Private ruling: Commercial debt forgiveness
Date of advice: 14 September 2017
Published: January 2018
Ruling period: Income year ended 30 June 2017
Date scheme commenced: 26 May 2015

Ruling: Q1: Do the commercial debt provisions in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997) apply when a loan made to you is forgiven by the Trustee of the Trust (Trust)? | A1: Yes.

Relevant facts and circumstances: You are an Australian resident company. The Trust holds 100% of your shares. The Trust loaned you an amount in the income year ended 30 June 2015. A Loan Agreement documented the loan and it was subsequently registered with an amount of duty paid on the loan. The property of the Trustee was provided as security for the loan. A caveat was lodged over your property as security for the loan. You conducted a small business at the time the loan was made. At this time there was a genuine expectation that your business would grow and be able to pay dividends in the future. Throughout the life of the loan, you made some repayments and interest was charged on the loan. You used the loan funds in your business, and hence the interest charged on the loan was deductible to you. You sold your business in the income year ended 30 June 2017. As you have ceased trading, you intend to de-register. Due to the closure of your business, you are unable to repay the outstanding loan balance. Due to your incapacity to repay the loan, the Trust forgave the loan. This was recorded in your meeting minutes, with a recording that the rules in Division 245 of the ITAA 1997 would be applied for the following reasons: ● When the Trust lent the money that the company was solvent. ● When the Debt was forgiven the company was insolvent as it was sold. ● The loan was not a “personal use asset” and that the Trust lent money to the company so that it could generate future Dividends (income producing purpose). ● There was a genuine expectation that dividends will be paid and that way the reason the Trust lent the money. Therefore: ● The Trust will treat the balance of the loan amount as a capital loss. ● You have no effect (not income and not capital) except that the balance of the loan will reduce any carried forward tax losses and carried forward capital losses.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 245. | Income Tax Assessment Act 1997 Subdivision 245-C. | Income Tax Assessment Act 1997 Subdivision 245-E. | Income Tax Assessment Act 1997 Subsection 245-2(1). | Income Tax Assessment Act 1997 Section 245-10. | Income Tax Assessment Act 1997 Section 245-35. | Income Tax Assessment Act 1997 Section 245-85. | Income Tax Assessment Act 1997 Section 245-195.

Reasons for decision: Summary: Subsection 245-2(1) of the ITAA 1997 provides that Division 245 applies to the forgiveness of a commercial debt. A debt is a commercial debt pursuant to section 245-10 of the ITAA 1997 if interest paid or payable on the debt is deductible to the debtor. 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 your case, the loan was forgiven by the Trust in the income year ended 30 June 2017. As the interest charged on the loan was deductible to you, the commercial debt forgiveness rules in Division 245 of the ITAA 1997 apply to the forgiveness of the debt. There are some exceptions to these rules, however these don’t apply in your situation. Subdivision 245-E of the ITAA 1997 provides that the application of Division 245 of the ITAA 1997 will require you to reduce the following amounts (in the following order) by the net forgiven amount of the debt: (a) your tax losses from previous income years; (b) your net capital losses from previous income years; (c) some undeducted expenditures; (d) the cost bases of some CGT assets. If any net forgiven amount remains after reducing your tax losses, net capital losses, undeducted expenditure and CGT asset cost bases, the balance is disregarded pursuant to section 245-195 of the ITAA 1997. The net forgiven amount of the debt is calculated under section 245-85 of the ITAA 1997 by reducing the gross forgiven amount of the debt by any amount that is already taken into account in determining the debtor’s taxable income because the debt was forgiven. Subdivision 245-C of the ITAA 1997 provides that the gross forgiven amount of the debt reflects the loss that the creditor makes for tax purposes. It is calculated by working out the value of the debt when the debt is forgiven, less any consideration given in respect of the forgiveness. Generally, the value of the debt is its market value at the time of the forgiveness assuming the debtor is solvent when the debt is incurred as well as when the debt is forgiven. Based on the information you have provided, you will have a net forgiven amount of the outstanding loan balance. This will be applied to reduce any tax or net capital losses you have from previous income years, any undeducted expenditures and the cost bases of some CGT assets. Any net forgiven amount remaining after the reduction of these amounts will be disregarded. The rulings in the register have been edited and may not contain all the factual details relevant to each decision. Do not use the register to predict ATO policy or decisions.