Private ruling: Debt forgiveness, CGT Event C2 and Discontinuance supply
Date of advice: 25 May 2016
Published: July 2016
Ruling period: Year ended 30 June 20xx
Date scheme commenced: 1 July 20xx

Ruling: Q1: Can the value of the right to sue and seek compensation that is given up be used to offset a debt pursuant to section 245-65 of the Income Tax Assessment Act 1997 (ITAA 1997) in working out the gross forgiven amount of the debt? | A1: Yes | Q2: Does CGT event C2 under Part 3-1 of the ITAA 1997 apply to your disposal of your right to seek compensation? | A2: Yes | Q3: Is the discontinuance supply arising from releasing your claim against the bank for negligence and misleading conduct subject to GST? | A3: No

Relevant facts and circumstances: You are in the business of property development and investments in commercial real estate projects. You are registered for GST or required to be registered for GST. The bank has provided a series of loans to you since 20xx. Around 20xx you entered into an arrangement with the bank which are advanced lending products. You suffered losses as a result of the bank's negligence and misleading and deceptive conduct in relation to these products. In 20xx you filed a statement of claim in the relevant Court against the bank for causing loss by negligence and by misleading and deceptive conduct. A summary of your losses claimed are as follows: • Interest and capital break costs relating to your arrangement of approximately $X,000,000. • Losses from remarketing and selling costs of Development Z of approximately $X,000,000. • Losses of approximately $XX,000,000 for properties sold undervalue in relation to Developments Z-Z • Losses of approximately $XXX,000,000 for loss opportunities for projects which did not proceed because of cash flow problems. The bank attempted to establish a claim against you for debts owed. This claim by the bank was released by you entering into a settlement with the bank on in 20xx to settle all claims both parties had. As part of the settlement and in order for the bank to discharge their claims against you, you agreed to: • Pay an amount to the bank; • Return the original of the Y Bank Guarantee; • To deliver documents to the bank to effect the bank obtaining the full and unencumbered benefit of the Y Finance via either assignment to the bank of the benefit of the loan, granting of first ranking security interest in the bank over the Y Finance or by the transfer of shares issued in Y Finance. • Release the bank and its officers, employees and agents from all claims, demands, actions, suits or proceedings for damages, debt, restitution, equitable compensation, account, injunctive relief, specific performance or any other remedy, whether by original claim, cross-claim or otherwise and whether arising at common law, in equity, under statute or otherwise in respect of, arising from or any way related to you, your claim, your property or the dealings between the bank and you. • Undertake certain obligations in relation to properties at Y.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1997 Paragraph 104-25(1)(b) | Income Tax Assessment Act 1997 Paragraph 104-25(1)(d) | Income Tax Assessment Act 1997 Subsection 104-25(2) | Income Tax Assessment Act 1997 Subsection 104-25(3) | Income Tax Assessment Act 1997 Subsection 110-25(2) | Income Tax Assessment Act 1997 Subsection 110-35(2) | Income Tax Assessment Act 1997 Section 116-20 | Income Tax Assessment Act 1997 Subsection 116-20(1) | Income Tax Assessment Act 1997 Section 116-30 | Income Tax Assessment Act 1997 Subsection 116-30(1) | Income Tax Assessment Act 1997 Section 245-10 | Income Tax Assessment Act 1997 Section 245-35 | Income Tax Assessment Act 1997 Section 245-37 | Income Tax Assessment Act 1997 Section 245-65 | Income Tax Assessment Act 1997 Subsection 245-65(1) | Income Tax Assessment Act 1997 Subsection 245-65(3) | Income Tax Assessment Act 1997 Section 245-75 | Income Tax Assessment Act 1997 Subsection 245-75(1) | Income Tax Assessment Act 1997 Subsection 245-75(2) | Income Tax Assessment Act 1997 Paragraph 245-75(2)(a) | A New Tax System (Goods and Services Tax) Act 1999 Section 9-5 | A New Tax System (Goods and Services Tax) Act 1999 Subsection 9-10(1) | A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-10(2)(e) | A New Tax System (Goods and Services Tax) Act 1999 Paragraph 9-10(2)(g) | A New Tax System (Goods and Services Tax) Act 1999 Section 9-15 | A New Tax System (Goods and Services Tax) Act 1999 Section 9-40 | A New Tax System (Goods and Services Tax) Act 1999 Section 195-1

