Private ruling: Division 7A - Debt forgiveness
Published: August 2012
Ruling period: 1 July 2007 to 30 June 2012

Ruling: Question and Answer | Will the Commissioner exercise his discretion under subsection 109G(4) of the Income Tax Assessment Act 1936 and not treat the forgiven debt as a deemed dividend? | No.

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. You had an accident at work. The injury you sustained was misdiagnosed, resulting in major nerve damage and you are unable to do your normal duties. You created an invention and wanted to commercialise it; you were advised to create a company; as the owner of the invention you transferred the invention to the company. You are the sole director of the company. You brought in other people, as partners, to you market your invention. You went overseas to market your invention. It became clear to you as you continued to market your invention that your partners lacked integrity. You also became aware your partners did not want you as a partner. You sold the rights to your invention and received the payments in instalments. Your accountant gave you incorrect advice and you used the company's money as your own. You were not made aware of the Division 7A provisions and the need to put in place a loan agreement. The money from the company was used for the following; · To purchase a shop - now transferred to the company to pay off debt. · To purchased vehicles - you still own a vehicle · To purchase a share of a house - you let your parents live in the property rent free. · Pay off you home. · Cover general living expenses. You were audited and the issue of taking money from the company was identified. At this time you had changed accountants and loan agreements was put in place. You have honoured the loan agreements. You draw dividends from the company and the company has a large franking balance. You want the loans to be cleared so you can rebuild your business. The burden of the tax has seriously inhibited any chance to reinvest in your company to make it grow. At the start of each financial year you are already in the red for a huge amount of money. You have to pay 46 cents in the dollar for every dollar you earn and have been doing this for the past four years under extreme hardship. You want to have the loans forgiven and wiped so that you have a zero loan balance and because at the end of the day you are the sole director and own the company outright.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 109F(1) | Income Tax Assessment Act 1936 subsection 109G(4)

Reasons for decision: Summary: Subsection 109F(1) of the Income Tax Assessment Act 1936 (ITAA 1936) provides that a private company is taken to pay a dividend to an entity at the end of the company's income year if during that year the company forgives all or part of a debt owned by an entity who is a shareholder or an associate of a shareholder. The debt forgiven will still be deemed a dividend if it is forgiven after the entity ceases to be a shareholder or an associate of a shareholder if a reasonable person would conclude that the debt was forgiven because the entity was a shareholder or their associate at some time. Subsection 109G(4) of the Income Tax Assessment Act 1936 Commissioner may treat forgiveness as not giving rise to dividend. A private company is not taken under this Division to pay a dividend because of the forgiveness of a debt owed by an entity if the Commissioner is satisfied that: (a) the debt was forgiven because payment of the debt would have caused the entity undue hardship; and (b) when the entity incurred the debt, the entity had the capacity to pay the debt; and (c) the entity lost the ability to pay the debt in the foreseeable future as a result of circumstances beyond the entity's control. The Commissioner has an overriding discretion to allow a forgiveness of a debt which would otherwise be a deemed dividend under Division 7A, by ignoring the effect of section109F of the ITAA 1936, provided that payment of the debt would cause the entity "undue hardship". It is a condition for the Commissioner's discretion to be exercised that the Commissioner is satisfied that when the debt arose the recipient had the capacity to pay the debt and that the recipient "lost" the ability to pay the debt as a result of circumstances beyond the entity's control. It is unclear what will constitute circumstances beyond the entity's control. However, it may be expected that such circumstances may include loss of market share, loss of competitive advantage, high staff costs and turnover, unfavourable exchange rate variations, unfavourable stock market fluctuations. The Explanatory Memorandum to Act No 47 of 1998 states: In exercising his discretion the Commissioner will take into account the ability of the shareholder or associate to repay the loan at the time it was granted, at the time it was forgiven and at any foreseeable future time. The Commissioner will only exercise his discretion if he is satisfied that the shareholder had the ability to pay at the time of receipt of the loan and lost the ability to pay, permanently, through no fault of his or her own'' | Detailed Reasoning - Application to your circumstances: To be eligible for debt forgiveness you must satisfy all the requirements set out under 109G(4) of the ITAA 1936. You have not satisfied requirement (c) of section 109G(4) of the ITAA 1936 You have assets at your disposal; a share in a property and equity in your own home, because you used some of the money you borrowed from the company to pay off your mortgage. Review of the company's Summary of Profit & Loss Statements and Summary of Balance Sheets shows you have been drawing dividends from the company these and the large company franking balance could be applied to reduce your tax liability. Therefore you have not lost the ability to pay the debt in the foreseeable future as a result of circumstances beyond your control.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.