Private ruling: Income tax - Commercial debt forgiveness
Published: November 2014
Ruling period: Income year ended 30 June 20ZZ
Date scheme commenced: November 20YY

Ruling: Q1: Does the agreement by the creditor to accept an amount in full and final discharge and release of the obligation to repay interest free loans made to the taxpayer in an earlier year constitute forgiveness of a debt for the purposes of Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the value of the debt at the forgiveness time as worked out under section 245-55 of the ITAA 1997 be the present value of the debt at the forgiveness time? | A2: Yes. The value of the debt at the forgiveness time, as worked out under section 245-55 of the ITAA 1997, will be the present value of the debt at the forgiveness time calculated using the 10 year Australian Government Bond rate as a discount rate. | Q3: In working out the gross forgiven amount of the debt under section 245-65 of the ITAA 1997, will the amount paid be offset against the value of the debt at the forgiveness time? | A3: Yes. The amount of the payment made in full and final discharge and release of the obligation to repay the interest free loans, will be offset against the value of the debt at the forgiveness time, being the present value of the debt calculated using the 10 year Australian Government Bond rate as a discount rate. | Q4: Will the gross forgiven amount be reduced by any amounts when calculating the net forgiven amount under section 245-85 of the ITAA 1997? | A4: No. | Q5: Will the net forgiven amount be applied, under section 245-130 and in accordance with section 245-135 of the ITAA 1997, in reduction of the taxpayer's net capital losses? | A5: Yes.

Relevant facts and circumstances: The taxpayer is an unlisted Australian resident public company. The taxpayer borrowed money, in the form of two loans, from the creditor to assist in their business operations. Both loans were made on the same terms. The loans were interest free loans to be repaid at the end of the term of the loans. The creditor has now agreed to accept an amount in full and final discharge and release of the obligation to repay the interest free loans made to the taxpayer. The taxpayer has advised that although interest on the loans was not payable, had interest been payable, an interest deduction would have been available. The taxpayer has advised that: • no amounts have been or will be included as assessable income under other provisions of the ITAA 1997 as a result of the release from the obligation to pay the loans; • no amounts have reduced a deduction otherwise allowable to you in any year of income under a provision other than Division 245 of the ITAA 1997 (except a reduction under Division 727 of the ITAA 1997 which deals with indirect value shifting) as a result of the release from the obligation to pay the loans; • no cost base of any CGT asset you own has been, or will be, reduced under Part 3-1 or 3-3 of the ITAA 1997 as a result of the release from the obligation to pay the loans. The present value of the loan amounts was calculated as at 30 June 20YY based on the 10 year Australian Government Bond rate as at 30 June 20YY. The present value of the loan amounts was calculated as at 30 June 20XX based on the 5 year Australian Government Bond rate as at 30 June 20XX. As at 30 June 20XX the taxpayer had no tax losses and an amount of net capital losses carried forward to later income years. As at 30 June 20YY the taxpayer had no tax losses and an amount of net capital losses carried forward to later income years.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 245 | Income Tax Assessment Act 1997 section 245-10 | Income Tax Assessment Act 1997 section 245-35 | Income Tax Assessment Act 1997 section 245-55 | Income Tax Assessment Act 1997 subsection 245-55(1) | Income Tax Assessment Act 1997 Subdivision 245-C | Income Tax Assessment Act 1997 section 245-65 | Income Tax Assessment Act 1997 subsection 245-65(1) | Income Tax Assessment Act 1997 paragraph 245-75(1)(b) | Income Tax Assessment Act 1997 section 245-85 | Income Tax Assessment Act 1997 subsection 245-85(1) | Income Tax Assessment Act 1997 section 245-105 | Income Tax Assessment Act 1997 section 245-115 | Income Tax Assessment Act 1997 section 245-120 | Income Tax Assessment Act 1997 section 245-130 | Income Tax Assessment Act 1997 section 245-135 | Income Tax Assessment Act 1997 section 245-145 | Income Tax Assessment Act 1997 section 245-175 | Income Tax Assessment Act 1997 section 245-195 | Income Tax Assessment Act 1997 section 995-1 | Income Tax Assessment Act 1997 Parts 3-1 and 3-3 | Income Tax Assessment Act 1997 Division 727