Reasons for decision: Summary: Yes. The value of the right to sue and seek compensation that is given up can be used to offset a debt pursuant to section 245-65 of the ITAA 1997 in working out the gross forgiven amount of the debt as it is 'property'. | Detailed Reasoning - Detailed reasoning: A commercial debt is defined in section 245-10 of the ITAA 1997. A debt is a commercial debt if any part of the interest paid or payable is or would be allowable as a deduction to the debtor. A debt is also a commercial debt if interest is not payable in respect of a debt but had interest been payable the amount would have been allowable as a deduction to the debtor. Section 245-35 of the ITAA 1997 states a debt is forgiven if the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished. Section 245-65 deals with consideration given by the debtor which can be used to offset a commercial debt when it is forgiven. This is used in working out the gross forgiven amount of a debt. Item 1 in subsection 245-65(1) of the ITAA 1997 states that where the debt is a moneylending debt then in working out the gross forgiven amount the following amounts can offset the debt in respect of the forgiveness: (a) An amount that the debtor has paid; (b) The market value of property that the debtor has given; and (c) The market value of an obligation of the debtor to pay an amount or to give property; Item 6 in subsection 245-65(1) of the ITAA 1997 (read in conjunction with section 245-37 of the ITAA 1997) states that where the debt is forgiven by the creditor subscribing for shares in the debtor company then the amount of the offset is worked out using the formula in subsection 245-65(3). Section 245-75 of the ITAA 1997 is about the calculation of the gross forgiven amount of the debt. Under subsection 245-75(1) of the ITAA 1997 if no consideration is paid or given, the gross forgiven amount of the debt is equal to the notional value of the debt. If the value of the debt exceeds any offset then the gross forgiven amount is the excess. Under subsection 245-75(2) of the ITAA 1997where the notional value of the debt at the time when the debt is forgiven is equal to or less than the consideration there is no forgiven amount in respect of the debt and subdivisions 245-D to 245-F of the ITAA 1997 (being the remaining provisions of the Division) do not apply in respect of the debt. The term 'property' is not defined for the purposes of Division 245 and therefore takes its ordinary meaning. In Jones v. Skinner (1836) 5 LJ Ch 90, Langdale MR said that 'property is the most comprehensive of all terms which can be used, in as much as it is indicative and descriptive of every possible interest that a person can have'. In the High Court of Australia case of Hepples v. FC of T 91 ATC 4808; (1991) 22 ATR 465 ( Hepples) McHugh J suggested that a right to sue is a proprietary right once it is vested in the grantee. His Honour observed (91 ATC at 4840; 22 ATR at 502): When a person creates a right in another person to sue him or her, the grantor does not dispose of any asset of his or her own. The personal right to sue is never vested in the grantor, even momentarily. It is only when the right to sue is vested in the grantee, and not before, that it bears the character of a proprietary right. 48. Hill J also considered these issues in Reuter v. FC of T 93 ATC 4037; (1993) 24 ATR 527. In that case Mr Reuter entered into a covenant with Rothwells not to sue in relation to the payment of a fee, and in return for granting that covenant Mr Reuter received $8m. Hill J concluded that the taxpayer's right was a personal chose in action against Rothwells for the payment of a fee. His Honour referred to his earlier comments in FC of T v. Cooling 90 ATC 4472; (1990) 21 ATR 13, where he said (albeit referring to the provisions in the 1936 Act), in relation to the reference in the legislation to an asset (90 ATC at 4486; 21 ATR at 28): what is comprehended is an item of property or an interest in property rather than rights of a non-proprietary kind. 49. His Honour went on to say (93 ATC at 4050; 24 ATR at 543): In part this view was derived from the fact that an asset had to be capable of disposition to give rise to a taxable gain (unless otherwise a deemed disposition arose by virtue of the Statute). Secondly, the words "any other right" and the words "any other form of incorporeal property" in para. (a) of the definition suggested that ... it was only proprietary rights or interest that were included within the definition. Taxation Ruling TR 95/35 (TR 95/35) at paragraph 61 states that 'there is sufficient authority to support our conclusion that a right to seek compensation is proprietary in nature'. The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 2) 1996 at paragraph states: Consideration 6.56 In the interests of consistency between the parties to a debt forgiveness transaction, the rules relating to consideration seek broadly to mirror those elsewhere in the Act, particularly those contained in the capital gains provisions of Part IIIA. The general rules 6.57 The basic rules for valuing consideration are contained in subsection 245-65(1). By and large, they reflect existing subsection 160ZD(1) [section 116-30 of the ITAA 1997] in its application to capital gains. In summary, consideration is the sum of amounts of money the debtor is required to pay in respect of the forgiveness or, if property other than money is required to be given, the market value of the property. If both money and property are given, the consideration is the sum of the amounts of money and the market value of the property. 