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Ruling

Subject: Commercial debt forgiveness

Question 1

Will the debt forgiveness rules in Division 245 of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) apply to the forgiveness of an unpaid present entitlement?

Answer: No.

Question 2

Will the forgiveness of an unpaid present entitlement generate a capital loss for the beneficiaries of the trust?

Answer: No.

This ruling applies for the following periods:

Financial year ending 30 June 2011.

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are a beneficiary of the family trust.

The family trust is a discretionary trust.

The trust accounts show that there is a loan to you, as beneficiary, for unpaid present entitlements to income which are recorded as unsecured liabilities.

You have paid tax on these unpaid distributions as required under income tax law.

These distributions were made by the trust several years ago.

The trust has recorded net losses for all of the years since then.

There is no interest accruing on these beneficiary loans for unpaid present entitlements.

The debt had no market value at the time it was forgiven.

Relevant legislative provisions

Division 245 of Schedule 2C to the Income Tax Assessment Act 1936

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

Division 7A of Part III of the of the Income Tax Assessment Act 1936

Section 109XA of the Income Tax Assessment Act 1936

Section 104-25 of the Income Tax Assessment Act 1997

Section 116-30 of the Income Tax Assessment Act 1997

Section 102-20 of the Income Tax Assessment Act 1997

Section 108-5 of the Income Tax Assessment Act 1997

Section 110-30 of the Income Tax Assessment Act 1997

Section 116-20 of the Income Tax Assessment Act 1997

Section 116-30 of the Income Tax Assessment Act 1997

Reasons for decision

Debt forgiveness provisions

The debt forgiveness provisions are in Division 245 of Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936).

These provisions operate to deny tax losses (revenue losses), net capital losses, future deductions of certain expenditure, or cost bases of certain assets. The total denied is equivalent to the amount forgiven, and is applied in the order shown.

The basic requirement in section 245-25 of schedule 2C of the ITAA 1936 is that the debt be a commercial debt. A debt is a commercial debt if any interest payable on that debt (if it were levied) would be an allowable deduction.

Pursuant to subsection 245-25(1) of Schedule 2C to the ITAA 1936 a debt is a commercial debt if subsections (2), (3) or (4) provide that the debt is a commercial debt.

As no interest was ever payable in respect of the debt subsection 245-25(2) of schedule 2C of the ITAA 1936 is not enlivened. Furthermore, subsection 245-25(4) of schedule 2C of the ITAA 1936 is not relevant.

Subsection 245-25(3) of schedule 2C of the ITAA 1936 provides:

A debt is a commercial debt if interest, or an amount in the nature of interest, is not payable in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount:

· would have been allowable as a deduction to the debtor; or

· would have been so allowable apart from the operation of an exception provision.

An interest free loan provided by a trust beneficiary of a non-fixed trust to the trust does not satisfy the definition of a commercial debt listed in section 245-25 of Schedule 2C of the ITAA 1997. This includes any unpaid present entitlements of income from a discretionary trust to its beneficiaries which have been shown as unsecured liabilities in the trust accounts.

This means that there are no income tax implications from the debt forgiveness provisions if a liability in the trust accounts which arose due to unpaid present entitlements is ultimately forgiven by the beneficiary.

Division 7A

Division 7A of Part III of the ITAA 1936 applies where a private company makes payments to shareholders or their associates. Payments include amounts paid, lent or forgiven.

This division has been mentioned as it also may apply if there is a company associated with the trust and/or the trust beneficiary even though it is not directly involved in the transaction. If no association exists, then this division cannot apply.

Broadly, the division would operate to deem the forgiveness of a debt to be a deemed dividend if the other requirements shown in that division have been satisfied.

One requirement to be considered is in section 109XA of the ITAA 1936. This section may apply if the trust has a company as a beneficiary who also has an unpaid distribution from the trust and a shareholder of that company is or is associated with the other beneficiary.

Note that for forgiven debts, section 109XA of the ITAA 1936 only applies to debts owed to the trustee by a beneficiary which are then forgiven by the trustee. The section also applies to payments made by the trustee to the beneficiary, and to loans made by the trustee to the beneficiary.

Section 109XA of the ITAA 1936 does not apply to debts owed by the trustee to the beneficiary and then subsequently forgiven by the beneficiary.

Net capital gain/loss

You can only make a capital gain or capital loss if a capital gains tax (CGT) event happens to a CGT asset (section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997)).

When you made the loan to the trust you acquired a debt, which is a CGT asset (section 108-5 of the ITAA 1997).

The debt owed to you is a personal use asset because you made the loan without the expectation of receiving interest income or deriving greater trust distributions and you are not in the business of lending money (paragraph 108-20(2)(d) of the ITAA 1997).

Accordingly, as the debt owed to you is a personal-use asset, you are not entitled to claim a capital loss if such is made on the forgiveness of the debt.

CGT event C2 will happen when you forgive the debt (section 104-25 of the ITAA 1997).

The time of the event will be when you enter into the contract to forgive the debt; or if there is no contract, the date the relevant documentation in relation to the debt forgiveness is completed, effectively releasing the trust from its obligations under the loan (subsection 104-25(2) of the ITAA 1997).

Cost base and reduced cost base

Broadly, the cost base and reduced cost base of an asset is the money paid to acquire it plus any incidental cost relating to its acquisition (section 110-30 of the ITAA 1997).

For you, this is the amount of your loan to the trust.

Capital proceeds

Normally, the capital proceeds will be the amount you received as a result of the CGT event happening, i.e. the consideration you received (section 116-20 of the ITAA 1997). However, when a debt is forgiven, the market value of the debt is substituted as the capital proceeds (subsection 116-30(1) of the ITAA 1997).

The market value of the debt at the time of its disposal is worked out as though the debt was not waived and was never intended to be waived (subsection 116-30(3A)).

In your case, as you will receive no consideration for the disposal of the debt, you will be taken to have received an amount equal to the market value of the debt at the time of the disposal.

Calculating your capital gain or loss

If the market value is less than the amount owed to you (the face value) then you will make a capital loss. However, the capital loss will be disregarded as a loss made from a personal use asset.

If the market value equals the face value you will make neither a capital gain or loss unless you incur incidental costs, in which case you will make a capital loss. However, the capital loss will be disregarded as a loss made from a personal use asset.

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