Edited version of private advice

Authorisation Number: 1051610069067

Date of advice: 24 April 2020

Ruling

Subject: Deductions - capital loss - loan to employer - interest on loan - employer expenses - travel expenses - legal expenses

Question 1

Are you entitled to a deduction for a loan you made to your former employer that was not repaid?

Answer

No.

Question 2

Has a capital gains tax (CGT) event happened, such that you can claim a capital loss for the loan and other debts owed to by your former employer and not repaid?

Answer

No (see reasons for decision).

Question 3

Are you entitled to a deduction for operational expenses that you paid on behalf of your former employer that were not reimbursed?

Answer

No.

Question 4

Are you entitled to a deduction for travel expenses you incurred when you were required to travel for work purposes?

Answer

Yes (reduced by amounts reimbursed).

Question 5

Are you entitled to continue claiming deductions for the interest incurred on the loan taken out to on-lend funds to your former employer?

Answer

Yes.

Question 6

Are you entitled to a deduction for legal expenses you incurred in attempting to recover money owed to you by your former employer?

Answer

Yes. To the extent that they were incurred to recover money owed that is revenue in nature.

This ruling applies for the following periods

Financial year ended 30 June 20XX

Financial year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You were employed as a director of Company A Pty Ltd (your former employer).

Your former employer did not provide you with a company credit card and requested that you use your personal credit card to pay for your own travel expenses and to pay business operating expenses. These were to be then reimbursed on a monthly basis.

You incurred expenses for your former employer's business operations of approximately $XX in the financial year ended 30 June 20XX that were not reimbursed.

You incurred work related travel expenses amounting to approximately $XX in the financial year ended 30 June 20XX that were also not reimbursed.

You also borrowed $XXX and on-lent it to your former employer at a small margin. Your former employer repaid you in monthly instalments.

You submitted monthly expense reconciliation statements to your former employer that included:

·        travel expenses that you had incurred, and

·        business operating expenses that you had incurred.

Your monthly expenses were consistently reimbursed by your former employer during the first year the arrangement was in place.

The monthly expense payment subsequently ceased after your former employer encountered cash flow problems.

You resigned from your employment with your former employer shortly after they encountered cash flow problems.

Your former employer went into liquidation shortly after your resignation, with the liquidator ceasing trading immediately at the time of appointment.

You are listed as an unsecured creditor in the statutory liquidator's report dated, owed an estimated $XX.

The statutory liquidator's report states that a dividend is not expected to be paid to unsecured creditors.

In relation to your travel expenses, clause 7 of your employment contract provided:

·        your base of work was your home in City Y

·        where your duties permitted, you were able to work from your home

·        your employer expected you to travel wherever the business required, facilitating expansion of the business across Country A and Country B

·        at other times, and as your role required you were expected to spend time working from the businesses main office in City Z, and

·        where you were required to travel for work purposes the Company was required to pay your reasonable accommodation and travel costs in accordance with clause 13.

Clause 13 of your employment contract provided that the company (your former employer) was to pay your reasonable accommodation and travel costs where you were required to travel outside of your home city for work purposes (subject to receiving prior approval).

Where you were required to travel for work, this travel occurred on work time.

You have incurred legal expenses to date totalling $XX attempting to recover the money owed to you by your former employer. Approximately $XX of this was incurred in the financial year ended 30 June 20XX with the balance incurred in the financial year ended 30 June 20XX.

You filed a Statement of Claim in the State Supreme Court alleging the company's directors owed you:

1. $XXX for the loan;
2. interest on the loan;
3. $XX for operating and operational expenses;
4. Interest on expenses; and
5. Costs.

You subsequently reached agreement and executed a deed of settlement for a sum of $XXX, to discharge, and forever quit and abandon all claims you had against the company directors.

You received the deed of settlement sum.

The company liquidators recently provided an advice to creditors that also indicated that you were unlikely to receive any dividend payment from the liquidation.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 subsection 20-20(2)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-145

Income Tax Assessment Act 1997 section 110-55

Income Tax Assessment Act 1936 section 51AH

Reasons for Decision

Question 1

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides for general deductions for expenditure to the extent that it is incurred in the gaining or producing of assessable income, or in the carrying on of a business to gain or produce assessable income. No deduction is allowable to the extent that the expenditure is capital, private or domestic in nature, or another provision of the tax law prevents it.