6.58 If the debt is a moneylending debt, ie, from a loan made by the creditor in the ordinary course of a moneylending business, consideration will include - in addition to any immediate money or property consideration - the market value of any obligation of the debtor to pay amounts in the future. This additional test will ensure that the value of consideration payable over a period of time appropriately reflects the time value of money and (in an appropriate case) the creditworthiness of the debtor. In your case, the loan is considered a commercial debt as defined in section 245-10 of the ITAA 1997 as any interest payable by you would be deductible as the debt incurred relates to a revenue producing business. The amount that the bank has released and forgiven is $XXX,000,000. However, in working out the gross forgiven amount the Commissioner has taken into account the following amounts to offset: Amount paid The payment of $XX,000,000 is an amount which you as the debtor has paid in respect of the forgiveness of a moneylending debt which pursuant to Item 1(a) of subsection 245-65(1) of ITAA 1997 can offset against the value of the debt. Property - Right to seek compensation According to the definition of 'property' given by case law the definition appears to be broad. In the High Court of Australia case of Hepples the court stated that the right to sue may be of a proprietary nature. Under TR 95/35 the Commissioner is of the view that a right to seek compensation is proprietary nature and therefore 'property'. Taking into account the intent expressed by the explanatory memorandum by considering section 116-30 of the ITAA 1997 and given the object and purpose of division 245-65 of the ITAA 1997, it appears that property (especially CGT assets) which can be disposed of and which is of value is intended to be covered. Therefore, your right to seek compensation is 'property' which has been given up or disposed of. Even though that right is not a physical asset which has been 'given' to the bank, the Commissioner considers that it is nevertheless property which has been disposed of or given up for the benefit of the bank and which more importantly is 'as a result of, or in respect of, the forgiveness of the debt' as required by subsection 245-65(1) of the ITAA 1997. Therefore the market value of the right to seek compensation can also be used to offset against the value of the debt pursuant to Item 1 paragraph (b) of subsection 245-65(1) of the ITAA 1997. Other obligations pursuant to settlement agreement The following obligations by you as per the settlement agreement fall within items 1(b) and 1(c) in the table under subsection 245-65(1) of the ITAA 1997 being market value, at the time of forgiveness of property given or market value of property subsequently required to give, or item 6 in the table under subsection 245-65(1) being shares subscribed for by the bank to apply to the debt: • Deliver to the bank documents in order for the bank to obtain full and unencumbered benefit of the Y Finance via either, assignment of the loan, granting of a first ranking security or by transfer of shares to the bank issued inY Pty Ltd; • Return to the bank of the original of the Y Bank Guarantees for cancellation; • Obligations in respect of 'Property B'; The Commissioner considers that it is not necessary to individually work out market value of each of these items of property above as it is considered that the market value of the total of the amounts paid, property given or required to be given, and any shares transferred is equal to the notional debt claimed by the bank being $XXX,000,000 which effected a mutually acceptable settlement by all parties. Therefore, as the forgiven amount is equal to the amount offset, there is no gross forgiven amount pursuant to paragraph 245-75(2)(a) of the ITAA 1997. Therefore it is not necessary to consider the remaining provisions (245-D to 245-F of the ITAA 1997) including calculating the net forgiven amount. | Detailed Reasoning - Question 2: Does CGT event C2 under Part 3-1 of the ITAA 1997 apply to your disposal of your right to seek compensation? | Summary: Yes. CGT event C2 under Part 3-1 of the ITAA 1997 applies to your disposal of your right to seek compensation as you released your ownership of this intangible asset. | Detailed Reasoning - Detailed reasoning: Section 104-25 of the ITAA 1997 discusses CGT event C2 which refers to cancellation, surrender