Private ruling: Net capital loss and debt forgiveness
Date of advice: 24 October 2017
Published: March 2018
Ruling period: Year ended 30 June 201Y
Date scheme commenced: During the year ended 30 June 201Y

Ruling: Q1: Has Company 1 incurred a net capital loss under Part 3-1 of the Income Tax Assessment Act 1997 (ITAA 1997) for the income year ended 30 June 201Y? | A1: No | Q2: If Company 1 has incurred a net capital loss for the income year ended 30 June 201Y, should the Y debt amount written off in favour of Company 1 in that income year be applied pursuant to section 245-130 of the ITAA 1997 in reduction of that net capital loss? | A2: This question is not applicable as Company 1 did not incur a net capital loss for the income year ended 30 June 201Y (see question 1). | Q3: Is the benefit received by Company 1 in the form of forgiven debts by the Compromised Creditors assessable income of Company 1 under the ITAA 1997 for the income year ended 30 June 201Y? | A3: No | Q4: If the benefit received by Company 1 in the form of forgiven debts by Compromised Creditors is not assessable income of Company 1 for the income year ended 30 June 201Y, should the portion of that amount not in respect of a ‘tax-related liability’ be applied by Company 1 pursuant to Subdivision 245-E of the ITAA 1997 in reduction of certain tax attributes that could otherwise reduce its taxable income? | A4: Yes

Relevant facts and circumstances: Company 1 operated its business until it was placed into external administration in mid-late 201X. Company 1 ceased being externally administered and in late 201Y was returned to the control of its directors. Loss – the X debt Company 2 was part of a group of companies with Company 1. Company 2 ceased trading in mid 201X. Liquidators were appointed to Company 2 in mid 201X. In mid 201X, Company 1 submitted a Formal Proof of Debt or Claim (General Form) with the liquidator of Company 2 stating that Company 2 was indebted to Company 1 (the ‘X debt’). The X debt was payable by Company 2 as a trade debtor. In its Report to the Creditors of Company 2 in late 201X, the liquidator stated as follows: I advise that I am expecting that there will be a possible distribution to preferred (employee) creditors of [Company 2]. However, at this stage we are unable to provide a projected return to preferred (employee) creditors as it is subject to change upon the successful recovery of voidable transactions. Once the matters are settled, a further report will be provided to creditors in order to declare a dividend to the creditors of [Company 2]… Company 1 made the commercial decision during the year ended 30 June 201Y to abandon any attempt to recover the X debt and wrote off this receivable in its books. This decision has been explained by Company 1 to have been made following the receipt of verbal advice from the liquidator that they expected that funds available upon realisation of the assets of Company 2 would only be sufficient to pay a distribution to priority (employee) creditors. No deed of release was issued by Company 1 to Company 2 in respect of the X debt. In its Annual Report to Creditors of Company 2 in mid-late 201Y, the liquidator advised that: … there will be a distribution in relation to outstanding wages and superannuation to priority (employee) creditors of the Company. I note that a further report will shortly be provided to priority (employee) creditors in order to declare a dividend and detail a projected return. In its Report to Creditors of Company 2 in mid 201Z, the liquidator advised that in late 201Y they declared a first and final dividend to preferred (employee) creditors of Company 2 with respect to outstanding wages and superannuation for xx cents in the dollar, and noted that there were insufficient funds to declare a further dividend to any class of creditors. The liquidation of Company 2 was finalised in early-mid 201A. Company 2 was deregistered in mid 201A. Gain – the Y debt In the income year ended 30 June 201Y, Company 1 also received an accounting gain in respect of unpaid labour hire fees owing to Company 3 by Company 1 (the ‘Y debt’). The Y debt accrued against Company 1’s loan account with Company 3. Following Company 3s placing into liquidation and during the year ended 30 June 201Y, the appointed liquidator chose not to call up the Y debt, and wrote it off in favour of Company 1. The Y debt was declared in Company 1’s ASIC Form 507 Report as to affairs, as part of its external administration. Compromised Creditors In the income year ended 30 June 201Y, Company 1 received a benefit from Compromised Creditors comprising of: (a) the balance of Company 1’s unpaid trade creditors which were written off; and (b) the following amounts which were written-off: (i) payable superannuation payments; and (ii) payable GST payments.

