In this section
Appendix 1: Commercial debt forgiveness
If a commercial debt owed by a company is forgiven during the income year, the company should apply the ‘net forgiven amount’ of that debt to reduce the company’s tax losses, net capital losses, certain undeducted revenue or capital expenditure and the cost bases of CGT assets, in that order.
A debt is a commercial debt if the whole or any part of interest (or an amount in the nature of interest) paid or payable on the debt has been, or can be, deducted, or could have been deducted but for a specific exception provision in the income tax law (other than the exceptions in subsection 8-1(2) for outgoings of a capital nature, private or domestic outgoings and for outgoings relating to exempt income or non-assessable non-exempt income). Where interest is not payable in respect of the debt, it is still a commercial debt if interest would have been deductible if interest had been charged. The commercial debt forgiveness rules also apply to a non-equity share issued by a company.
A debt is forgiven if the company’s obligation to pay the debt is released, waived or otherwise extinguished, other than by repaying the debt in full.
A debt is also forgiven if:
- the right to recover it ceases because of the expiry of a limitation period
- a creditor assigns the right to receive payment of the debt to an associate of the debtor, or to another entity under an arrangement to which the entity and debtor were parties
- the debtor is a company, and the creditor subscribes to shares in that company to enable the debtor to repay the debt it owes to the creditor, and the debtor uses any of the money subscribed in or towards payment of the debt
- an agreement is entered into under which the obligation to pay some or all of the debt will end without the debtor incurring any obligation (other than an insignificant obligation).
Calculation of net forgiven amount
Calculate the net forgiven amount as follows:
Step 1: Determine the value of the debt. This is usually the lesser of:
- the market value at the time of the forgiveness, assuming that when you incurred the debt you were solvent and able to pay all your debts when they fell due, and your capacity to pay the debt is unchanged at the date of forgiveness, and
- the sum of what would have been the market value at the time of forgiveness if there had been no change from the date you incurred the debt in any rate of interest or currency exchange rates that affects the market value of the debt, and each amount you have deducted or can deduct as a result of the forgiveness that is attributable to such a change.
For more information about working out the value of a debt, see section 245-65 of the ITAA 1997.
Step 2: Calculate the gross forgiven amount of the debt by subtracting from the value of the debt certain amounts paid or given in respect of the forgiveness; see section 245-65 of the ITAA 1997.
Step 3: Work out the net forgiven amount by subtracting from the gross forgiven amount the sum of the following:
- any amount which has been or will be included in the assessable income of the company under a provision apart from Division 245 as a result of the debt forgiveness. For example, a gain resulting from a debt forgiveness can be treated as ordinary income of the debtor where the debt forgiven is inextricably linked to the ordinary business of the debtor
- any amount by which a deduction otherwise allowable to the debtor has been, or will be, reduced because of the debt forgiveness under a provision other than Division 245 and Division 727 (about indirect value shifting)
- any amount by which the cost base of any of your CGT assets has been, or will be, reduced as a result of the forgiveness of a debt under Part 3-1 or 3-3 (about capital gains and losses).
Step 4: Where the debtor and creditor were companies under common ownership from when the debt was incurred until it was forgiven, the companies may sign a written agreement that the creditor is to forgo a specified amount of:
- a capital loss, or
- a deduction for a bad debt under section 8-1 or section 25-35 of the ITAA 1997 for the forgiveness income year, that it would otherwise have been entitled to because of the debt forgiveness.
Such an agreement must be made before either company lodges its income tax return for the forgiveness income year (or such later date as the Commissioner determines in writing). Where that is the case, reduce the creditor’s capital loss or deduction by the specified amount (which must not exceed the amount worked out under 3 above). For the debtor company, reduce the amount remaining after 3 above by the same amount.
Step 5: The amount remaining (if any) is the net forgiven amount of the debt. Add the net forgiven amount of each debt forgiven during the income year to arrive at the total net forgiven amount for the income year.
Application of total net forgiven amount
Apply this total net forgiven amount to reduce the amounts the company has in the following categories, in the order listed:
- tax losses
- net capital losses
- certain expenditures, and
- cost bases of certain CGT assets.
Within each category, the company may choose the order of the items against which the total net forgiven amount is applied, and the amount applied in reduction of each item, provided the total net forgiven amount is applied to the maximum extent possible within that category. Once the total net forgiven amount is applied against all the amounts in a category, apply any excess against the next category in the above order. If there is an excess remaining after applying the amount against all categories, disregard this excess.
These are tax losses from an earlier income year that are undeducted at the beginning of the forgiveness income year, and that the company could deduct, assuming it had enough assessable income, in the forgiveness income year or a later income year.
Net capital losses
These are unapplied net capital losses that were made in income years before the forgiveness income year and that could be applied in working out the company’s net capital gain in the forgiveness income year, assuming that the company had sufficient capital gains.