and similar endings. Paragraphs 104-25(1)(b) and (d) of the ITAA 1997 states, in part, that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged, satisfied or surrendered. Subsection 104-25(2) of the ITAA 1997 states that the time of the event is: (a) when you enter into the contract which results in the asset ending; or (b) if there is no contract when the asset ends. Subsection 104-25(3) of the ITAA 1997 states that you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. Paragraph 3 of Taxation Ruling TR 95/35 confirms that the right to seek compensation is a CGT asset. It states that it is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract or other compensable damage. It is acquired at the time of the compensable wrong and is disposed of when it is satisfied, surrendered, released or discharged. The cost base of the right to seek compensation is determined in accordance with the provisions of Subdivision 110-A of the ITAA 1997. Expenditure or an outgoing forms part of the cost base of a right to seek compensation if there is a direct and substantial link between the expenditure or outgoing and the arising of the right to seek compensation. Any legal fees or expenses you incurred in relation to the CGT event can be included in the cost base. Paragraph 104 of TR 95/35 states that if the right to seek compensation arises in respect of a monetary loss of the taxpayer then the amount of that loss is included in the cost base of the right to seek compensation for that loss. It is an amount which the taxpayer has paid or is required to pay in respect of the acquisition of the right to seek compensation for having to incur the expenditure. Section 116-20 of the ITAA 1997 deals with capital proceeds. Subsection 116-20(1) states that the capital proceeds from a CGT event are the total of the money or market value of property you receive or entitled to received. Modification rule 1 in relation to capital proceeds is the Market value substitution rule. Subsection 116-30(1) of the ITAA 1997 states that where you receive no capital proceeds from a CGT event then you are taken to have received the market value of the CGT asset that is the subject of the event. In your case, you held a CGT asset in the form of a right to seek compensation. The asset, being the right to seek compensation, is acquired at the time of the bank's negligence and misleading and deceptive conduct. This asset was subsequently released when you entered into an agreement with the bank to settle the matter. In working out your cost base, the commissioner considers that you may include the following amounts as part of your first element cost base under subsection 110-25(2) of the ITAA 1997, being amounts that you paid or required to pay in respect of the acquisition of the right to seek compensation: • Interest on swaps • Capital break cost on swaps • Remarketing & selling costs on Development Z However, if these amounts have been claimed as revenue expenses then they cannot also be included as part of the first element cost base. The commissioner also considers that any legal expenses that you incurred relating to obtaining the right to seek a compensation payment are incidental costs within subsection 110-35(2) of the ITAA 1997 and included in the second element of the cost base under subsection 110-25(3) of the ITAA 1997. Amounts such as future losses or lost opportunity losses cannot be claimed as they are not amounts that you have paid or required to have paid. In relation to capital proceeds you received no compensation from the bank upon releasing your right to seek compensation. Pursuant to subsection 116-20(1) of the ITAA 1997 you did not receive or were not entitled to receive any money or property, therefore there were no capital proceeds. As you received no capital proceeds we must therefore consider the market value substitution rule under subsection 116-30(1) of the ITAA 1997. Pursuant to the subsection you are taken to receive the market value of the CGT asset that is the subject of the event, being the releasing of the right to seek compensation. The commissioner considers that the market value of this right to seek compensation (being the CGT asset the subject of the event) is equal to the bank's claim against you, being $XXX,000,000 (or the market value of the claim as may be determined) minus the amount you paid to the bank, being $XX,000,000, minus the market value of all property given by you to the bank pursuant to the settlement agreement. This net amount represents the benefit you could have received by way of compensation by the bank, but which was instead offset by a counter-claim the bank had against you. | Detailed Reasoning - Question 3: Is the discontinuance supply arising from releasing your claim against the bank for negligence and misleading conduct subject to GST? | Summary: No. Your discontinuance