Private ruling: Commercial Debt Forgiveness
Published: May 2013
Ruling period: Financial year ended 30 June 2013 | Financial year ended 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Will the commercial debt forgiveness provisions contained within Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the forgiveness of the debt? | A1: 

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. The Trust has an outstanding borrowing owing to a beneficiary. No interest is payable, or has been payable in respect of the borrowing. The Trust used a portion of the proceeds of the borrowing to acquire a residential property. The Trust used the remaining portion of the proceeds of the borrowing to make an interest free loan to a child of the beneficiary. The beneficiary's child (also a beneficiary) uses the property as their main residence and does not pay any rent for its use. The beneficiary will forgive the borrowing owed to them by the Trust. The Trust intends to then vest the ownership of the property to the child.

Relevant legislative provisions: Income Tax Assessment Act 1997 - Section 245-2 | Income Tax Assessment Act 1997 - Section 245-10

Reasons for decision: Summary: Section 245-2 of the Income Tax Assessment Act 1997 (ITAA 1997) provides an amount of a commercial debt which is forgiven, is generally applied to reduce the revenue and capital losses incurred by the debtor in the year the debt is forgiven. A commercial debt refers to a debt where the whole or any part of interest, or an amount in the nature of interest, paid or payable in respect of the debt is allowable as a deduction to the borrower. Where no interest is payable in respect of a debt (for instance, an interest-free loan), the debt is a commercial debt if, had interest been payable, it would have been deductible to the borrower: Section 245-10 of the ITAA 1997. In your situation, while no interest was payable by the trust in respect of the loan from the beneficiaries, the debt may still constitute a commercial debt where, should interest have been payable, it would be deductible to the trust. Whether interest has been incurred in the course of gaining or producing assessable income generally depends on the purpose of the borrowing and the use to which the borrowed funds are put. Where a borrowing is used to acquire an assessable income producing asset, or relates to expenses of an assessable income producing activity, the interest on this borrowing is considered to be incurred in the course of gaining or producing assessable income and is therefore deductible under section 8-1 of the ITAA 1997: Taxation Ruling TR 95/25. As the debt was used by the trust to acquire a residential property which was not used to derive rental income and to make an interest free borrowing, the trust would not be entitled to a deduction for interest incurred on the debt had it been payable, as it would not have been incurred in the production of assessable income. Accordingly, as the debt does not constitute a commercial debt for the purposes of section 245-10 of the ITAA 1997, the commercial debt forgiveness provisions contained within Division 245 of the ITAA 1997 will not apply to the forgiveness of the debt.