Reasons for decision: Summary: The agreement by the creditor to accept an amount in full and final discharge and release of the obligation to repay the interest free loans made to the taxpayer in an earlier year constitutes forgiveness of debt for the purposes of Division 245 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Division 245 of the ITAA 1997 applies to any commercial debt (or part of a commercial debt) that is forgiven. The term 'debt' is not a defined term for the purposes of Division 245 of the ITAA 1997 or for the Income Tax Assessment Acts generally. Accordingly, it is necessary to apply the rules of statutory interpretation to determine its meaning. Technical words that are not defined are to be given their technical meaning. The technical meaning of the word 'debt' is defined in Butterworth's Australian Legal Dictionary 1997, Butterworth's, NSW: A sum of money owed: Director of Public Prosecutions v. Turner [1073] 3 All ER 124 at 126. A debt is a sum of money which is now payable or will become payable in the future by reason of a present obligation: debtum in praesenti, solvendum in futuro. It is a right which a creditor has to enforce by taking action in a court of law against the person who owes the money (the debtor). A debt will be considered to be commercial in cases where interest in respect of the debt is not payable, but had it been, that interest would have been deductible: section 245-10 of the ITAA 1997. In this case, the creditor agreed to loan the taxpayer amounts which the taxpayer must repay. The taxpayer has advised that, although interest is not payable, had interest been payable, an interest deduction would have been available. Accordingly, the loans will be 'commercial debt' for the purposes of Division 245 of the ITAA 1997. Section 245-35 of the ITAA 1997 provides that a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full. In this case, the creditor has agreed to accept an amount in lieu of full payment of the loans made to the taxpayer in an earlier year. This payment will release the taxpayer from the obligation to repay the debt. Accordingly, the agreement by the creditor to accept an amount constitutes forgiveness of a commercial debt for the purposes of Division 245 of the ITAA 1997. | Summary: The value of the debt at the forgiveness time, as worked out under section 245-55 of the ITAA 1997, will be the present value of the loans calculated using the 10 year Australian Government Bond rate at the time of forgiveness as a discount rate. | Detailed Reasoning - Detailed reasoning: Generally, the value of a debt at the time it is forgiven is the amount that would have been its market value at the forgiveness time: subsection 245-55(1) of the ITAA 1997. The term 'market value' is not defined in any general provision in the tax legislation. It is defined in section 995-1 of the ITAA 1997 but not in a way that fixes its meaning in all contexts. As a result, the term 'market value' usually takes on its ordinary meaning unless specifically defined or qualified in a particular provision. Sometimes market value is assessed using a standard of value that does not always reflect an identical concept to market value. Where a measure is inconsistent with the measure of market value, such a measure will not be accepted as a substitute for market value. The taxpayer has determined the present value of the amount of the loans as at 30 June 20XX based on the 5 year Australian Government Bond rate as at 30 June 20XX and the present value of the amount of the loans as at 30 June 20YY based on the 10 year Australian Government Bond rate as at 30 June 20YY. In this case, the Commissioner accepts that a present value calculation adopting an Australian Government Bond rate as a discount rate is consistent with a measure of market value. Further, it is considered that using the 10 year Australian Government Bond rate is more appropriate than using the 5 year Australian Government Bond rate. Accordingly, a present value based on a 10 year Australian Government Bond rate at the time of forgiveness will be accepted as a substitute for the market value of the debt at the forgiveness time. | Summary: The amount of the payment made in full and final discharge and release of the obligation to repay the interest free loans, will be offset against the value of the debt at the forgiveness time, being the present value of the debt calculated using the 10 year Australian Government Bond rate as a discount rate. | Detailed Reasoning - Detailed reasoning: The rules to calculate the gross forgiven amount of a debt that has been forgiven are set out in Subdivision 245-C of the ITAA 1997. In accordance with these rules, the value of a forgiven debt, as worked out under section 245-55 of the ITAA 1997, can be offset by amounts paid or given in respect of the forgiveness. The rules to determine the amount that can be offset against the value of a debt are set out in section 245-65 of the ITAA 1997. The table in subsection 245-65(1) of the ITAA 1997 sets out, on an item-by-item basis, the rules which determine the amount that can be offset against the value of a debt. In accordance with Item 2 of the table in subsection 245-65(1) of the ITAA 1997, the value of a debt that is not a moneylending debt is offset by the sum of each amount that the debtor has paid, or is required to pay as a result of, or in respect of, the forgiveness of the debt. Item 2 only applies if none of items 3, 4, 5 and 6 applies. In accordance with the conditions in subsection 245-65(2) of the ITAA 1997, Item 3 of the table in subsection 245-65(1) of the ITAA 1997 only applies to a debt that is not a moneylending debt where either: (1) there is no amount or property paid or given, or (2) the amount that would otherwise be taken to be paid or given is greater or less than the market value of the debt when it is forgiven, and the debtor and the creditor were not dealing with each other at arm's length in relation to the forgiveness; and either: (1) the creditor is a resident when the debt is forgiven, or (2) the forgiveness is a capital gains tax event (CGT) event involving an asset that is taxable Australian property. Items 4 and 