Private ruling: Debt forgiveness and deceased estate
Date of advice: 9 September 2022
Published: November 2022
Ruling period: Year ended 30 June 2022 | Year ending 30 June 2023
Date scheme commenced: 1 July 2021

Ruling: Q1: Will the forgiveness of the loans give rise to a deemed dividend under section 109F of the Income Tax Assessment Act ( ITAA 1936)? | A1: No.

Relevant facts and circumstances: The deceased died in late 2021, leaving a will dated a year prior to their death. The executors and trustees named in the will are Person 1 and Person 2. Probate of the deceased's will has not been granted. Company 1 made loans to the deceased for the years ended 30 June 2016 to 30 June 2020 inclusive (the section 109N loans) under written agreements that complied with the requirements of section 109N of the ITAA 1936. Minimum annual repayments of principal and interest were made in accordance with section 109E of the ITAA 1936. Company 1 had also made loans to the deceased for the years ended 30 June 2021 and 30 June 2022 (new loans) that had not been required to be placed under section 109N terms as at the date of the deceased's death. It is proposed that a Deed of Forgiveness will be executed by Company 1 whereby they will agree to forgive the section 109N loans and the new loans (collectively the loans). Company 2 is a shareholder of Company 1 and is also trustee of Trust 1. The deceased was an associate of Trust 1, by reason of being a beneficiary.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 109D. | Income Tax Assessment Act 1936 section 109F. | Income Tax Assessment Act 1997 section 245-35. | Taxation Administration Act 1953 subsection 260-140(2) of Schedule 1.

Reasons for decision: Summary: Subsection 109F(1) of the ITAA 1936 provides a private company is taken to pay a dividend to an entity at the end of the private company's year of income if all or part of a debt the entity owed the private company is forgiven in that year and either: a) the amount is forgiven when the entity is a shareholder in the private company, or an associate of such a shareholder; or b) a reasonable person would conclude (having regard to all the circumstances) that the amount is forgiven because the entity has been such a shareholder or associate at some time. Subsection 109F(2) of the ITAA 1936 provides the amount of the dividend is equal to the amount of debt forgiven subject to the private company's distributable surplus as determined under section 109Y of the ITAA 1936. Subsection 109F(7) of the ITAA 1936 provides that where a private company forgives an amount of debt resulting from a constituent loan that is taken into account in working out the amount of an amalgamated loan pursuant to subsection 109E(3) of the ITAA 1936, the private company is taken to forgive the same amount of debt resulting from the amalgamated loan. The death of a shareholder borrower does not, of itself, trigger an automatic forgiveness of a loan. Subsection 109F(3) of the ITAA 1936 provides that an amount of a debt is forgiven for the purposes of Division 7A of the ITAA 1936 if and when the amount would be forgiven under the commercial debt forgiveness rules in Division 245 of the Income Tax Assessment Act (ITAA 1997). Relevantly, section 245-35 of the ITAA 1997 provides a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived or is otherwise extinguished other than by repaying the debt in full. An issue arises as to whom the potential dividend will arise under section 109F of the ITAA 1936 where a loan is made to a shareholder who dies before the loan is repaid. For a deemed dividend to arise under subsection 109F(1) of the ITAA 1936 in respect of a forgiven debt, the entity at the time the debt is forgiven must be: • a shareholder in the private company, or an associate of such a shareholder and • it owes the debt. ATO Interpretive Decision ATO ID 2012/741 Income Tax: Amalgamated Loans and executors of deceased estates provides that the entity to whom the private company is taken to have paid the dividend must be the same entity to whom the private company made the amalgamated loan. For subsection 109E(1) of the ITAA 1936 to apply, the private company must have made the loan to the executor of the deceased estate. Accordingly, as the private company made the loan to the shareholder, the executor of the shareholder's deceased estate is not treated as having received a deemed dividend in respect of the amalgamated loan. | Detailed Reasoning - Pre-existing Division 7A loans: The pre-existing Division 7A of the ITAA 1936 loans made by the company to the deceased shareholder met the conditions in subsection 109E(3) of the ITAA 1936. As such, the loans are taken to be amalgamated loans for the purposes of Division 7A of the ITAA 1936. The company has sufficient distributable surplus at the time the forgiveness of the loans is proposed to occur for the purposes of subsection 109F(2) of the ITAA 1936. ATO ID 2012/741 states - "Accordingly, as the private company made the loan to the shareholder, the executor of the shareholder's deceased estate is not treated as having received a deemed dividend in respect of the amalgamated loan." The executor will not be taken to owe the debts (the loans) being forgiven as they are not the entity with whom the loan was made. As such one of the conditions in subsection 109F(1) of the ITAA 1936 will not be satisfied because the executors, in that capacity, are not the shareholder or associate of the shareholder. Therefore, a deemed dividend will not arise under section 109F of the ITAA 1936 to the estate of the deceased if the company forgives the pre-existing Division 7A of the ITAA 1936 loans.