When losses are not deductible

Stock in trade is the lifeblood of a business. When stock is lost, or destroyed, the loss normally gives rise to a tax deduction. But this is not always the case.

Peter O’Halloran - Tax advice

In Solaglass Finance Company v The Commissioner for Inland Revenue, heard in the Supreme Court of Appeal in 1989, Solaglass had made loans available to a number of subsidiary companies. The loans became bad and could not be recovered.

The majority of the judges held that the losses were not deductible; one ruled that they were.

The difference of opinion originated in sections 11 and 23 of the Income Tax Act. Section 11(a) allows deductions where losses are incurred in the production of income, provided that such losses are not of a capital nature.

Section 23(g) provides instances where amounts meeting the Section 11(a) criteria are not allowable. The two sections must be read together.

The majority of judges held that, although allowable under Section 11(a), the company’s losses were disqualified as tax deductions by Section 23(g).

No trade
According to the section, only amounts wholly and exclusively laid out for the purposes of trade are deductible.

The judges believed that Solaglass’s losses did fall into this category, not least because they held that the word ‘trade’ had to refer to the trade actually carried out by the company.

The main ‘trade’ of Solaglass was the financial support of its subsidiaries. This support was given by consolidating the debt of all the subsidiaries and ensuring that each had the necessary funds to operate daily.

The subsidiaries then placed excess funds with the company. An important piece of evidence was that the interest rate charged between the company and the subsidiaries varied according to the financial position of each.

Put another way, Solaglass was not an independent lender, but an interested and connected party, and the losses it incurred could not be deemed part of ‘trade’.

A different take
The dissenting judge took a different view of the matter. He agreed that the company existed to support the subsidiaries, but held that the main business of the company (its ‘trade’) was to lend money within the group.

Therefore, the money that was lost had been utilised for the exclusive purpose of trade. The judge felt that the fact the company dealt only with loans made to subsidiaries did not detract from the exclusive trade requirement.

Nonetheless, the majority carried the day and the money lost was held by the court to be non-deductible.