Private ruling: Debt forgiveness not giving rise to a dividend.
Published: July 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2013

Ruling: Q1: Will the Commissioner apply section 109G(4) of the Income Tax Assessment Act 1936 (ITAA 1936) to the loan forgiven by the company to the directors? | A1: Yes.

Relevant facts and circumstances: The two individuals are the directors of and indirect shareholders of the company. The only assets of the company are loans, both secured and unsecured. The company made a loan to the directors. At the time the loan was made, the directors were in a financial position to repay the loan. Subsequent to the loan being made the directors' assets and wealth have significantly declined due to the global financial crisis and as such they are have not been in a financial position to pay more than the minimum loan repayments for purposes of Division 7A of the Income Tax Assessment Act 1936 ( ITAA 1936). The directors need assistance by way of the age pension to help meet their daily living expenses, and the company is contemplating forgiving the loan. The directors are elderly and there is no realistic possibility of them returning to gainful employment. The directors have limited income and are not in a financial position to continue to pay the loan or the tax if the loan is forgiven and a deemed dividend is triggered as per section 109F of the ITAA 1936.

Relevant legislative provisions: Section 109F of the Income Tax Assessment Act 1936 | Section 109G of the Income Tax Assessment Act 1936

Reasons for decision: Summary: As per Subdivision B of the ITAA 1936 - Private company payments, loans and debt forgiveness are treated as dividends. 109F(1) Forgiven debt treated as dividend. "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. Note: In some cases forgiving a debt does not give rise to a dividend. See section 109G." As per section 109G(4) 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." | Detailed Reasoning - Application to your circumstances: The company is contemplating forgiving the debt of the loan to the directors to avoid causing them undue hardship. When the loan was made by the company, the directors had the capacity to pay the debt. Subsequent to the loan being made the directors lost the ability to pay the debt currently and in the foreseeable future due to the global financial crisis which was beyond the taxpayers' control. The directors' assets and wealth has significantly declined due to the circumstances beyond their control. The directors have limited income and due to their age have no realistic possibility of returning to gainful employment. The taxpayers would be caused undue hardship if payment of the debt was forgiven and a dividend was deemed as per section 109F of the ITAA 1936. After consideration of all the circumstances in your case the Commissioner will exercise his discretion under section 109G(4) of the ITAA 1936 to allow the company to forgive the loan made to the directors without giving rise to a dividend.