Relevant legislative provisions: Income Tax Assessment Act 1997 | Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(4) | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 section 100-35 | Income Tax Assessment Act 1997 section 100-50 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 subsection 104-25(1) | Income Tax Assessment Act 1997 paragraph 104-25(2)(b) | Income Tax Assessment Act 1997 subsection 104-25(3) | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 subsection 110-55(2) | Income Tax Assessment Act 1997 subsection 116-30(1) | Income Tax Assessment Act 1997 subsection 118-20(1) | Income Tax Assessment Act 1997 Division 245 | Income Tax Assessment Act 1997 section 245-1 | Income Tax Assessment Act 1997 subsection 245-2(1) | Income Tax Assessment Act 1997 paragraph 245-10(b) | Income Tax Assessment Act 1997 paragraph 245-35(a) | Income Tax Assessment Act 1997 paragraph 245-40(f) | Income Tax Assessment Act 1997 subsection 245-85(2) | Income Tax Assessment Act 1997 section 245-115 | Income Tax Assessment Act 1997 section 245-130 | Income Tax Assessment Act 1997 subsection 245-130(1) | Income Tax Assessment Act 1997 subsection 245-130(2) | 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 Subdivision 245-E | Income Tax Assessment Act 1997 section 995-1 | Taxation Administration Act 1953 section 255-1 of Schedule 1 Question 1 | Summary | Company 1 did not incur a net capital loss under Part 3-1 of the ITAA 1997 for the income year ended 30 June 201Y, being the year in which the X debt was written off. Company 1 incurred a capital loss of that amount for the income year ended 30 June 201Z, being the year in which Company 1’s ownership of the X debt ended for the purposes of section 104-25.

Reasons for decision: Summary: As established in response question 1 of this ruling, Company 1 did not incur a net capital loss for the income year ended 30 June 201Y. The Y debt amount forgiven in favour of Company 1 during the income year ended 30 June 201Y cannot be applied in reduction of a net capital loss incurred by Company 1 in a later income year. | Detailed Reasoning - Reason for decision: Division 245 applies to any commercial debt you owe that is forgiven (subsection 245-2(1)). The Y debt amount was a ‘commercial debt’ within the meaning of paragraph 245-10(b) because interest, or an amount in the nature of interest, could have been deducted by Company 1 had it been paid by Company 1 in respect of the Y debt. Paragraph 245-35(a) states that a debt is forgiven if and when the debtor’s obligation to pay the debt is released, waived or otherwise extinguished other than by repaying the debt in full. Company 1’s obligation to pay the Y debt was released, waived or otherwise extinguished upon the liquidator’s writing off of that debt in favour of Company 1 and, as such, constituted a forgiveness of the Y debt pursuant to paragraph 245-35(a). That amount, together with other net forgiven amounts of all of Company 1’s debts forgiven in the income year ended 30 June 201Y (if any), is applied to reduce classes of amounts that could otherwise reduce Company 1’s taxable income in the same or a later income year in the following order: ● tax losses from previous income years (section 245-115) ● net capital losses from previous income years (section 245-130) ● deductions otherwise available in the income year, or a later income year, because of expenditure from a previous year (section 245-145), and ● cost bases of CGT assets (section 245-175). With specific regard to the application of any remaining net forgiven amounts in reduction of net capital losses, section 245-130 provides: | Detailed Reasoning - 245-130(1): The total net forgiven amount (if any) remaining after being applied under section 245-115 is applied, to the maximum extent possible, in reduction, in accordance with section 243-135, of your net capital losses (if any) specified in subsection (2). | Detailed Reasoning - 245-130(2): Those net capital losses are your net capital losses for income years before the forgiveness income year that you could apply in working out your net capital gain for the forgiveness income year if you had enough capital gains. As the Y debt was a debt forgiven in the income year ended 30 June 201Y, the extent to which the net forgiven amount of that debt has not been applied to reduce tax losses incurred by Company 1 from previous income years may only be applied to reduce net capital losses incurred by Company 1 from income years prior to that which ended on 30 June 