About commercial debt forgiveness
Generally, if a commercial debt owed by a taxpayer is forgiven during the income year, the taxpayer should apply the total 'net forgiven amount' of that debt to reduce in this order:
- tax losses from prior income years (in the order the taxpayer prefers)
- net capital losses from prior income years (in the order the taxpayer prefers)
- certain undeducted expenditure (set out in the table at section 245-145 of the ITAA 1997)
- cost bases of CGT assets.
However, a partnership can only apply the total net forgiven amount against undeducted expenditure because:
- partnerships can't have tax losses or net capital losses from prior income years
- for CGT purposes, each partner (and not the partnership) has a separate cost base (and reduced cost base) for the partner’s interest in each CGT asset of the partnership.
Any total net forgiven amount that remains after the partnership has applied it to certain undeducted expenditure is applied to the tax balances of the partners in accordance with their share of the partnership net income or loss.
Understanding commercial debt
A debt is a commercial debt if any part of, or an amount in the nature of, interest paid or payable on it is or would be an allowable deduction, or could have been deducted if not for some provision in the income tax legislation that has the effect of preventing a deduction (other than the exceptions in subsection 8-1(2) of the ITAA 1997 for outgoings of a capital nature, private or domestic outgoings and for outgoings relating to exempt income or non-assessable non-exempt income).
If interest isn't payable in respect of the debt, the debt is still a commercial debt if interest would have been deductible had interest been payable.
Forgiveness of a debt
Generally, a debt is forgiven if the partnership’s obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full.
A debt is also forgiven if one or more of the following happen:
- a creditor assigns the right to receive payment of the debt to an associate of the debtor
- a creditor subscribes for shares in a debtor company to enable the debtor to repay the debt it owes to the creditor, and the debtor uses any of the money subscribed to repay some or all of the debt
- the right to recover the debt ceases because of the expiry of a limitation period.
Calculation of the net forgiven amount
Calculate the net forgiven amount of a debt as follows:
- Determine the value of the debt, this is usually the lesser of either
- the market value of the debt at the time of forgiveness (assuming the partnership was solvent at the time the partnership incurs the debt and there isn't a change in partnership’s capacity to pay the debt from the time they incur the debt)
- 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 you incur the debt 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 assigned debt – see sections 245-60 and 245-61 of the ITAA 1997.
- Calculate the gross forgiven amount of the debt by subtracting from the value of the debt certain amounts in respect of the forgiveness – see section 245-65 of the ITAA 1997. This is normally the sum of the amounts of money the partnership has paid, or the market value of the property the partnership has given, in respect of the forgiveness of the debt. Special rules apply in determining the amount to subtract if a debt is forgiven by subscribing for shares in the debtor company or if the debt is assigned.
- Reduce the gross forgiven amount of the debt by any amount
- which has been, or will be, included in the partnership’s assessable income for any income year as a result of the forgiveness of the debt
- by which a deduction otherwise allowable to the partnership has been, or will be, reduced 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)
- by which the cost base of any CGT assets of the partnership has been, or will be, reduced under Part 3-1 or 3-3 (the CGT provisions) of the ITAA 1997 as a result of the forgiveness of the debt. The amount (if any) remaining is the new forgiven amount of the debt.
- The total of the net forgiven amount of each debt that is forgiven during the income year is the 'total net forgiven amount' for the income year.
Application of total net forgiven amount
Apply the total net forgiven amount to reduce the amounts the partnership has for certain undeducted expenditures.
The partnership may choose the items against which it applies the total net forgiven amount, providing it applies it to the maximum extent possible within the total available undeducted expenditures. If any balance remains after applying the amount to the maximum extent possible, special rules apply to partnerships..
Expenditures
Expenditures against which you can apply the total net forgiven amount are limited to those the partnership incurs before the forgiveness income year which remain undeducted but which would be deductible in that year or future income years.
These expenditures are:
- deductible under Division 40 of the ITAA 1997 (capital allowances)
- those you incur in borrowing money to produce assessable income under section 25-25 of the ITAA 1997
- on scientific research under subsection 73A(2) of the ITAA 1936
- on R&D deductible under Division 355 of the ITAA 1997
- advance revenue under Subdivision H of Division 3 of Part III of the ITAA 1936
- on acquiring a unit of industrial property to produce assessable income under subsection 124M(1) of the ITAA 1936
- on Australian films under section 124ZAFA of the ITAA 1936
- on assessable income-producing buildings and other capital works under section 43-10 of the ITAA 1997.
There are 2 principal methods for reducing expenditures:
- Straight line deduction: If you calculate the deduction as a percentage, fraction or proportion of a base amount (for example, deductions for the decline in value of depreciating assets you calculate using the prime cost method), make the reduction to the base amount. The effect is that you reduce the deductions allowable in the forgiveness income year and later income years. The total amount of deductions allowable is limited to the reduced base amount. Treat the amount of the reduction as if it had been a deduction when calculating any balancing adjustment amount.
- Diminishing balance deduction: If the deduction for a particular expenditure is a percentage, fraction or proportion of an amount you work out after considering any previous deductions for the expenditure (for example, deductions for the decline in value of depreciating assets you calculate using the diminishing value method), treat the amount of the reduction as being allowable as a deduction before the forgiveness income year.
If we disallow any deductions under the ITAA 1936 or the ITAA 1997 because of recouping an amount of expenditure that is subject to reduction as a result of the above debt forgiveness rules. Include in the assessable income of the partnership in the income year you recoup expenses, the expenditure you recoup against which you reduce the total net forgiven amount was .
Special rules
Special rules apply if a partnership (other than a corporate limited partnership) has a total net forgiven amount which they can't fully apply in reducing the categories of amounts.
Any part that you can't apply in that way you allocate to the partners in the proportion they share in the net income of the partnership or the partnership loss. Each partner is taken to have had a debt forgiven during the forgiveness income year, and the amount calculated under the formula is added to the individual partner’s other net forgiven amounts (if any) in calculating the partner’s total net forgiven amount for the forgiveness income year. For more information, see subsection 245-215 of the ITAA 1997.
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