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Ruling

Subject: Commercial debt forgiveness

Question 1

Is the amount which has been treated as a loan from the bank a liability to the company?

Answer

No.

Question 2

Is the forgiveness of the debt to the shareholders/directors subject to the commercial debt forgiveness rules?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

The company was sold in the 2009-10 financial year.

The balance sheet at date of sale included the following two amounts which the company has treated as liabilities:

Loan Shareholders/Directors $xx,xxx

Loan Bank $xx,xxx

The amount which has been referred to as shareholder/directors loan of $xx,xxx was made up of day-to-day purchases for the company paid for by the vendors. There was an arrangement by which the company would make periodic repayments to the vendors.

The amount which has been referred to as shareholders/directors loan of $xx,xxx was forgiven as part of the settlement.

The amount which has been referred to as shareholders/directors loan of $xx,xxx was an informal arrangement on which no interest was ever charged.

The $xx,xxx bank loan was taken out by the vendors in 200X. They used the $xx,xxx borrowed to help fund the purchase of the total shareholding in the company from the previous owner.

The amount which has been treated as a loan to the company of $xx,xxx was paid out by the vendors prior to settlement.

The sale contract includes a retention sum to be paid to the previous owners (the vendors) once all tax issues for 2009/2010 are resolved.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 245-25 of Schedule 2C

Income Tax Assessment Act 1936 Section 245-105 of Schedule 2C

Reasons for decision

Question 1

The $xx,xxx amount appears in the company's Statement of Financial Position as at January 2010 as a non-current liability. This amount was borrowed from the bank in order to fund the purchase of the shares in the company by the vendors when they purchased the shares in the company in 200X. As the $xx,xxx was used to purchase the shares in the company, the amount was a liability of the vendors and not the company.

Therefore, as the amount was not a company liability but a liability in the shareholders' names, there is nothing to forgive.

Question 2

Division 245 of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) sets out the consequences when a commercial debt is released, waived or otherwise extinguished prior to the 2010-11 income year. The commercial debt forgiveness rules are contained in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997) for debts forgiven in the 2010-11 and later income years.

Section 245-25 of Schedule 2C to the ITAA 1936 includes in the definition of a commercial debt a debt in relation to which the interest payable is an allowable deduction to the debtor, or if no interest is paid, if it were paid it would have been an allowable deduction.

This amount has been treated as a loan in the books of the company. However, this amount was not a loan. If the directors/shareholders had lent the company a sum of money from which the company paid its expenses, then it would have been a loan. Instead, the directors/shareholders paid some of the company's expenses and there was an arrangement by which the company would repay the directors/shareholders the amount they had spent with the repayments being made periodically. Although the amount owed was not a loan, it was still a debt owed by the company.

In this case, the debt was a commercial debt. Although no interest was charged on the debt, the interest would have been deductible to the company had it been charged. Therefore the debt is subject to the commercial debt forgiveness rules.

The 'total net forgiven amount', as per subsection 245-105(1) of Schedule 2C to the ITAA 1936, is the sum of all net forgiven amounts of the debtor for the particular income year.

Subsections 245-105(5) to (8) of Schedule 2C to the ITAA 1936 provide that the total net forgiven amount must be applied, to the maximum extent possible, to make reductions in the order listed hereunder:

(1) deductible revenue losses (if any) incurred by the debtor before the forgiveness year

(2) where there is any unapplied total net forgiven amount (referred to as the 'residual forgiven amount'), reduce deductible net capital losses (if any) incurred by the debtor before the forgiveness year

(3) where there is any residual forgiven amount, reduce deductible expenditure taken into account in the debtor's tax return for the forgiveness year and future income years

(4) where there is any residual forgiven amount, reduce the relevant cost bases of certain assets of the debtor at the beginning of the forgiveness year.

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