ATO ID 2011/22: Commercial debt forgiveness: whether the notional value of a debt can be less than its face value if the debtor is solvent
Date of decision: 24 February 2011
Year of income: Year ended 30 June 2009
Business line: Public Groups and International

Issue
Can the notional value of a fixed term debt for the purposes of the debt forgiveness rules in subsection 245-55(1) of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) be less than its face value if the debtor is solvent at all times?

Decision
Yes. In determining the notional value of the debt under subsection 245-55(1) of Schedule 2C to the ITAA 1936, the first applicable amount as calculated under subsection 245-55(2) can be less than the face value of the debt where, because of the debt's fixed term and fixed interest rate, the value of the debt has become less than the prevailing market rate of interest.

Facts
In 2006 Debtor raised finance by issuing $10,000 unsecured notes carrying a fixed rate of return to unrelated creditors, including Creditor. The maturity date of the notes was 2016 and Creditor could only terminate the note earlier with the approval of Debtor. At all times Debtor had the capacity to pay all its debts as and when they became due. In 2009, because of the Global Financial Crisis, the rate of the return on the notes became far less than the prevailing rate of interest that would have been payable on notes with otherwise equivalent terms. Having surplus funds available Debtor made a public offer to all the holders of the notes to redeem them at a discount to their face value. Having severe liquidity problems Creditor (and others) accepted the offer as it was unable to sell the note for more than the amount offered by Debtor. Sections 245-60 and 245-61 of Schedule 2C to the ITAA 1936 do not apply to these debts. Debtor was not entitled to any deduction for the purposes of paragraph 245-55(3)(b) of Schedule 2C to the ITAA 1936 in respect of market variables.

Reasons for decision
Summary: The notional value of a debt under subsection 245-55(1) of Schedule 2C to the ITAA 1936 is the lesser of the first applicable amount calculated under subsection 245-55(2) and the second applicable amount calculated under subsection 245-55(3). The first applicable amount is to be determined on the assumption (as per the facts of this case) that Debtor had the capacity to pay all its debts when the debts were incurred and when they were forgiven. Although Debtor had the capacity to fully repay its debts, the value of Creditor's note had become less than its face value because the fixed interest rate it carried was less than the relevant prevailing interest rate and Creditor had no power to demand either its early repayment or an increase in its interest rate. In view of the fact that Creditor was unable to sell the note for a greater amount to a third party it is considered that the value of the note as an asset of Creditor at the time of forgiveness upon redemption is the amount paid by Debtor. The second applicable amount is to be determined on the assumption that there has been no change in the market variables prior to the forgiveness of the debt. If the market variable of interest rates had not changed due to the Global Financial Crisis, the value of the notes would have remained the same, being their face value. The second applicable amount is therefore the face value of the debt. As the first applicable amount being the amount paid by Debtor to redeem the note is less than the second applicable amount (face value of the debt) the notional value of the debt is the discounted amount paid by the Debtor upon redemption.

Legislative references: Income Tax Assessment Act 1936 Schedule 2C subsection 245-55(1) Schedule 2C subsection 245-55(2) Schedule 2C subsection 245-55(3) Schedule 2C paragraph 245-55(3)(b) Schedule 2C section 245-60 Schedule 2C section 245-61
Subject references: Debt forgiveness