An expense will usually be capital in nature where it is incurred with the intention to create an asset or advantage of a lasting and enduring nature (British Insulated & Helsby Cables Ltd v. Atherton (1926) AC 205; (1926) 10 TC 155). In contrast, revenue expenditure is often repetitious or recurring in nature. Therefore, unless you are in the business of money lending, loans are generally considered to be capital in nature.

In your case, you are not in the business of money lending. The loan to your former employer was an investment that was intended to provide you a lasting and enduring advantage and is considered capital in nature. As such, you are not entitled to a deduction under section 8-1 of the ITAA 1997 for any unrepaid amounts of the loan (and therefore cannot offset the amount lost against your other income).

Question 2

You make a capital gain (or loss) if and only if a capital gains tax (CGT) event happens (section 102-20 of the ITAA 1997). The gain or loss is made at the time of the event.

A CGT asset is any form of property or a legal and equitable right that is not property (section 108-5 of the ITAA 1997). A debt owed to you is an intangible CGT asset.

The relevant CGT events in your case are CGT events C2 and G3.

CGT event C2

CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset expiring or by it being released, discharged, redeemed, cancelled, abandoned, surrendered, or forfeited (subsection 104-25(1) of the ITAA 1997). The time of the event is when you enter into the contract that results in the asset ending; or if there is no contract, when the asset ends.

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.

CGT event C2 also happens if the owner of a debt executes a deed of release in favour of the borrower such that they are legally barred from collecting the debt. However, the mere writing off of a debt is insufficient to constitute a cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment at law, or in equity, for the purposes of subsection 104-25 of the ITAA 1997. Nor is it sufficient that a debt is forgiven or abandoned without any legal impediment imposed on its collection.

In your case, you have entered into a deed of settlement with the two directors of the company. The deed of settlement will legally prevent you from pursuing further loan repayments or other recovery action against the directors as individuals. However, at this time, there is nothing legally stopping you from pursuing repayment of debts from the company, as such, CGT event C2 has not yet happened.

CGT event G3

Loans provided to companies are considered financial instruments (subsection 104-145(3) of the ITAA 1997).

CGT event G3 happens, if in relation to financial instruments issued by or created in relation to a company, a liquidator or administrator of the company declares in writing that they have reasonable grounds to believe that the instruments, have no value or have only negligible value (subsection 104-145(1) of the ITAA 1997).

In your case, the liquidator has not yet made such a declaration in writing to the satisfaction of subsection 104-145(1) of the ITAA 1997. Therefor the CGT event G3 has not yet happened, and you are not yet entitled to claim a capital loss.

You can choose to make a capital loss equal to the reduced cost base of your financial instruments at the time of the declaration if and when this occurs (subsection 104-145(4) of the ITAA 1997).

The amount of the capital loss will be the amount by which the reduced cost base of the debt owed to you exceeds the capital proceeds received. If you do not receive any capital proceeds you will be taken to have received the market value of the debt owed to you (subsection 116-30(1) of the ITAA 1997). The market value of an irrecoverable debt is nil.

The reduced cost base includes the amounts of expenditure to acquire the asset but does not include amounts that you have received as a recoupment of expenditure, or amounts that you have deducted or can deduct (section 110-55 of the ITAA 1997).

In your case, the reduced cost base will include your outgoings for the loan, loan interest, expenses you incurred on behalf of your employer, credit card interest, and legal expenses. This amount will then need to be reduced, so as to exclude debt amounts recouped via the deed of settlement, and further by any amounts that you have deducted or can deduct.

Note: The deductible amounts of the debts owed to you are outlined in the other sections of the reason for decision.

Question 3

An outgoing is considered to be incurred in gaining or producing assessable income if there is a sufficient connection between the outgoing and the activities which produce or are expected to produce assessable income (Ronpibon Tin NL v. FC of T (1949) 78 CLR 47).

Taxation Ruling TR 2019/D4 Income tax: employees: deductions for work expenses under section 8-1 of the Income Tax Assessment Act 1997 (TR 2019/D4), provides the Commissioners view on the deductibility of work expenses incurred by employees.