supply is not subject to GST as there is no taxable supply. | Detailed Reasoning - Detailed reasoning: Section 9-40 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you must pay GST on any taxable supply that you make. Section 9-5 of the GST Act states that: You make a taxable supply if: (a) you make a supply for *consideration; and (b) the supply is made in the course or furtherance of an *enterprise that you *carry on; and (c) the supply is *connected with Australia; and (d) you are *registered or *required to be registered. However, the supply is not a *taxable supply to the extent that it is *GST-free or *input taxed. (The asterisks in this ruling indicate terms defined under section 195-1 of the GST Act.) The GST consequences of a court order or out-of-court settlement will depend on a number of matters, including whether a payment made under the order or settlement constitutes consideration for a supply and, if so, whether the supply is in the nature of a taxable supply. In your case, consideration provided to you by the bank is an out-of-court settlement for damages due to losses and costs incurred as a result of the negligence and misleading and deceptive conduct by the bank. Goods and Services Tax Ruling GSTR 2001/4 (GSTR 2001/4) sets out the Commissioner's view on the GST consequences resulting from court orders and out-of-court settlements. It considers, amongst other things, the concept of supply and the nexus that must exist between a payment and a supply in order to establish the relationship of a supply for consideration. Paragraph 21 of GSTR 2001/4 states: A supply for consideration is the first step towards there being a taxable supply. However, for there to be a supply for consideration, three fundamental criteria must be met: (i) there must be a supply (ii) there must be a payment ; and (iii) there must be a sufficient nexus between the supply and the payment for it to be a supply for consideration However, a supply for consideration will not be a taxable supply unless the other requirements set out in section 9-5 of the GST Act are also satisfied. The term supply, under subsection 9-10(1) of the GST Act, includes any form of supply whatsoever. GSTR 2001/4 explains that supplies related to out-of-court settlements fall within one of three categories. These categories are: • earlier supply • current supply • discontinuance supply An earlier supply is a supply that occurred before the dispute arose, and which is the subject of the dispute. A current supply is one that may be created by the terms of the court order or out-of court settlement. A discontinuance supply may be characterised as: • surrendering a right to pursue further legal action (paragraph 9-10(2)(e) of the GST Act); • entering into an obligation to refrain from further legal action (paragraph 9-10(2)(g) of the GST Act); • releasing another party from further obligations in relation to the dispute (paragraph 9-10(2)(g) of the GST Act). However, whether a discontinuance supply would be a taxable supply would then depend on the requirements of section 9-5 of the GST Act being met in relation to that supply. In GSTR 2001/4, the Commissioner puts forth the view that the subject of the dispute may not give rise to a supply at all: 71.Disputes often arise over incidents that do not relate to a supply. Examples of such cases are claims for damages arising out of property damage, negligence causing loss of profits, wrongful use of trade name, breach of copyright, termination or breach of contract or personal injury. 72.When such a dispute arises, the aggrieved party will often assert its right to an appropriate remedy. Depending on the facts of each dispute a number of remedies may be pursued by the aggrieved party in order to ensure adequate compensation. Some of these remedies may be mutually exclusive but it is still open to the aggrieved party to plead them as separate heads of claim until such time as the matter is resolved by a court or through negotiation. 73.The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This damage, loss or injury, being the substance of the dispute, cannot in itself be characterised as a supply made by the aggrieved party. This is because the damage, loss, or injury, in itself does not constitute a supply under section 9-10 of the GST Act. Section 9-15 of the GST Act defines the term consideration broadly and states that it includes 'any payment, or any act or forbearance…' Paragraph 12 of Goods and Services Tax Ruling GSTR 2001/6 states that a 'payment' is not limited to a payment of money. It includes a payment in a non-monetary or in an 'in kind' form, such as providing goods, granting a right or performing a service (an act); and entering into an obligation (a forbearance). In your case you instigated proceedings against the bank for causing loss from negligence and from misleading and deceptive