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Ruling

Subject: Commercial debt forgiveness

Question 1

Does the notional value of the forgiven debt, for the purposes of the commercial debt forgiveness provisions of Division 245 of Schedule 2C of the Income Tax Assessment Act 1936 (ITAA 1936), take into account the debtor's capacity to pay the debt at the time of the forgiveness?

Answer

No, as the creditor is not a resident of Australia, the notional value is determined with the assumption that the debtor is solvent.

Question 2

Will the notional value of the forgiven debt, for the purposes of the commercial debt forgiveness provisions of Division 245 of Schedule 2C of the ITAA 1936, be decreased to take into account any market variables?

Answer

No, however the notional value of the debt may be increased to reflect any deductions allowable to the debtor as a result of these market variables.

Question 3

Are there any further consequences under Division 245 of Schedule 2C of the ITAA 1936 if there is an unapplied net forgiven amount after applying it to the maximum extent possible as required under Subdivision 245-E of Schedule 2C of the ITAA 1936?

Answer

No

This ruling applies for the following period

Years ended 31 December 2009

The scheme commenced on

1 January 2009

Relevant facts

The rulee is an Australian resident taxpayer and has no 'related companies' nor any entities under common ownership.

The debt was provided on arm's length terms by a non-resident (the creditor) to the rulee after 27 June 1996.

The debt satisfies the definition of a commercial debt under section 245-25 as a tax deduction is claimed for the interest charged on the debt.

The debt is not a moneylending debt and is not a non-recourse debt.

The rulee does not have the capacity to repay the debt, and the creditor is considering forgiving the debt. There are market variables included in the value of the debt.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 245 of Schedule 2C,

Income Tax Assessment Act 1936 Subdivision 245-D of Schedule 2C,

Income Tax Assessment Act 1936 Subdivision 245-E of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-55 of Schedule 2C,

Income Tax Assessment Act 1936 Subsection 245-55(4) of Schedule 2C,

Income Tax Assessment Act 1936 Sub-paragraph 245-55(3)(a)(iii) of Schedule 2C,

Income Tax Assessment Act 1936 Paragraph 245-55(3)(b) of Schedule 2C,

Income Tax Assessment Act 1936 Subsection 245-55(5) of Schedule 2C,

Income Tax Assessment Act 1936 Subsection 245-65(2) of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-75 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-110 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-120 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-125 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-130 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-135 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-140 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-145 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-150 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-155 of Schedule 2C,

Income Tax Assessment Act 1936 Paragraph 245-155(1)(c) of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-165 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-170 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-175 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-180 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-195 of Schedule 2C,

Income Tax Assessment Act 1936 Section 245-60 of Schedule 2C,

Income Tax Assessment Act 1997 Section 104-25,

Income Tax Assessment Act 1997 Section 855-15,

Income Tax Assessment Act 1997 Part 3-1 ,

Income Tax Assessment Act 1997 Part 3-3,

Income Tax Assessment Act 1997 Division 40 and

Income Tax Assessment Act 1997 Division 43.

Reasons for decision

Note that unless otherwise specified, all legislative references are to Schedule 2C of the ITAA 1936.

Questions 1 and 2.

Calculation of the notional value of the forgiven debt

Section 245-10 provides that Schedule 2C applies where a forgiveness of a commercial debt occurs after 27 June 1996.

Notional value - non-recourse debt

If the debt is a non-recourse debt section 245-60 applies to limit the notional value of the debt in certain circumstances to the lower of the outstanding amount of the debt at the time of the forgiveness, and the market value of the rights of the creditor referred to below. The circumstances are:

The loan was incurred directly to finance the cost of acquiring property (or construction or development of property, but not

· to finance the manufacture of goods, and

· the creditor's rights in the event of a debtor default is limited to any of the following rights (including the right to money's payable from):

· the property or the use of the property

· goods or services produced, supplied, delivered or provided by the use of the property

· the loss or disposal of the debtor's interest in the property

· any security held over the property

· the financial obligation of an end-user of the property.

Notional value - debts other than non-recourse debts

In accordance with section 245-55 the notional value of a debt is worked out with the assumption that the debtor is solvent both at the time that the debt was incurred and at the time that it was forgiven unless the exception outlined in subsection 245-55(4) operates.

The exception in subsection 245-55(4) applies if

· the debtor and creditor did not deal with each other at arm's length in respect of the incurring of the debt, and

· the debt was not a moneylending debt, and either

· The creditor was a resident at the time the debt was forgiven, or

· The forgiveness of the debt was a CGT event that happened to a CGT asset that was taxable Australian property (of the creditor).

In this case the above exception does not apply as:

· the creditor is not a resident of Australia,

· no CGT event happened to an asset that is taxable Australian property, and

· the debt is at arm's length.

CGT event C2 may have happened to the creditor's intangible asset (the debt) under section 104­25 of the Income Tax Assessment Act 1997 (ITAA 1997). However the debt is not taxable Australian property within the meaning of that term in section 855­15 of the ITAA 1997.

The lower of two amounts is the notional value of the forgiven debt under section 245-55. The first applicable amount is the value of the debt forgiven assuming that the debtor was solvent both at the time the debt was incurred and when the debt was forgiven.

Sub-paragraph 245-55(3)(a)(iii) provides that the second applicable amount includes an amount that is to be calculated as if no changes in market variables had occurred between the time when the debt was incurred and the time when the debt was forgiven.