The requirement that expenses be incurred in the course of producing assessable income means that it is not enough to show only that there is some general link or causal connection between expenditure and the production of income. The expenditure must have a sufficiently close connection to performance of the employment duties and activities through which the employee earns income (paragraph 22 of TR 2019/D4).

The essential character of an outgoing is generally determined objectively. As a general rule, an outgoing will not be deductible unless it is incurred in gaining or producing the assessable income of the taxpayer who incurs it. In Bartlett & Anor v FC of T (2003) FCA 1125, tax preparation for a company's accounts incurred by a company director was not an allowable deduction under section 8-1 of the ITAA 1997, as the expenditure related to the company's income producing activities, and not those of the taxpayer (company director).

In ATO Interpretive Decision 2002/341 Income Tax: Deductions - employee pays employer companies operating expenses; the taxpayer was a shareholder, director and employee of a small private company. A deduction was not allowed for company expenses paid out of the taxpayer's salary. The expenses were considered to be incurred in order to produce the assessable income of the company rather the taxpayer's own salary and wages.

The relevance of express or implied conditions of employment is also discussed in TR 2019/D4 at paragraph 26 and 27. Expenses do not become deductible merely because an employer requests that the employee incur the expense. The question of deductibility must always be answered with reference to the statutory tests, involving an objective determination of the connection between the expense and the employee's income-earning activities.

In your case, the operating expenses of the company cannot be considered expenses that you were required to incur in order to fulfil your role as an employee. The deductibility of the expenses is not influenced by your employees request that you incur them, nor the fact that similar expenses had previously been reimbursed.

The expenses were incurred to produce the company's assessable income. As they are not referable to your income producing activities you are not entitled to a deduction for them under section 8-1 if the ITAA 1997.

Question 4

Employees who incur travel expenditure in the course of carrying out their income producing activity may be entitled to a deduction under section 8-1 of the ITAA 1997.

Where an employee receives a reimbursement of a deductible expense, the deductible amount available is reduced by any reimbursement they receive (section 51AH of the Income Tax Assessment Act 1936). Reimbursements by employers for travel expenditure incurred by employee's are normally regarded as a fringe benefit under the Fringe Benefit Tax Assessment Act 1986, and therefore not assessable income to the employee.

Draft Taxation Ruling TR 2019/D7 Income Tax: when are deductions allowed for employees' transport expenses? (TR 2019/D7) sets out when an employee can deduct transport expenses under section 8-1 of the ITAA 1997. This includes the cost of travel by airline, train, taxi, car, bus, boat or other vehicle.

Paragraph 11 of TR 2019/D7 provides factors that that are indicative of when transport (travel) expenses have the character of being incurred in producing assessable income. Your circumstances align closely with these factors as per the following:

·        the travel occurred on work time

·        the travel occurred whilst you were under the direction of your employer

·        the travel fitted within the duties of your employment

·        the travel was relevant to the practical demands of carrying out your work duties, and

·        it was a condition of your employment contract that travel was undertaken as required to fulfil your duties.

In your case, your employment contract stipulated that your base of work was your home in City Y and that where your duties permitted, you could work from home. Your employer had an expectation that you would travel wherever the business required. It is accepted that travel was a fundamental part of your employment.

Unlike the ordinary case of home to work travel, your travel from your base of operations at home in City Z and other distant locations was not merely attributable to your choice of where to live, but instead was a necessary consequence of your employment duties needing to be performed in more than one location. In other words, the distance between your alternate work places caused the need for the travel to be part of that for which you were employed.

As such, you are entitled to a deduction for your travel expenses incurred for work travel under section 8-1 of the ITAA 1997 in the financial year ended 30 June 20XX, to be reduced by any reimbursement you received for the expenses.

It is the Commissioner view that part of the deed of settlement sum, apportioned on a reasonable basis, provides a reimbursement for some of the travel expenditure you incurred in the financial year ended 30 June 20XX. Your available deduction for this year will need to be reduced by this same apportioned amount.

Question 5

Interest repayments are deductible under section 8-1 of the ITAA 1997 if the interest repayments are incurred by the taxpayer in gaining or producing assessable income and the loss or outgoing is not capital or of a capital, private or domestic nature (Taxation Ruling TR 95/25 Income tax: deductions for interest under section 8-1 of the Income Tax Assessment Act 1997 following FC of T v Roberts; FC of T v. Smith).