201Y. Any net capital loss incurred by Company 1 and comprising the capital loss made in respect of the ending of the X debt in the income year ended 30 June 201Z cannot therefore be reduced by the net forgiven amount of the Y debt. | Summary: The benefit received by Company 1 in the form of forgiven debts by the Compromised Creditors will not be assessable income of Company 1 under the ITAA 1997 for the income year ended 30 June 201Y. | Detailed Reasoning - Reasons for Decision: Section 6-5 includes income according to ordinary concepts (ordinary income) in assessable income. Whether or not a particular amount is income according to ordinary concepts depends on the nature and character of the receipt in the hands of the taxpayer. Ordinary income may be said to be derived pursuant to subsection 6-5(4) which provides that an amount of ordinary income will be taken to be received as soon as it has been applied or dealt with in any way on behalf of or as directed by the taxpayer. The amount of debt written off by the Compromised Creditors in favour of Company 1 does not constitute an amount paid or credited to Company 1, nor an amount which is applied or dealt with on behalf of Company 1 or as Company 1 directs. As the debt written off in Company 1’s favour was not received by, or credited to Company 1 (either directly or as deemed by subsection 6-5(4)), the amount will not be subject to tax pursuant to section 6-5. Further, the benefit received by Company 1 in the form of forgiven debts by the Compromised Creditors will not constitute statutory income of Company 1 pursuant to section 6-10. | Summary: As the benefit received by Company 1 in the form of forgiven debts by Compromised Creditors is not assessable income of Company 1 for the income year ended 30 June 201Y, that amount can be applied by Company 1 pursuant to Subdivision 245-E, to the extent that it is not in respect of a tax-related liability, in reduction of certain tax attributes that could otherwise reduce its taxable income. | Detailed Reasoning - Reason for decision: When a creditor forgives a commercial debt you owe, you make a gain. As confirmed by question 3 of this ruling, this is usually not included in your assessable income. Instead, Division 245 offsets the forgiven amount against amounts that could otherwise reduce your taxable income in the same or a later income year (section 245-1). Division 245 applies to any commercial debt you owe that is forgiven (subsection 245-2(1)). The debt payable to the trade creditors and the debt payable in respect of superannuation were ‘commercial debts’ within the meaning of paragraph 245-10(b) because interest, or an amount in the nature of interest, could have been deducted by Company 1 had it been paid by Company 1 in respect of those debts. Company 1’s obligation to pay the trade creditor and superannuation debts was released, waived or otherwise extinguished upon their writing off in favour of Company 1 and, as such, constituted a forgiveness of those commercial debts pursuant to paragraph 245-35(a). That amount, together with other net forgiven amounts of all of Company 1’s debts forgiven in the income year ended 30 June 201Y (including the Y debt), is applied to reduce classes of amounts that could otherwise reduce Company 1’s taxable income in the same or a later income year in the following order: ● tax losses from previous income years (section 245-115) ● net capital losses from previous income years (section 245-130) ● deductions otherwise available in the income year, or a later income year, because of expenditure from a previous year (section 245-145), and ● cost bases of CGT assets (section 245-175). To the extent that any of the net forgiven amount of the trade creditor and superannuation debts remains after application of that amount in making reductions under the provisions of Subdivision 245-E, that remaining amount is disregarded (section 245-195). Division 245 does not apply if the debt is a tax-related liability (paragraph 245-40(f)). ‘Tax-related liability’ is defined in section 995-1 as having the meaning given by section 255-1 in Schedule 1 to the Tax Administration Act 1953 . That provision defines a tax-related liability to mean a pecuniary liability to the Commonwealth arising directly under a taxation law (including a liability the amount of which is not yet due and payable). Therefore, Division 245 will not apply to the debt payable by, and written off in favour of, Company 1 in respect of GST, as this amount is a tax-related liability.

