Division 7A applies to all debts forgiven on or after 4 December 1997, regardless of when the debt arose.
A debt or part of a debt is forgiven under the following circumstances.
- Your obligation to pay the debt (or part of the debt) is released, waived or otherwise extinguished (other than as a result of you fully paying the debt in cash or in property, where the arm's length value of the property is at least equal to the amount of the debt).
- The private company loses its right to sue for recovery of the debt due to the operation of a statute of limitations. The limitation period is six years (except for the Northern Territory where it is three years) from the date that the right to sue to recover commences but can be extended if you acknowledge or make a part payment of the debt.
- You enter into an arrangement with the private company, where your obligation to pay the debt will end at a future time without you having to pay anything (other than a token amount). The arrangement does not have to be legally enforceable and the debt may still remain in the private company's accounting records.
Caramel Pty Ltd is owed $100,000 by a shareholder, Jessica. Jessica enters into an arrangement with Caramel Pty Ltd in the 2005-06 income year under which her obligation to pay the debt will end on 30 June 2008 provided she pays Caramel Pty Ltd consideration of $1,000 on that day. Caramel Pty Ltd continues to record the debt from Jessica as an asset worth $100,000.
The debt of $100,000 is forgiven at the time the arrangement is entered into. Caramel Pty Ltd is taken to pay a dividend to Jessica of $100,000 on 30 June 2006, subject to Caramel Pty Ltd's distributable surplus. The actual forgiveness of the debt on 30 June 2008 is disregarded as the amount has already been treated as a dividend.
- You enter into a 'debt parking' arrangement. This is where:
- the private company assigns its right to receive payment of the debt to a new creditor, who is either your associate or a party to an arrangement with you about the assignment
- it is reasonable to expect that the new creditor will not require you to repay the debt.
Cosy Pty Ltd is owed $7,000 by its shareholder Fred. In the 2005-06 income year, Cosy Pty Ltd assigns its right to receive payment of the debt to Fred's wife, Maxine.
This is a debt parking arrangement because Maxine is an associate of Fred's and it is reasonable to expect that Maxine will not require Fred to repay the debt. Cosy Pty Ltd is taken to pay a dividend of $7,000 to Fred on 30 June 2006, subject to Cosy Pty Ltd's distributable surplus.
- It is reasonable to expect that the private company will not insist or rely on you repaying the debt. Examples of this may include:
- you losing the capacity to repay the debt
- the private company never requiring you to make a repayment
- the private company not treating the debt as a genuine liability (for example, the debt is not included on financial statements prepared for third parties)
- you subscribe for shares in the private company to enable the company to make a payment in discharge of the debt, and the company applies all or any of the subscription money towards the debt. The amount taken to be forgiven is the subscription money applied by the private company. The time of forgiveness is when the money is applied.