conduct. You subsequently entered into a settlement with the bank where you surrendered your right to take legal action against the bank, its officers, employees and agents. In return, the bank agreed to release you from all claims that the bank had against you. The amounts claimed by the bank in effect were used to offset your legal claims. It is considered that this is sufficient consideration by the bank under the broad definition of 'consideration' for the purposes of whether there may be a 'taxable supply'. The supply is considered a discontinuance supply as the consideration provided by the bank was not in relation to an earlier supply you made or to a current supply that you made or required to make. Instead the consideration was for the discontinuance of your legal action. To determine if the discontinuance supply is a taxable supply, it is also necessary to consider the terms of the final settlement to establish whether there is a nexus between the consideration provided and the discontinuance supply. Paragraphs 106 and 107 of GSTR 2001/4 provides further guidance on a discontinuance supply: 106.Where the only supply in relation to an out-of-court settlement is a 'discontinuance' supply, it will typically be because the subject of the dispute is a damages claim. In such a case, the payment under the settlement would be in respect of that claim and not have a sufficient nexus with the discontinuance supply. 107. In most instances, a 'discontinuance' supply will not have a separately ascribed value and will merely be an inherent part of the legal machinery to add finality to a dispute which does not give rise to additional payment in its own right. They are in the nature of a term or condition of the settlement, rather than being the subject of the settlement. Further, paragraph 109 of GSTR 2001/4 states: 109. We consider that a payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for a discontinuance supply. We do not consider that the claim, which is the subject of your dispute, is lacking in substance and therefore there is no nexus between the discontinuance supply that you will make and the consideration you will receive. As a result, you will not make a supply for consideration in relation to the out-of-court settlement. The Commissioner further expands on his view on the distinction between a damages claim and a discontinuance supply in paragraphs 110 and 111 of GSTR 2001/4. With respect to an out-of-court settlement, paragraph 111 makes the following comment: 111.If a payment is made under an out-of-court settlement to resolve a damages claim and there is no earlier or current supply, the payment will be treated as payment of the damages claim and will not be consideration for a supply at all, regardless of whether there is an identifiable discontinuance supply under the settlement. The dispute will be settled by the parties under the terms of the settlement where monetary claims by each party will be countered against each other. In line with the Commissioner's view discussed above, we consider that the consideration by the bank is related to your damages claim and is not considered to be consideration for a taxable supply by you to the bank. As such, the payment is not subject to GST. | Detailed Reasoning - Other information: Anti-overlap Both the debt forgiveness provisions and the CGT provisions apply concurrently in this situation. That is, transactions such as the disposal of an asset which occur to offset a debt is still subject to the CGT provisions in relation to that disposal. Obtaining valuations Guidance on the processes involved in establishing a market valuation for tax purposes can be obtained from the ATO guide: Market valuation for tax purposes . A copy is available at https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Calculating-a-capital-gain-or-loss/Market-valuation-for-tax-purposes/. The guide outlines accepted principles of valuation and supplements other advice and guidance provided by the ATO on valuation maters. Depending on the situation, a market valuation may be undertaken by a: • registered valuer or member of a recognised professional valuation body • director, for balance sheet purposes, or • person without formal valuation qualifications whose assessment is based on reasonably objective and supportable data. Apportionment The private ruling deals with the issues for the group as a whole (as requested) and has not considered the apportionment of tax liability between individual members of the group which may be necessary. Taxation of Financial Arrangements The ruling has not considered the application of Division 230 of the Income Tax Assessment Act .

Question 1: Can the value of the right to sue and seek compensation that is given up be used to offset a debt pursuant to section 245-65 of the ITAA 1997 in working out the gross forgiven amount of the debt?