ATO ID 2007/168: Commercial Debt Forgiveness: whether the interim use of bridging finance precludes a debt from being non-recourse
Date of decision: 29 June 2007
Year of income: Year ended 30 June 2007
Business line: Public Groups and International

Issue
Does a commercial debt constitute a non-recourse debt pursuant to section 245-60 of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) to the extent it is used to repay bridging finance that was solely incurred in the acquisition of the relevant property?

Decision
Yes. A commercial debt constitutes a non-recourse debt pursuant to section 245-60 of Schedule 2C to the ITAA 1936 to the extent it is used to repay bridging finance that was solely incurred in the acquisition of the relevant property.

Facts
Debtor acquired 'property' for the purposes of section 245-60 of Schedule 2C to the ITAA 1936. That property was only acquired based upon the understanding that it would be funded using the relevant debt, a debenture. Due to delays in organising the debenture, debtor had to initially pay for the property using short term bridging finance from a related party. The bridging finance and the debenture both constituted commercial debts as defined in section 245-25 of Schedule 2C to the ITAA 1936. The debenture was forgiven for the purposes of section 245-35 of Schedule 2C to the ITAA 1936 in the relevant year of income. The rights of the debenture holder were limited in regards to the property in the requisite manner specified in subsection 245-60(1) of Schedule 2C to the ITAA 1936.

Reasons for decision
Summary: Section 245-10 of Schedule 2C to the ITAA 1936 provides that Schedule 2C to the ITAA 1936 applies where a forgiveness of a commercial debt occurs after 27 June 1996. Subsection 245-60(2) of Schedule 2C to the ITAA 1936 provides that the notional value of a non-recourse debt as defined, is the lesser of the amount of the debt and its market value at the time of forgiveness. In this instance the rights of the creditor are limited in the requisite manner prescribed in subsection 245-60(1) of Schedule 2C to the ITAA 1936. However, section 245-60 of Schedule 2C to the ITAA 1936 also requires such debts to be 'incurred directly in respect of the financing of the cost of acquisition, construction or development of property...'. The term 'directly' is not defined in the section and its meaning in that particular context has not been considered by the courts. However, Bowen CJ and French J of the Federal Court in their majority decision in Commissioner of Taxation v. Faywin Investments (1990) 22 FCR 461; 90 ATC 4361; (1990) 21 ATR 256 examined the meaning of 'directly' in the context of a provision about conferring a tax deduction for capital outlays expended in producing a film. Having regard to the concessional nature of that provision they stated, that '...the requirement that moneys expended be expended "directly" in production is no more than a requirement that there be a sufficiently close connection between the outlay and the production process'. Similarly, in Goods and Services Tax Ruling GSTR 2003/7 at paragraph 22 the Commissioner ruled in the context of subsection 38-190(1) of the New Tax System (Goods and Services Tax) Act 1999 that 'directly connected with' contemplates a very close link or association. Based upon the particular facts it is evident that but for the debenture the relevant property would not have been acquired using the bridging finance, or indeed at all. Therefore the debenture constitutes a non-recourse debt for the purposes of section 245-60 of Schedule 2C to the ITAA 1936.

Legislative references: Income Tax Assessment Act 1936 Schedule 2C, section 245-10 Schedule 2C, section 245-25 Schedule 2C, section 245-35 Schedule 2C, section 245-60 Schedule 2C, subsection 245-60(1) Schedule 2C, subsection 245-60(2)
Case references: Commissioner of Taxation v. Faywin Investments Pty Ltd (1990) 22 FCR 461 90 ATC 4361 (1990) 21 ATR 256
Related public rulings and determinations: Goods and Services Tax Ruling GSTR 2003/7
Related ATO interpretative decisions: ATO ID 2007/167
Subject references: Borrowings & loans Commercial debt Commercial debt forgiveness Dealings & transactions Non recourse loans