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If a commercial debt owed by the trust is forgiven during the income year, apply the net amount of debts forgiven to reduce the trust’s tax losses, net capital losses, certain undeducted revenue or capital expenditure, and the cost base of CGT assets, in that order.
A debt is commercial if any part of the interest payable on it is or would be an allowable deduction if not for some specific exception provision. If interest is not payable, the debt is still a commercial debt if interest, if charged, would have been deductible.
A debt is forgiven if the trust’s obligation to pay the debt is released or waived or otherwise extinguished other than by repaying the debt in full.
A debt is also forgiven if a creditor assigns it to an associate of the debtor, in certain other circumstances, or if the right to recover it ceases.
Calculation of net forgiven amount
Calculate the net forgiven amount as follows:
- Determine the value of the debt. This is usually the lesser of the
- value of the debt at the time of forgiveness (assuming the trust was solvent at the time the debt was incurred and the trust’s creditworthiness has not changed from the time the debt was incurred), and
- sum of the value of the debt at the time the debt was forgiven (based on the above assumptions and assuming that any market variables remain constant) and any amounts allowable as deductions because of the forgiveness of the debt that are attributable to changes in market variables. This might occur because of a decrease in value of the debt due to market movements. Special rules apply in calculating the notional value of non-recourse debt and in respect of debt parking circumstances. See sections 245-60 and 245-61 of the ITAA 1997.
2. Calculate the gross forgiven amount of the debt by deducting from the value of the debt certain amounts in respect of the forgiveness. These amounts are normally the sum of the amounts of money the trust is required to pay in respect of the forgiveness or, if property is required to be given, the market value of the property. Special rules apply in determining the consideration given for the forgiveness if a debt is forgiven in exchange for shares, or if there are debt parking circumstances. See section 245-65 of the ITAA 1997.
3. Reduce the gross forgiven amount by any amount
- which has been, is, or will be, included in the trust’s assessable income as a result of the forgiven debt
- by which a deduction otherwise allowable to the trust has been or will be reduced as a result of the forgiven debt except for a reduction under Division 727External Link (indirect value shifting) of the ITAA 1997, and
- by which the cost base to the trust of any CGT asset has been or will be reduced as a result of the forgiveness of the debt under Part 3-1External Link or 3-3 of the ITAA 1997. The balance remaining is the net forgiven amount of that debt.
4. Add the net forgiven amount to the net forgiven amounts of other debts 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 trust has in the following categories, in the order listed:
- tax losses
- net capital losses
- expenditures, and
- cost bases of certain CGT assets.
Within each category, the trust may choose the loss, item of expenditure or asset against which the total net forgiven amount is applied, provided it 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 to the maximum extent possible against all categories, disregard this excess.
These are tax losses incurred by the trust in an earlier income year and undeducted at the beginning of the forgiveness year.
Net capital losses
These are unrecouped net capital losses incurred in income years before the forgiveness year.
Expenditures are limited to those incurred before the forgiveness year which remain undeducted but which, on conditions prevailing at the beginning of the forgiveness year, would be deductible in that year or future years. Expenditures mean:
- expenditure deductible under Division 40 of the ITAA 1997 (uniform capital allowances)
- expenditure incurred in borrowing money to produce assessable income
- expenditure on scientific research
- advance revenue expenditure
- expenditure on acquiring a unit of industrial property to produce assessable income
- expenditure on assessable income-producing buildings and other capital works.
There are two principal methods for reducing expenditures:
- If the deduction is calculated as a percentage of a base amount (for example, deductions for decline in value of depreciating assets calculated under the prime cost method), make the reduction to the base amount.
- The effect is that deductions allowable in the forgiveness year and later years are reduced.
- The total amount of deductions allowable is limited to the reduced base amount.
- The amount of the reduction is treated as if it had been a deduction when calculating any required balancing adjustment amount.
- If the deduction for a particular expenditure is a percentage, fraction or proportion of an amount worked out after taking into account any deductions for the deductible expenditure previously allowed to the trust (for example, deductions for decline in value of depreciating assets calculated under the diminishing value method) the forgiven amount is taken to have been allowed as a deduction before the forgiveness income year.
If any deductions are disallowed under the ITAA 1936 or the ITAA 1997 as a result of recouping an expenditure, the total net forgiven amount by which the recouped expenditure was previously reduced is treated as assessable income in the year it is recouped.
Cost bases of certain CGT assets
The cost bases of certain CGT assets owned by the trust at the beginning of the forgiveness year may be reduced by the trust’s total net forgiven amount, essentially, these are assets where a capital gain or capital loss might arise on a CGT event, such as disposal, happening to them.
Assets whose cost bases are 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 108-20External Link of the ITAA 1997. Also excluded are CGT assets whose cost is deductible, such as depreciating assets.
The trust may choose the CGT assets whose cost bases are to be reduced and the extent of that reduction. However, the cost base of assets that constitute investments in associates of the trust must be reduced last. If a trust chooses to apply an amount to reduce either the cost base or the reduced cost base of a CGT asset, then at any time from the beginning of the forgiveness income year, each of the relevant cost bases (that is, the cost base or reduced cost base) is taken to be reduced.
Ordinarily, the reduction of a CGT asset’s relevant 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)External Link of the ITAA 1997) if an event occurred after the first day of the forgiveness year that would cause the reduced cost base of the asset to be reduced.
The reduction of the relevant cost base of a CGT asset affects the calculation of the amount of the capital gain or capital loss on a CGT event happening to the nominated CGT asset because the relevant cost base that is taken into account in determining the capital gain or capital loss must reflect that reduction.
Last modified: 05 Jul 2014QC 35444