000 incurred.

4. By a notice of objection which is undated but presumably was lodged with the respondent in good time, the applicant claimed that the $8,000 lost was an allowable deduction under sec. 52 of the Act and in the alternative under sec. 51 of the Act. Besides the formal grounds the applicant also asserted a previous history of investing in futures over a number of years.

5. At the hearing of this matter the applicant's representative did not rely upon sec. 52 of the Act because the transactions had been entered into after 20 September 1985 (sec. 52(1A)). He therefore sought to rely only on sec. 51(1).

6. Some confusion arose in the course of the proceedings as to whether the issue was deductibility of the payment of $8,000 to Lincoln Hunt Australia Pty. Ltd. or the losses incurred in respect of the various transactions which resulted in losses of approximately $7,800 and also the loss of a fee of $800 payable to Lincoln Hunt Australia Pty. Ltd. by the applicant for the setting up of the arrangement. Exhibit D includes five contract advices showing details of contracts entered into for the applicant in relation to the Treasury Bonds. Three of these contract advices reveal transaction losses as follows:

                               $
      18 November 1985      2,919.61
      4 December 1985       2,372.88
      17 December 1985      2,507.80
                           ---------
                           $7,800.29
                           ---------
          

Adding to that figure of $7,800 the account establishment fee of $800, it will be apparent that the applicant had lost all up an amount of $8,600. However, the terms of his agreement with Lincoln Hunt Australia Pty. Ltd. were such as to not make him liable for any losses exceeding his initial deposit with Lincoln Hunt Australia Pty. Ltd. of $8,000.

7. The arrangements entered into for the applicant were based upon futures contracts for purchase and sale of United States Treasury Bonds for equal values so that the applicant was not at any time exposed to any risk of having to accept or supply Treasury Bonds. The arrangements by their very nature, although based upon buying and selling of bonds in the future, depended upon movement in market yield rates in such a way that the applicant would obtain a margin in those market rates and thereby achieve a profit. I am satisfied from the documents which are in evidence before the Tribunal that the applicant was only interested in and only entered into transactions for the purpose of achieving a gain on the expected movements in the margin between the interest rates of the respective bonds and that the transactions were not entered into in any sense for the purpose of purchase or sale of Treasury Bonds. There is no evidence before the Tribunal as to whether or not the futures contracts for bonds were in existence but in view of the nature of the arrangements, the existence or otherwise of the futures contracts themselves is irrelevant. The arrangements were only concerned with the yields on United States Treasury Bonds (ex. A).

8. The applicant's case was quite straightforward. His representative argued that the losses incurred in respect of the investment were losses incurred in the course of gaining or producing assessable income and were not outgoings of capital or of a capital nature. The respondent argued that the outgoings were losses of capital or of a capital nature, that the losses were not incurred in the course of gaining assessable income and in any event if they were allowable they could only be allowable pursuant to sec. 160ZO(2) of the Act.

9. In view of the submissions of the respondent it is necessary that I first consider whether the losses on the contracts represent a net capital loss for the purpose of sec. 160ZO. In my view the answer to that is straightforward. Part IIIA of the Act applies to assets as defined. ``Assets'' are defined under sec. 160A so as to embrace any form of property including options, choses in action, any other right, and any other form of corporeal property. It was not made clear to the Tribunal as to how the respondent suggested that the arrangements in question were assets as defined. It is clear enough from the definition that ``asset'' is defined to include all forms of property. In particular ``asset'' includes choses in action which therefore includes rights enforceable by bringing an action to maintain or secure those rights. The question is not whether United States Treasury Bonds are

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choses in action because the arrangements entered into by the applicant did not have the purpose of, nor did they so result in, the applicant obtaining ownership of bonds. The only rights obtained by the applicant from the arrangements was the right to call for payment of an amount representing the profit arising from a favourable movement in the margin or differential of yields between the different series of bonds. In the event of adverse movements in the margin or differential the applicant lost to the extent of his investment.

10. An essential ingredient in a capital loss is that there must be a disposal of an asset (sec. 160Z). If, therefore, the loss suffered did not arise from the disposal of an asset there is simply no capital loss and therefore no net capital loss within the terms of sec. 160ZC, and no net capital loss for the purposes of sec. 160ZO.

11. I cannot, therefore, see any basis for the application of Pt IIIA in respect of the losses on the arrangements. As to whether the amounts are losses incurred in the gaining of assessable income, I am satisfied that they were so incurred to the extent of $7,200. The reasons for this decision are as follows. Only one purpose for entering into these arrangements is apparent on the facts and that was to derive a profit from trading on the margins or differentials of the yields on the different series Treasury Bonds. This is not to say that the applicant was trading in options because clearly he was not. He was trading on an expectation that bond yields would move over a period of time in such a way so as to create a profitable margin in respect of the futures contracts to which his arrangements related. No other objective purpose could be attributed to the transactions. The essential character of the loss is that of losses incurred in the course of speculating for the purpose of making a profit and thereby deriving assessable income. In these circumstances there is only one possible conclusion and that is that the losses are losses within the first positive limb of sec. 51(1). The losses arose out of the arrangements and were satisfied out of the investment of $8,000 made by the applicant with Lincoln Hunt Australia Pty. Ltd. Certainly the losses were satisfied as between Lincoln Hunt Australia Pty. Ltd. and the applicant by being deducted from the investment of the $8,000, however, this is not to say that the amounts claimed represent a loss of capital. For these reasons I am satisfied that the losses were not losses of capital or of a capital nature and are therefore allowable deductions within the terms of sec. 51 of the Act to the extent of $7,200. The allowable loss has been fixed at $7,200 because the applicant was not liable within the terms of the contract with Lincoln Hunt Australia Pty. Ltd. for an amount in excess of his original investment which was $8,000 less $800 establishment fee. He could not therefore incur losses in excess of $7,200. It was not suggested to me that the $800 fee was deductible.

12. The objection decision under review will be set aside and the objection allowed in part by allowing a deduction of $7,200.