These are certain categories of undeducted expenditure incurred by the company before the forgiveness income year which would be deductible in that or a future income year were nothing to happen to affect its deductibility (other than a recoupment in the forgiveness income year). The relevant categories are:
- expenditure deductible under Division 40 of the ITAA 1997 (depreciating assets)
- expenditure incurred in borrowing money to produce assessable income under section 25-25 of the ITAA 1997
- expenditure on scientific research under subsection 73A(2) of the ITAA 1936
- R&D expenditure deductible under Division 355 of the ITAA 1997
- advance revenue expenditure under Subdivision H of Division 3 of Part III of the ITAA 1936
- expenditure on acquiring a unit of industrial property to produce assessable income under former subsection 124M(1) of the ITAA 1936
- expenditure on Australian films under section 124ZAFA of the ITAA 1936
- expenditure on assessable income-producing buildings and other capital works under section 43-10 of the ITAA 1997.
There are two principal methods for reducing expenditures:
- Straight line deduction: If the amount that could be deducted in relation to a particular expenditure, apart from the reduction, is calculated as a percentage, fraction or proportion of a base amount (for example, deductions for the decline in value of depreciating assets calculated under the prime cost method), make the reduction to the base amount. The reduction must not exceed the base amount less the amount of that part of the expenditure in respect of which an amount has been, or can be, deducted for any income year before the forgiveness income year. The effect of the reduction is that the total amount of deductions allowable in the forgiveness income year and later income years is limited to the reduced base amount. A deduction of the amount of the reduction is taken to have been made in respect of the expenditure before the forgiveness income year for the purpose of calculating any required balancing adjustment amount.
- Diminishing balance deduction: If the amount that could be deducted in relation to a particular expenditure, apart from the reduction, is a percentage, fraction or proportion of an amount worked out after taking into account any previous deductions for the expenditure (for example, deductions for the decline in value of depreciating assets calculated under the diminishing value method), the amount of the reduction is taken to have been allowed as a deduction before the forgiveness income year.
If any deductions are disallowed under the income tax law as a result of recouping after the forgiveness income year an amount of expenditure that is subject to reduction as a result of the above debt forgiveness rules, the amount, or total of the amounts, applied in reduction of the expenditure is included in the assessable income in the income year in which the expenditure is recouped.
Cost bases of certain CGT assets
The cost bases and reduced cost bases of certain CGT assets owned by the company at the beginning of the forgiveness income year are reduced by the total net forgiven amount remaining after reducing the expenditures (see above). These are assets where a capital gain or capital loss might arise on a CGT event occurring, such as disposal of the assets.
CGT assets with cost bases not subject to reduction include those for which a capital gain or capital loss will not arise or is unlikely to arise if a CGT event happens to them, for example, CGT assets acquired before 20 September 1985, trading stock or a personal use asset within the meaning of section 108-20 of the ITAA 1997. Also excluded are CGT assets for which the cost is deductible, such as depreciating assets. For a complete list of categories of CGT assets not subject to cost base reduction, see subsection 245-175(2) of the ITAA 1997.
The company may choose the CGT assets whose cost bases or reduced cost bases are to be reduced, and the extent of that reduction. However, the cost bases and reduced cost bases of CGT assets that constitute investments in, or in relation to, associates of the company must be reduced last.
If a company chooses to apply an amount to reduce either the cost base or the reduced cost base of a CGT asset, then as at any time on or after the beginning of the forgiveness income year, the cost base and reduced cost base of each relevant CGT asset is taken to be reduced by that amount.
Ordinarily, the reduction of a CGT asset’s cost base and reduced cost base cannot exceed the amount that would have been the reduced cost base of the asset, calculated as if the asset was disposed of at market value on the first day of the forgiveness income year. However, a special rule applies (see subsection 245-190(3) of the ITAA 1997) if an event occurred after the beginning of the forgiveness income year that would cause the reduced cost base of the asset to be reduced.
The reduction of the cost base and reduced cost base of a CGT asset affects the calculation of the amount of any capital gain or capital loss on a CGT event happening to the asset, because the cost base or reduced cost base that is taken into account in determining the capital gain or capital loss must reflect that reduction.
Consolidated and MEC groups
Where a commercial debt is owed by a member of a consolidated or MEC group to a non-group entity, the head company is treated as the debtor for its income tax purposes. If the debt is forgiven, the head company must calculate the net forgiven amount and apply this amount to the head company's tax losses, net capital losses, certain expenditures and the cost bases of certain CGT assets.
In certain circumstances the head company of a consolidated group can apply a transferred tax loss or net capital loss with a nil available fraction to reduce the total net forgiven amount under the commercial debt forgiveness rules (see section 707-415 of the ITAA 1997).
One of the consequences of consolidation is that intra-group loans and intra-group dealings are not recognised for the group’s income tax purposes. Where a debt owed by one member of a consolidated or MEC group to another member of the same group is forgiven, the transaction is disregarded by the head company of the income tax consolidated group, and the commercial debt forgiveness rules do not apply to that forgiveness.
Last modified: 18 Jan 2023QC 67979