5 of the table in subsection 245-65(1) of the ITAA 1997 only apply when a debt is assigned. Item 6 of the table in subsection 245-65(1) of the ITAA 1997 only applies to debt-for-equity swaps. If the value of a debt when it was forgiven exceeds the amount offset under section 245-65 of the ITAA 1997 in relation to the debt, the gross forgiven amount of the debt is the excess: paragraph 245-75(1)(b) of the ITAA 1997. In this case the creditor has agreed to accept an amount in full and final discharge and release of the obligation to repay the interest free loans made to the taxpayer. As Items 3, 4, 5 and 6 of the table in subsection 245-65(1) of the ITAA 1997 do not apply and the debt is not a moneylending debt, the value of the debt will be offset by the amount that you will be required to pay at the time of forgiveness in respect of the forgiveness of the debt. | Summary: The gross forgiven amount does not need to be reduced by any amounts when calculating the net forgiven amount under section 245-85 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 245-85(1) of the ITAA 1997 describes three types of amounts which, if they arise to the debtor as a result of a debt forgiveness, must be subtracted from the gross forgiven amount of a debt to arrive at the net forgiven amount of a debt. The three types of amounts are: any amount that has been or will be included in the assessable income of the debtor in any year of income under a provision of the ITAA 1997 other than Division 245 of the ITAA 1997; any amount which reduces a deduction otherwise allowable to the debtor in any year of income under a provision other than Division 245 of the ITAA 1997 (except a reduction under Division 727 of the ITAA 1997 which deals with indirect value shifting); any amount by which the cost base of a CGT asset owned by the debtor has been, or will be, reduced under Part 3-1 or 3-3 of the ITA 1997. The taxpayer has advised that • no amounts have been or will be included as assessable income under other provisions of the ITAA 1997 as a result of the release from the obligation to pay the loans; • no amounts have reduced a deduction otherwise allowable to you in any year of income under a provision other than Division 245 of the ITAA 1997 (except a reduction under Division 727 of the ITAA 1997 which deals with indirect value shifting) as a result of the release from the obligation to pay the loans; and • no cost base of any CGT asset you own has been, or will be, reduced under Part 3-1 or 3-3 of the ITAA 1997 as a result of the release from the obligation to pay the loans. As no amounts of the type described in subsection 245-85(1) of the ITAA 1997 have arisen, the gross forgiven amount does not need to be reduced by any amounts when calculating the net forgiven amount under section 245-85 of the ITAA 1997. | Summary: The net forgiven amount will be applied, under section 245-130 and in accordance with section 245-135 of the ITAA 1997, in reduction of your net capital losses. | Detailed Reasoning - Detailed reasoning: As specified in section 245-105 of the ITAA 1997, the total net forgiven amount for a forgiveness income year is applied in accordance with sections 245-115 to 245-195 of the ITAA 1997 to reduce the following tax balances: • deductible tax losses incurred by the debtor (section 245-115 of the ITAA 1997); • deductible net capital losses incurred by the debtor in respect of income years before the forgiveness income year (section 245-130 of the ITAA 1997); • deductible expenditures that are to be taken into account in arriving at the taxable income of the debtor for the forgiveness income year or a later income year (section 245-145 of the ITAA 1997), and • the relevant cost bases of the debtor's CGT assets other than those specifically excluded (section 245-175 of the ITAA 1997). So long as the total net forgiven amount is applied to the maximum extent possible in reduction of tax losses, a taxpayer can choose the order in which losses are deducted and the amount applied to reduce each of those losses: section 245-120 of the ITAA 1997. Any net forgiven amount remaining after reducing tax losses either because there are insufficient tax losses or there are no losses, is next applied against net capital losses. Any part of the total net forgiven amount for the forgiveness income year remaining after being successively applied against the tax balances listed above is disregarded; it is neither carried forward and added to the taxpayer's net forgiven amounts of any succeeding year of income or is it assessable to tax: section 245-195 of the ITAA 1997. For the purposes of section 245-130 of the ITAA 1997, net capital losses are losses that the debtor has for an income year earlier than the forgiveness income year and which are eligible to be applied in working out the debtor's net capital gain (assuming the debtor had sufficient capital gains) for the forgiveness income year, ignoring the effect of this subdivision. In this case, the taxpayer has no deductible tax losses and an amount of earlier year net capital losses that exceed the net forgiven amount. Accordingly, the net forgiven amount will be applied, under section 245-130 and in accordance with section 245-135 of the ITAA 1997, in reduction of the taxpayer's net capital losses. Any part of the total net forgiven amount remaining after this will be successively applied against the remaining tax balances listed above.