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Ruling

Subject: Business - Income tax - capital gains tax - debt forgiveness

Question and Answer

Will company X be subject to capital gains tax upon the release of the debt payable by it to company Y?

No.

Will the company X be subject to the Commercial debt forgiveness provisions upon the release of the debt payable by it to company Y?

No.

Will the company X be subject to income tax upon the release of the debt payable by it to company Y?

No.

This ruling applies for the following period

1 July 2012 to 30 June 2013

Relevant facts and circumstances

Taxpayer B owns 100% of the shares issued by company Y.

Taxpayer B owns all of the A class shares issued by company X.

Company X has also issued an E Class Share to Taxpayer C.

Company X and company Y are private companies.

Company X owed company Y a certain amount.

The loan company X has with company Y is a commercial debt.

Taxpayer B negotiated a marriage settlement with taxpayer C. The marriage settlement was formalised in Consent Orders.

Pursuant to clause 9.12.2 of the Consent Orders, taxpayer B is required to transfer the whole of their right, title and interest in shares in company X to taxpayer C.

Pursuant to clause 9.4 of the Consent Orders, taxpayer B is required and company Y are to do all acts and things and sign all documents necessary to extinguish all loans owed by taxpayer C and company X. Accordingly, company Y will release company X from the debt.

Company X and company Y are not dealing at arms length.

Company X is not in the business of money lending.

Company X did not borrow with the intention of making a profit.

No consideration will be paid for the forgiveness of the debt owed by company X.

The forgiveness of the debt did not arise out of business operations.

The market value of the debt, at the time of the forgiveness, is equal to the face value of the debt advanced, therefore the net forgiven amount will be nil.

Pursuant to clause 9.5 of the Consent Orders taxpayer B is required to obtain a Private Binding Ruling from the Australian Taxation Office as to, inter alia, any income tax, penalties, charge and interest payable by company X in relation to the forgiveness of this debt.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-1

Income Tax Assessment Act 1997 Section 6-5

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 subsection 245-C

Income Tax Assessment Act 1997 subsection 245-G

Income Tax Assessment Act 1997 Section 245-10

Income Tax Assessment Act 1997 subsection 245-85(1)

Income Tax Assessment Act 1997 subsection 245-85(1)(a)

Reasons for decision

Capital Gains Tax

Section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) refers to a Capital Gains Tax (CGT) event C2 happening if an intangible asset ends because it is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered, forfeited or expired.

In CGT Determination Number 3, TD 3; "What are the CGT consequences for the borrower (debtor) when a debt is waived?", it states, in part:

1. For CGT purposes, the borrower is not considered to have an asset. Accordingly, when the lender waives the debt, the borrower does not dispose of an asset and therefore makes no capital gain or loss.

2. No other CGT provisions apply to cause a capital gain or loss to the borrower when the lender waives the debt.

Application to your circumstances

Company X (debtor) owes company Y (creditor).

Company Y has forgiven company X the debt.

Therefore, there are no CGT consequences for company X when company Y forgives their debt.

Commercial debt forgiveness

Under Section 245-10 of the ITAA 1997 it states:

Subdivisions 245-C to 245-G of the ITAA 1997 apply to a debt of yours if:

(a) the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or

(b) interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or

(c) interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2)(a), (b) and (c)) that has the effect of preventing a deduction.

If not for the special tax consequences that affect the taxpayer (as a debtor) under Div 245, the forgiveness of a debt may give rise to a duplication of deductions in respect of the same outgoing.

The creditor is able to shift the burden of the loss (as a result of the debt forgiveness) as a tax deduction or capital loss.

The debtor, now relieved of the liability to repay the loan, will also continue to claim deductions in respect of the revenue or capital losses or expenditures arising from the debt (depending on how the moneys borrowed or incurred were applied) resulting in the duplication of deductions.

The "gain" made by the debtor as a result of the debt forgiveness under Div 245 is usually not included in the taxpayer's assessable income except in certain circumstances, e.g. if the gain is regarded as ordinary income.

Division 245 seeks to eliminate the potential duplication of deductions described above by applying the amount of debt forgiven to reduce certain specified amounts which the taxpayer would otherwise use to reduce the taxpayer's taxable income.

The amounts to be reduced are as follows:

· tax losses

· net capital losses

· a wide range of deductible expenditures, and

· the cost bases of certain CGT assets

When Div 245 applies, a debtor is required to reduce its tax balances (if it has any) in the above order by an amount called the net forgiven amount.

Under subsection 245-75(2) of the ITAA 1997 the following applies:

If the value of the debt when it was forgiven is equal to or less than the amount offset:

(a) there is no gross forgiven amount in respect of the debt; and

(b) Subdivisions 245-D to 245-F (about how to work out the net forgiven amount of a debt and how to treat it) do not apply in respect of the debt.

Application to your circumstances

Company X and company Y are not dealing at arms length and no consideration will be paid for the forgiveness of the debt owed by company X.

The market value of the debt, at the time of the forgiveness, is equal to the face value of the debt advanced, accordingly the net forgiven amount will be nil. Therefore the commercial debt forgiveness provisions do not apply to company X.

Income Tax

Under section 6-1 of the ITAA 1997 it states that the assessable income of a taxpayer consists of ordinary income and statutory income.

Section 6-5 of the ITAA 1997 states that, is you are an Australian resident, your assessable income includes the ordinary income you derive directly or indirectly from all sources, both in and out of Australia.

Subsection 245-85(1) of the ITAA 1997 deals with types of amounts, which, if they arise to the debtor as a result of a debt forgiveness must be subtracted from the gross forgiven amount of a debt to arrive at the net forgiven amount of a debt.

Any amount that has been or will be included in the assessable income of the debtor in any year of income under a provision apart from Div 245 as a result of the debt forgiveness (s 245-85(1)(a)). This includes instances where the forgiveness of the debt results in a "gain" which is treated as ordinary income. A gain resulting from a debt forgiveness can be treated as ordinary income of the debtor where the debt forgiven is inextricably linked to the ordinary business of the debtor (Warner Music Australia Pty Ltd v FC of T 96 ATC 5046).

Application to your circumstances

Company X is not in the business of money lending and did not borrow with the intention of making a profit. The forgiveness of the debt by company Y did not arise out of business operations. Accordingly, the forgiveness of the debt by company Y does not give rise to ordinary income in the hands of company X.

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