Private ruling: Commissioner's discretion - Division 7A debt forgiveness
Published: July 2013
Ruling period: 1 July 20XX to 30 June 20YY

Ruling: Question and answer | Will the Commissioner exercise his discretion under subsection 109G(4) of the Income Tax Assessment Act 1936 and not treat the forgiven debt as a deemed dividend? | No.

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 was established. Since establishment the Trust activities have involved property subdivision, development and sale which represented trading stock to the Trust. The final property lots were sold and the entity proceeded to finalise matters with the view to winding up. An external finance facility was paid out and the only matters remaining were loan balances owing to the related parties. The debt owed by the Trust to the Company and related parties was forgiven. The Company is a related party of the beneficiary Company X. The shareholder of the Company is Trust 2 of which Company X is trustee. The beneficiaries of Trust 2 are Company Y as trustee for Trust 3 and Company X and not subject to the private ruling request. The loan owing to Company Y in its capacity as trustee of Trust 3 was forgiven. The loan balances were incurred throughout the life of the Trust's operational activities. At the time the forgiven debt was made the Trust was able to repay the amount loaned. The loan to the Company was not a fixed amount from a fixed point in time rather the value has fluctuated over the years as contributions were made by the Company or funds released to the Company when available. The loaned funds were contributed to assist with capital and ongoing business development requirements. The loan balance and transactions were not relevant for the definition of ordinary income for the Trust. The decision to wind up the activities of the Trust had resulted from the completion of the property subdivision it was developing. The subdivision consisted of a number of stages. The final X stages were subdivided out of some residual land and the topography of the land delayed development beyond the completion of the first stages which in turn resulted in slow sales rate and low sale prices. Given most of the subdivision occurred more than 7 years ago the detailed sales records are not available. The delay in sales also resulted in costs being incurred such as interest, land tax, rates which further eroded any potential profit margins. This was a long term business venture between X parties which has been completed. The delay in finalising the subdivision due to the poor quality of the last lots and the global financial crisis that has seen a difficult and competitive residential property market in the last few years has meant that the project has extended past the anticipated completion date. The parties involved were unable to realise the appropriate anticipated cash returns from the Trust's activities resulting in an outstanding liability that is unable to be paid from the assets of the Trust. The repayment of the loan by the Trust would place undue hardship on the Trust as it holds no assets upon which to secure external finances and has ceased trading with no opportunity to generate future income to fund the repayment of the loan. The Trust's inability to repay the debt is a result of unfavourable trading and market conditions beyond the Trust's control.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 109F(1) | Income Tax Assessment Act 1936 subsection 109G(4) | Income Tax Assessment Act 1936 Section 109Y

Reasons for decision: Summary: Under Division 7A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) amounts paid, lent or forgiven by a private company to certain associated entities are treated as dividends, unless they come within specific exclusions. The provisions apply where the recipient of the payment, loan or forgiven amount is a shareholder or an associate of a shareholder of the private company. Under subsection 109F(1) of the ITAA 1936 a private company is taken to pay a dividend to an entity (being a shareholder of or associate of a shareholder of the company) at the end of its year of income if all or part of a debt owed by the entity to the company is forgiven in that year. The amount of the dividend equals the amount of the debt forgiven, subject to section 109Y of the ITAA 1936. However subsection 109G(4) of the ITAA 1936 provides that a private company will not be taken to pay a dividend in such circumstances if: a) the debt was forgiven because payment of the debt would have caused the entity undue hardship; 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. The Explanatory Memorandum to Act No 47 of 1998 states: "The Commissioner has a power to exclude a forgiven debt from the operation of this Division where the Commissioner is satisfied that the shareholder or associate would suffer undue hardship. In exercising his discretion the Commissioner will take into account the ability of the shareholder or associate to repay the loan at the time it was granted, at the time it was forgiven and at any foreseeable future time. The Commissioner will only exercise his discretion if he is satisfied that the shareholder had the ability to pay at the time of receipt of the loan and lost the ability to pay, permanently, through no fault of his or her own." The CCH Federal Tax Reporter states that, whilst it is unclear what will constitute "circumstances beyond the entity's control" for this purpose, it may be expected that such circumstances may include loss of market share, loss of competitive advantage, high staff costs and turnover, unfavourable exchange rate variations or unfavourable stock market fluctuations. | Detailed Reasoning - Application to your circumstances: There were approximately Z lots in the entire subdivision across V stages. The final X stages were subdivided out of some residual land and the topography of the land delayed development beyond the completion of the first stages which in turn resulted in slow sales rate and low sale prices. Given most of the subdivision occurred more than 7 years ago the detailed sales records are not available. The final property lots were sold and the entity proceeded to finalise matters with the view to winding up. The loan balances were incurred throughout the life of the Trust's operational activities. The loan to the Company was not a fixed amount from a fixed point in time rather the value has fluctuated over the years as contributions were made by the Company or funds released to the Company when available. The parties involved were unable to realise the appropriate anticipated cash returns from the Trust's activities resulting in an outstanding liability that is unable to be paid from the assets of the Trust. | Detailed Reasoning - Conclusion: To be eligible for debt forgiveness you must satisfy all the requirements set out under 109G(4) of the ITAA 1936. You have been unable to provide details on the sale price of the individual lots. You have not shown that the Trust could meet its obligations when the debt was incurred. You have not shown that, between the time the debt was incurred until the final lots were sold, the Trust satisfied the debt, making the required minimum repayments of principle and interest. Accordingly, there is insufficient evidence to support you have satisfied all requirements of subsection 109G(4) of the ITAA 1936. Therefore; the Commissioner will not exercise his discretion under subsection 109G(4) of the ITAA 1936.

Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not considered the application of Part IVA to the arrangement you asked us to rule on.