For most CGT events you make a capital loss if your total costs associated with the CGT event exceed the capital amounts you receive (or are entitled to receive) from the event (section 100-35). Where your capital losses for the income year exceed the capital gains, the difference is your net capital loss (section 100-50). | Section 108-5 states that a CGT asset can be a legal or equitable right that is not property. Note 1 to section 108-5 expands on this to include, as an example of a CGT asset, a debt owed to you. Therefore, the X debt owed to Company 1 by Company 2 was a CGT asset of Company 1 under section 108-5. | Subsection 104-25(1) provides that CGT event C2 happens if ownership of an intangible CGT asset ends by the asset: | (a) being redeemed or cancelled; or | (b) being released, discharged or satisfied; or | (d) being abandoned, surrendered or forfeited; or | (e) if the asset is an option – being exercised; or | (f) if the asset is a convertible interest – being converted. | In the absence of a contract which results in the asset ending, the time of the CGT event C2 is when the asset ends (paragraph 104-25(2)(b)). | The mere writing off of a debt by a taxpayer is insufficient to constitute a cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment at law or in equity for the purposes of subsection 104-25(1). | For an asset such as a debt or a loan, the requirements of subsection 104-25(1) would be met when the creditor or the lender (as appropriate) is no longer entitled to seek payment of any outstanding amount. | In respect of a corporate debtor who has been placed in liquidation, the debt will continue to exist until such time as the liquidator has realised the company’s assets and declared a final dividend (if any). | Alternatively, the debt may be extinguished sooner by forgiveness under a deed of release such that the owner of the debt is legally barred from collecting the debt. In any event, a debt will not be extinguished if it is merely forgiven or abandoned without any legal impediment imposed on its collection. | On the basis of the above and without having issued a deed of release to Company 2 in respect of the X debt, Company 1’s ownership of the X debt owed to Company 1 by Company 2 only ended for the purposes of subsection 104-25(1), by reason of cancellation, release, discharge, satisfaction, surrender, forfeiture, expiry or abandonment, when Company 1 was legally impeded from recovering any of the X debt. | Company 1’s ownership of the X debt owed to Company 1 by Company 2 did not end as a result of a mere (verbal) statement by the liquidator on the likely outcome of the liquidation of Company 2. Company 1’s ownership of the X debt is instead considered to have ended upon the liquidator’s declaration of a first and final dividend to preferred (employee) creditors of Company 2, at which time Company 2 was effectively released from all provable debts (i.e. in late 201Y). | As such, the CGT event C2 under section 104-25 in respect of the ending of the X debt owned by Company 1 happened in the income year ended 30 June 201Z, and not in the income year ended 30 June 201Y (when the X debt was written off). | Company 1 will have made a capital loss from this event in the year ended 30 June 201Z if the capital proceeds from the ending of the X debt were less than the reduced cost base of the X debt (subsection 104-25(3)). | As Company 1 received no consideration for the ending of the X debt, it is taken to have received, as capital proceeds, an amount equal to the market value of the debt at the time of the ending (subsection 116-30(1)). On the basis that Company 2 was insolvent at the time, the market value of the debt was nil. | The reduced cost base of the X debt was the face value of the X debt (subsection 110-55(2)). | As the X debt constituted an amount owing to Company 1 in the ordinary course of Company 1’s business, it was not a personal use asset such that the capital loss made on it is not disregarded pursuant to subsection 118-20(1).