Private ruling: Debt forgiveness
Date of advice: 24 September 2018
Published: November 2018
Ruling period: Year ended 30 June 2019 | Year ended 30 June 2020 | Year ended 30 June 2021 | Year ended 30 June 2022
Date scheme commenced: 1 July 2018

Ruling: Q1: Will the debt forgiveness amount loaned to the trust by you result in a capital gains tax event for you? | A1: Yes

Relevant facts and circumstances: You are a trustee and a beneficiary of the trust. The trust obtained a loan from a banking institution to purchase the business. The loan was secured against trustees’ primary residence. After an extended period of poor trading, the decision was made to pay out the loan from your personal funds to remove the risk of losing the home. To obtain the funds to pay out the loan monies you withdrew from a superannuation fund. You also loaned the trust an additional amounts of money from ongoing injections of funds over a number of years. The additional amounts were funded from a personal line of credit. The trust used the additional funds to maintain liquidity, i.e. pay wages, suppliers and fund the ongoing losses. There was never a loan agreement in place, interest paid, an expectation of interest to be paid or an expectation that the amounts would be repaid or recovered in the future. The trust’s financial accounts show that there is a loan to you. You want to classify the amount recorded as a loan on the balance sheet as a capital investment. The loan is an asset of yours. The entire debt will be forgiven. No consideration will be paid for the forgiveness of the debt owed by the trust. The debt is irrecoverable.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Subsection 104-25(2) | Income Tax Assessment Act 1997 Subsection 104-25(3) | Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Subsection 108-20(1) | Income Tax Assessment Act 1997 Paragraph 108-20(2)(d) | Income Tax Assessment Act 1997 Section 110-30 | Income Tax Assessment Act 1997 Section 116-20 | Income Tax Assessment Act 1997 Subsection 116-30(1) | Income Tax Assessment Act 1997 Subsection 116-30(3A)

Reasons for decision: Summary: You can only make a capital gain or capital loss if a capital gains tax (CGT) event happens to a CGT asset (section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997)). When you made the loan to the trust you acquired a debt, which is a CGT asset (section 108-5 of the ITAA 1997). CGT Determination Number 2 TD 2 Capital Gains: What are the CGT consequences for the lender (Creditor) when a debt is waived? specifically states that a debt is an asset of the lender. The loan you made to the trust is considered to be an asset to which CGT event C2 will apply. The forgiveness of a loan is a release, discharge or satisfaction of the debt which ends ownership of the CGT asset. Consequently, CGT event C2 applies when you forgive the loan you have made to the trust. The time of the event will be when you enter into a contract to forgive the debt; or if there is no contract, the date the relevant documentation in relation to the debt forgiveness is completed, effectively releasing the trust from its obligations under the loan (subsection 104-25(2) of the ITAA 1997). Subsection 104-25(3) of the ITAA 1997 provides that when CGT event C2 happens, you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if the capital proceeds are less than asset's reduced cost base. | Detailed Reasoning - Cost base and reduced cost base: Broadly, the cost base and reduced cost base of an asset is the money paid to acquire it plus any incidental cost relating to its acquisition (section 110-30 of the ITAA 1997). For you, this is the amount of your loan to the trust. | Detailed Reasoning - Capital proceeds: Normally, the capital proceeds will be the amount you received as a result of the CGT event happening, i.e. the consideration you received (section 116-20 of the ITAA 1997). However, when a debt is forgiven, the market value of the debt is substituted as the capital proceeds (subsection 116-30(1) of the ITAA 1997). The market value of the debt at the time of its disposal is worked out as though the debt was not waived and was never intended to be waived (subsection 116-30(3A)). In your case, as you will receive no consideration for the disposal of the debt, you will be taken to have received an amount equal to the market value of the debt at the time of the disposal. Calculating your capital gain or loss If the market value is less than the amount owed to you (the face value) then you will make a capital loss. However, the capital loss will be disregarded if the loss is made from a personal use asset. If the market value equals the face value you will make neither a capital gain nor loss unless you incur incidental costs, in which case you will make a capital loss. The capital loss will be disregarded if it is a loss made from a personal use asset. Personal use asset Subsection 108-20(1) of the ITAA 1997 provides that a capital loss you make from a personal use asset is disregarded in working out your net capital gain or net capital loss. Under paragraph 108-20(2)(d) of the ITAA 1997, a debt is a personal-use asset if it arises other than: (i) in the course of gaining or producing your assessable income, or (ii) from your carrying on a business. Paragraph 47 of Taxation Ruling TR 96/23 Income tax: capital gains: implications of a guarantee to pay a debt states that the test of what is a personal-use asset requires a finding that the debt came to be owed for a primary purpose other than that of gaining or producing income or in carrying on of a business. The debt owed to you will be a personal use asset if you made the loan without the expectation of receiving interest income or deriving greater trust distributions and you are not in the business of lending money (paragraph 108-20(2)(d) of the ITAA 1997). If the debt owed to you is a personal-use asset, you are not entitled to claim a capital loss, if such is made on the forgiveness of the debt.