Private ruling: Taxation implications on debt forgiveness
Published: January 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Will you be subject to capital gains tax upon the release of the debt payable by Company 1 to Company 2? | A1: No | Q2: Will you be subject to the commercial debt forgiveness provisions upon the release of the debt payable by Company 1 to Company 2? | A2: No | Q3: Will you be subject to income tax upon the release of the debt payable by Company 1 to Company 2? | A3: No

Relevant facts and circumstances: Your partner owns 100% of the shares issued by Company 2. Your partner owns 100% of the A class shares issued by Company 1. Company 1 has also issued an E Class Share to you. On a date, Company 1 owed Company 2 a sum of money. You do not have a debt owed to Company 2. In the relevant financial year, you negotiated a settlement with your partner. The settlement was formalised in Consent Orders. Pursuant to clause 9.12.2 of the Consent Orders, your partner is required to transfer the whole of their right, title and interest in their shares in Company 1 to you. Pursuant to clause 9.4 of the Consent Orders, your partner and Company 2 are to do all acts and things and sign all documents necessary to extinguish all loans owed by you and Company1. Accordingly, Company 2 will release Company 1 from the debt. Company 1 and Company 2 are not dealing at arms length. Company 1 is not in the business of money lending. Company 1 did not borrow with the intention of making a profit. No consideration will be paid for the forgiveness of the debt owed by Company 1. The forgiveness of the debt did not arise out of business operations. Pursuant to clause 9.5 of the Consent Orders, your partner is required to obtain a Private Binding Ruling from the Australian Taxation Office as to, inter alia, any income tax, penalties, charge and interest payable by you and Company 1 in relation to the forgiveness of this debt.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1997 Section 245-10 | Income Tax Assessment Act 1997 Subdivision 245-C | Income Tax Assessment Act 1997 Subdivision 245-G | Income Tax Assessment Act 1997 Division 245 | Income Tax Assessment Act 1997 Subsection 6-5(1)

Reasons for decision: Summary: The forgiveness of a debt owed by Company 1 to Company 2 does not result in; · any capital gains tax consequences, or · any income tax consequences for you, as you are not the holder of any debt owed to Company 2 and have not personally received any benefit from the forgiveness of the debt. | Detailed Reasoning - Capital gains tax implications: Section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) refers to a capital gains tax (CGT) event C2 happening if an intangible asset ends because it is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, forfeited or expired. In CGT Determination Number 3, TD 3; "What are the CGT consequences for the borrower (debtor) when a debt is waived?" it states, in part; 1. For CGT purposes, the borrower is not considered to have an asset. Accordingly, when the lender waives the debt, the borrower does not dispose of an asset and therefore makes no capital gain or loss. 2. No other CGT provisions apply to cause a capital gain or loss to the borrower when the lender waives the debt. | Detailed Reasoning - Application to your circumstances: Company 1 (debtor) owes Company 2 (creditor) a sum of money. You do not have a debt owing to Company 2. Company 2 has forgiven the debt of Company 1. As the borrower, Company 1, is not considered to have an asset for CGT purposes, there is no asset disposed of when the lender waives the debt, therefore there will be no CGT consequences for Company 1 when Company 2 forgives their debt. Accordingly, as you do not personally have a debt with Company 2 and there are no CGT consequences for Company 1 in relation to the forgiven debt, there are no CGT consequences for you. | Detailed Reasoning - Commercial debt forgiveness: Under section 245-10 of the ITAA 1997 it states; Subdivisions 245-C to 245-G apply to a debt of yours if: (a) the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or (b) interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or (c) interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2)(a), (b) and (c)) that has the effect of preventing a deduction. If not for the special tax consequences that affect the taxpayer (as a debtor) under Division 245 of the ITAA 1997, the forgiveness of a debt may give rise to a duplication of deductions in respect of the same outgoing. The creditor is able to shift the burden of the loss (as a result of the debt forgiveness) as a tax deduction or capital loss. The debtor, now relieved of the liability to repay the loan, will also continue to claim deductions in respect of the revenue or capital losses or expenditures arising from the debt (depending on how the moneys borrowed or incurred were applied) resulting in the duplication of deductions. The "gain" made by the debtor as a result of the debt forgiveness under Division 245 of the ITAA 1997 is usually not included in the taxpayer's assessable income except in certain circumstances, eg if the gain is regarded as ordinary income. Division 245 of the ITAA 1997 seeks to eliminate the potential duplication of deductions described above by applying the amount of debt forgiven to reduce certain specified amounts which the taxpayer would otherwise use to reduce the taxpayer's taxable income. The amounts to be reduced are as follows: - tax losses - net capital losses - a wide range of deductible expenditures, and - the cost bases of certain CGT assets When Division 245 of the ITAA 1997 applies, a debtor is required to reduce its tax balances (if it has any) in the above order by an amount called the net forgiven amount. Under subsection 245-75(2) of the ITAA 1997 the following applies; If the value of the debt when it was forgiven is equal to or less than the amount offset: (a) there is no gross forgiven amount in respect of the debt; and (b) Subdivisions 245-D to 245-F (about how to work out the net forgiven amount of a debt and how to treat it) do not apply in respect of the debt. | Detailed Reasoning - Application to your circumstances: Company 2 has forgiven a debt owed by Company 1. The commercial debt forgiveness provisions apply to a 'debt of yours' and as the holder of the debt is Company 1 (and not you) the commercial debt forgiveness provisions do not apply to you. | Detailed Reasoning - Income tax implications: Subsection 6-5(1) of the ITAA 1997 defines ordinary income as income 'according to ordinary concepts.' Ordinary income has generally been held to include three categories, namely income from rendering personal services, income from property and income from carrying on a business. Instances where the forgiveness of a debt results in a 'gain' may also be treated as ordinary income of the debtor where the debt forgiven is inextricably linked to the ordinary business of the debtor ( Warner Music Australia Pty Ltd v FC of T 96 ATC 5046). | Detailed Reasoning - Application to your circumstances: Company 2 has forgiven a debt owed by Company 1. The forgiveness of the debt by Company 2 did not arise out of business operations. Company 1 is not in the business of money lending and did not borrow with the intention of making a profit. The transaction, or debt, in question arose between Company 1 (debtor) and Company 2 (creditor). You were merely an associate of the shareholder of Company 1 and Company 2 prior to the forgiveness of the debt and the sole shareholder of Company 1 post the forgiveness of the debt. You did not incur any personal liability for the debt nor receive any 'gain' or income on forgiveness of the debt. Accordingly, the forgiveness of the debt by Company 2 does not give rise to ordinary income.

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