Outgoings of interest are a recurrent expense. The fact that borrowed funds may be used to purchase a capital asset does not mean the interest outgoings are therefore on the capital account (Steele v. FC of T 99 ATC 4242; (1999) 41 ATR 139).

The Commissioner's view on the deductibility of interest incurred after income earning activities have ceased is provided in taxation ruling TR 2004/4 Income tax: deductions for interest incurred prior to the commencement of, or following the cessation of, relevant income earning activities (TR 2004/4).

Paragraph 10 of TR 2004/4, states that where interest has been incurred over a period after the relevant borrowings (or assets representing those borrowings) have been lost to the taxpayer and relevant income earning activities (whether business or non-business) have ceased..., the outgoing will still have been incurred in gaining or producing 'the assessable income' if the occasion of the outgoing is to be found in whatever was productive of assessable income of an earlier period.

Paragraph 12 of TR 2004/4, provides that an outgoing of interest in such circumstances will not fail to be deductible merely because the original loan is refinanced, whether once or more than once.

In your case, interest earned on the loan to your former employer is assessable as ordinary income under section 6-5 of the ITAA 1997 and the interest expenses on the loan that was on-lent were deductible under section 8-1 of the ITAA 1997. These interest expenses will continue to be deductible where the loan remains on foot for the (previous) income producing purpose as long as a legal or economic impediment to repaying the loan exists (Para 14 of TR 2004/4).

Part of the deed of settlement sum will need to be apportioned on a reasonable basis as an interest repayment on the loan. This amount will need to be included as assessable income under section 6-5 of the ITAA 1997 for the financial year ended 30 June 20XX.

Question 6

In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v FC of T (1946) 72 CLR 634; 8 ATD 190 per Dixon J). The nature or character of the legal expense follows the advantage which is sought to be gained by incurring the expense.

Where legal expenses arise as a consequence of the day to day activities of a taxpayer, the object of the expenditure is devoted towards a revenue end and the legal expenses are deductible (Herald & Weekly Times v FC of T 48 CLR 113; 2 ATD 169). Where, however, the expenditure is devoted towards a structural rather than operational purpose, the expenditure is of a capital nature and the expenses are not deductible (Sun Newspapers Ltd v FC of T (1938) 61 CLR 337; 5 ATD 87).

Legal expenses incurred in relation to employment contracts is considered in Taxation Determination TD 93/29 Income tax: if an employee incurs legal expenses recovering wages paid by a dishonoured cheque, are these legal expenses an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997? (TD 93/29).

Paragraph 5 of TD 93/29 provides that if the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action where the essential character of the advantage sought relates to an enduring advantage that is of a capital nature, the legal costs would not be deductible.

In your case, the legal expenses incurred to recover the loan capital and operational and travel expenses are capital in nature and not deductible under section 8-1 of the ITAA 1997. The amounts you paid on behalf of your former employer for operational and travel expenses as well as any interest incurred on these amounts are akin to a loan. Recovery of a portion of these amounts does not give rise to any assessable income; rather, these amounts are considered reimbursements of the expended amounts or repayment of the loaned amounts.

Note that the expenses incurred in relation to recovering the loan capital will form part of the reduced cost base of the loan under subsection 110-55(2) of the ITAA 1997.

Legal expenses incurred in pursuit of unpaid interest on the loan are considered to be revenue in nature and are therefore deductible under section 8-1 of the ITAA 1997 in the financial year that the expenses were incurred.

As your legal expenses were incurred in relation to both amounts that are revenue in nature as well as amounts which are capital in nature, your expenses will need to be apportioned. Where your solicitor's account is itemised, one reasonable basis for apportionment would be the time spent involving the revenue claim, relative to the time spent on the capital claim. If the solicitor's account is not itemised, a possible basis for apportionment would be either a reasonable costing of the work undertaken by the solicitor in relation to the revenue claim, or, where this is not possible, an apportionment on the basis of the monetary value of the revenue claim relative to the capital claim (paragraph 5 of TD 93/29).

The Commissioner considers a portion of the deed of settlement sum to be a part payment for your revenue legal expense costs. This amount, to be apportioned on a reasonable basis is included in your assessable income as an assessable recoupment under subsection 20-20(2) of the ITAA 1997 in the financial year ended 30 June 2020.

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