In addition paragraph 245-55(3)(b) provides that the second applicable amount also includes the sum of the amount(s) of any deductions that have been allowed or are allowable to the debtor as a result of the forgiveness that are attributable to changes in market variables that occurred between the time when the debt was incurred and its forgiveness.

Subsection 245-55(5) defines 'market variables' in relation to a debt as including changes in the rates of exchange between currencies, that effect the value of the debt.

The effect of the above is that the notional value of the debt may be increased to reflect deductions allowable to the rulee in respect of any market variables. In any case the lower of the two amounts as calculated above will be the notional value of the debt.

The amount of the debt to be forgiven is the starting point, or the notional value of the forgiven debt.

Question 3

Unapplied residual forgiven amount

The notional value of a debt that is not a moneylending debt is reduced by:

· consideration the debtor has paid or is required to pay,

· the market value of property the debtor has given or is required to give, and

· deemed consideration under subsection 245-65(2).

In this case, the creditor is not in the business of lending money, and the debt is not a moneylending debt.

The debtor has not given nor is required to give any property, and has not given any money as consideration in respect of the debt forgiveness.

Subsection 245-65(2) provides that the debtor may be deemed to have given consideration in respect of the debt forgiveness, if:

· there is no consideration provided by the debtor, or

· the consideration cannot be valued, or

· the amount of the consideration is not at market value and the debtor and creditor were not dealing at arms length in connection with the forgiveness, and either

· the creditor was a resident at the time of the forgiveness, or

The forgiveness of the debt was a CGT event that happened to a CGT asset that was taxable Australian property (of the creditor).

In this case, the debtor will not be deemed to have provided consideration because the creditor was always a non-resident and no CGT event has happened to an asset that was taxable Australian property of the creditor.

As there are no reductions to the notional value of the debt, section 245-75 provides that the gross forgiven amount is the same as the notional value of the debt.

The next step, as provided in Subdivision 245-D is to calculate the net forgiven amount of the debt. This is done by deducting the following amounts (subject to some exceptions) from the gross forgiven amount:

· an amount that would be included in the debtor's assessable income as a result of the forgiveness

· the amount of deductions normally available to the debtor that will be reduced as a result of the forgiveness, and

· the amount by which as a result of the forgiveness the cost bases of CGT assets of the debtor will be reduced under Part 3-1 or 3-3 of the ITAA 1997.

In this case there are no amounts of assessable income or deductions of the debtor that will be affected by the forgiveness of the debt. There are no CGT assets to which any reduction in the cost base would be required under either Part 3-1 or Part 3-3 of the ITAA 1997.

Consequently the net forgiven amount of the debt is the same as the notional value and gross forgiven amount.

Subdivision 245-E provides that the net forgiven amount is applied in the following order and to the maximum extent possible at each step.

Deductible revenue losses

Firstly, the total net forgiven amount is to be applied first, in accordance with sections 245-110 to 245-120, in reduction of deductible revenue losses (if any) incurred by the debtor in years of income before the forgiveness year of income.

Net capital losses

The amount remaining must then be reduced in accordance with sections 245-125 to 245-135 by any net capital losses incurred in a year before the forgiveness year that would be applied in calculation of the debtor's net capital gain in the forgiveness year.

Deductible expenditure

In accordance with sections 245-140 to 245-160, the residual net forgiven amount is applied in reduction of deductible expenditures (if any) that are to be taken into account in the assessment of the debtor's taxable income of the forgiveness year of income or any later year of income. The table of deductible expenditure in section 245-140 includes expenditure deductible under Division 40 of the ITAA 1997 (capital allowances) and capital works expenditure under Division 43 of the ITAA 1997.

Section 245-155 provides for the reduction in the calculation of the decline in value of depreciating assets.

Depending on which method (prime cost or diminishing value), has been used to calculate the rulee's deduction for the decline in value of those assets under Division 40 of the ITAA 1997, there are two methods to calculate the reduction of any deductible expenditure in the forgiveness year and later years:

· if the prime cost method is used, then the base amount (cost) of depreciating assets is reduced to nil for the 2007-08 income year and later years, or

· if the diminishing value method is used, then the opening adjustable values at the start of the forgiveness year is taken to have already been allowed as a deduction before the forgiveness year in respect of the depreciating assets.

In either case, the effect is that no decline in value deductions will be available in the forgiveness or later years in respect of those assets. In addition, where the prime cost method has been used in the years before the forgiveness year, paragraph 245­155(1)(c) applies so that those deductions cannot exceed the cost of the affected assets. If the opening adjustable values of the depreciating assets is less than the remaining net forgiven amount, the cost of those assets would be nil (if the prime cost method has been used).

Paragraph 245-155(1)(c) also applies where the prime cost method has been used, to limit the total deductions allowed for all years of income (including years of income before the forgiveness year) to the cost as reduced - that is, nil.

Cost bases of CGT assets

To the extent to which the total net forgiven amount cannot be applied as mentioned above it is to be applied, in accordance with sections 245-165 to 245-190, in reduction of the relevant cost bases of CGT assets (subject to certain exclusions) of the debtor at the beginning of the forgiveness year of income.

Section 245-195 applies so that there are no further consequences where any part of the total net forgiven amount remains after the application of the preceding provisions of Subdivision 245-E.

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