• Appendix 4: Commercial debt forgiveness

    If a commercial debt owed by the trust is forgiven during the income year, apply the ‘net forgiven amount’ of that debt 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 a commercial debt if any part of the interest payable on the debt is or would be an allowable deduction, or could have been deducted but for a specific exception provision in the ITAA 1997 (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 income non-exempt income).

    Where interest is not payable, a debt 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 trust’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 it to an associate of the debtor
    • the debtor is a company and the creditor subscribes for shares in that company
    • 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:

    1. Determine the value of the debt. This is usually the lesser of:    
      • the market 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 capacity to pay the debt has not changed from the time the debt was incurred), and
      • the sum of the market value of the debt at the time the debt was forgiven (based on the above assumptions and assuming that interest rates and currency exchange rates that affect the market value of the debt remain constant from the time the debt was incurred until the forgiveness time) plus any amounts allowable as deductions because of the forgiveness of the debt that are attributable to changes in those interest rates and currency exchange rates. This might occur because of a decrease in the value of the debt due to market movements. Special rules apply in calculating the value of non-recourse debt and previously assigned debt; see sections 245-60 and 245-61 of the ITAA 1997.
       
    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.
    3. Work out the net forgiven amount, by subtracting from the gross forgiven amount, any amount:    
      • which has been, or will be, included in the trust’s assessable income for any income year as a result of the forgiveness of the debt
      • by which a deduction otherwise allowable to the trust has been, or will be, reduced as a result of the forgiveness of the debt, except for a reduction under Division 727 of the ITAA 1997 (which is about(indirect value shifting) and
      • by which the cost base of any CGT assets of the trust has been, or will be, reduced as a result of the forgiveness of the debt under the CGT provisions of the ITAA 1997.
       

    The balance amount (if any) remaining is the net forgiven amount of that the debt.

    Total 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 trust 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 trust may choose the item 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 any excess remaining amount against all categories, disregard this excess.

    Tax losses

    These are tax losses from an earlier income year and undeducted at the beginning of the forgiveness income year.

    Net capital losses

    These are unapplied net capital losses that were made in income years before the forgiveness year and could be applied in working out the debtor’s net capital gain in the forgiveness income year, assuming that the trust had sufficient capital gains.

    Expenditures

    Expenditures against which the total net forgiven amount can be applied are limited to those incurred by the trust before the forgiveness income year which remain undeducted but which, on conditions prevailing at the beginning of the forgiveness income year, would be deductible in that year or future income years. Expenditures mean:

    • expenditure deductible under Division 40 of the ITAA 1997 (capital allowances)
    • expenditure incurred in borrowing money to produce assessable income under section 25-25 of the ITAA 1997
    • expenditure on scientific research
    • R&D expenditure deductible under Division 355 of the ITAA 1997
    • 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 the 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 income year and later income 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 the 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 amount of expenditure, the recouped expenditure against which the total net forgiven amount was previously reduced is included in the assessable income of the trust in the income year in which it is recouped.

    Cost bases of certain CGT assets

    The cost bases and reduced cost bases of certain CGT assets owned by the trust at the beginning of the forgiveness income year are reduced by the trust’s total net forgiven amount remaining after reducing the expenditures (see Expenditures).

    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 108-20 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 and reduced cost bases are 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 the cost base or the reduced cost base of a CGT asset, then 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 the capital gain or capital loss on a CGT event happening to the relevant CGT asset. This is 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.

    Last modified: 31 Aug 2016QC 48243