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07 Oct 10 Capital losses for intercompany debts disallowed - Re QFL Photographics Pty Ltd

Capital losses said to have been incurred when the assets and liabilities of a company were transferred to a related company, and intercompany debts owed by the transferor company to the transferee company were released, were disallowed by the Commissioner, who also imposed penalties. The Administrative Appeals Tribunal has now affirmed the Commissioner’s decision.

The case arose out of disputed entitlements to capital losses that QFL Photographic Pty Ltd claimed after releasing its related company ABC Photos Pty Ltd from two debts, those debts being an intercompany balance debt and a transfer debt said to be owed to QFL.

QFL and ABC (until its deregistration) had the same directors and were both wholly owned subsidiaries of QCPL. QFL’s business was selling photographic prints that ABC had developed from analogue photographic films. QFL paid ABC's expenses and recorded the amounts it paid in an intercompany account. ABC charged QFL fees for the development services that it provided and those charges were recorded in the same intercompany account. ABC had materials supply agreements and equipment leasing agreements with arm’s length suppliers.

QFL contended that in 1998 ABC transferred its assets and liabilities to QFL, merging the various elements of the photographic business into the one entity (QFL). Following this transfer QFL contended that ABC owed it two amounts totalling $2,641,622. The first amount said to be owed was the pre-existing intercompany balance debt of $614,140 (said to be a loan balance owed by ABC to QFL for expenses and outgoings paid by QFL on ABC's behalf). The second amount said to be owed was the transfer debt of $2,037,482 being the amount by which the ABC liabilities assumed by QFL exceeded the book value of assets transferred (again, said to be a loan made by QFL to ABC as a consequence of the two businesses being merged). Alternatively, QFL contended that it had rights of indemnity and subrogation against ABC in respect of the amount of $2,037,482 for which it became liable on the transfer of ABC's assets and liabilities to QFL.

In March 2000 QFL released ABC from debts it owed QFL and in November 2005 ABC was voluntarily deregistered without the loan balances said to be owed to QFL being paid.

The issues that needed to be resolved were:
(a) whether the transfer debt of $2,037,482, or rights of indemnity or subrogation to recover that amount, existed
(b) whether the intercompany balance debt of $614,140 existed
(c) if the debts or rights of indemnity or subrogation existed, whether they were CGT assets
(d) if the debts or rights of indemnity or subrogation existed and were CGT assets, what was the first element of their cost base?
(e) whether the market value substitution rule applied to set the first element of the cost base of these assets and/or whether the otherwise deductible rule applied to restrict the first element of cost base claimed
(f) whether there was a CGT event, and
(g) whether the administrative penalty imposed at 25% was correctly imposed.

The Tribunal upheld the Commissioner's decision, and made the following findings.

  1. Upon the transfer of ABC's assets and liabilities to QFL, on the terms on which that happened, the transfer debt of $2,037,482 owed by ABC to QFL came into existence. On the evidence, there was no right of indemnity or subrogation.
  2. ABC owed QFL the intercompany balance amount of $614,140 as at 30 June 1998.
  3. The intercompany balance and transfer debts met the CGT asset definition.
  4. The market value substitution rule applied to set the first element of the cost base of the relevant assets.
  5. Had there been first element of cost base after the market value substitution rule, that element of cost base would not have been reduced by the otherwise deductible rule.
  6. The release extinguished the debt owing by ABC to QFL in the sum of $2,651,673. That constituted CGT event C2.
  7. The Commissioner's penalty was correctly applied.

Re QFL Photographics Pty Ltd and FCT [2010] AATA 758 (Administrative Appeals Tribunal, Frank O’Loughlin, Senior Member, 5 October 2010).


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