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Ruling

Subject: Forgiveness of commercial debts

Question 1

In relation to the debt assignment from your financier to the group are either of subsections 245-35(4)(b)(i) and (ii) satisfied, such that there has been a debt forgiveness event to which the Commercial Debt Forgiveness ("CDF") Rules in Schedule 2C apply?

Answer

Yes.

This ruling applies for the following periods:

The income year ended 30 June 2010.

The scheme commences on:

1 July 2009.

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.

The company submitted a private ruling application (the application) in relation to the assignment of its debt from its financier to an overseas commodities trading group (the group).

In support of the application the company provided the following information:

· it was listed on the Australian Securities Exchange ("ASX")

· the group acquired an exclusive off-take agreement with the company

· the group is listed on an overseas securities exchange

· the group held more than 20% of the company's shares

· the group had representation on the company's board

· after the company suffered significant losses, the group assisted the company by paying it advances under the off-take agreement

· as well, the financier loaned the company funds

· due to adverse market conditions, the company breached its debt covenants with both its financier and the group

· an agreement was entered into between the parties to grant both the group and the financier security over the company's assets

· the company's financial position did not improve during this time and the group commenced negotiations with the financier which resulted in an agreement to assign the debt from the financier to the group (the "debt assignment")

· the assignment was effected by an agreement (the "transfer agreement")

· the company and its wholly owned subsidiary were both signatories to the transfer agreement

· the company was not involved in the negotiations for the debt assignment and it only ever provided information. The inclusion of the company and its subsidiary on the transfer agreement was merely to acknowledge the assignment.

· the purchase price for the debt was discounted by the financier

· after the assignment, the company continued to owe the full face value of the debt

· soon after the debt assignment took place, the loan assigned to the group was consolidated with existing loan balances between it and the company

· since the assignment, the company's cash flow (and ability to repay debts) have improved and it has repaid a significant amount of its debt to the group.

The company produces a commodity that the group markets and supplies.

Relevant legislative provisions

Income Tax Assessment Act 1936, Schedule 2C

Income Tax Assessment Act 1936, Schedule 2C subsection 245-15(1)

Income Tax Assessment Act 1936, Schedule 2C section 245-25

Income Tax Assessment Act 1936, Schedule 2C subsection 245-35(1)

Income Tax Assessment Act 1936, Schedule 2C section 245-35(4)

Income Tax Assessment Act 1936, Schedule 2C paragraph 245-35(4)(b)

Income Tax Assessment Act 1936, Schedule 2C subparagraph 245-35(4)(b)(i)

Income Tax Assessment Act 1936, Schedule 2C subparagraph 245-35(4)(b)(ii)

Income Tax Assessment Act 1936, Schedule 2C paragraph 245-35(4)(d)

Income Tax Assessment Act 1936, Schedule 2C paragraph 245-35(4)(e)

Income Tax Assessment Act 1936, Schedule 2C section 318

Income Tax Assessment Act 1936, Schedule 2C subsection 318(2)

Income Tax Assessment Act 1936, Schedule 2C paragraph 318(2)(a)

Income Tax Assessment Act 1936, Schedule 2C paragraph 318(2)(b)

Income Tax Assessment Act 1936, Schedule 2C paragraph 318(2)(c)

Income Tax Assessment Act 1936, Schedule 2C paragraph 318(2)(d)

Income Tax Assessment Act 1936, Schedule 2C paragraph 318(6)(b)

Income Tax Assessment Act 1936, Schedule 2C paragraph 318(6)(c)

Income Tax Assessment Act 1997, Division 245

Tax Laws Amendment (Transfer of Provisions) Act 2010

Reasons for decision

Commercial debt forgiveness (CDF) provisions

Effective 1 July 2010, Schedule 2C to the Income Tax Assessment Act 1936 (ITAA 1936) was repealed by the Tax Laws Amendment (Transfer of Provisions) Act 2010 (79 of 2010) and Division 245 was inserted in the Income Tax Assessment Act 1997 (ITAA 1997). Given this ruling applies for the period of the income year ended 30 June 2010, most references will be to the former Schedule 2C section 245 of the ITAA 1936.

The CDF provisions in Division 245 of Schedule 2C of the ITAA 1936 apply where a debtor's obligation to repay a commercial debt, is released, waived, or otherwise extinguished (subsection 245-35(1)). When this occurs it provides a gain that is not treated as assessable income. Schedule 2C sets out how the 'net forgiven amount' is established and how it reduces the taxpayer's tax losses, net capital losses, capital allowances and the cost bases of capital gains tax assets, which would otherwise reduce the taxpayer's future income tax liability (3.2 of Chapter 3 of the Explanatory Memorandum to Act No 79 of 2010).

A debt was described in former subsection 245-15(1) of the ITAA 1936 as 'an enforceable obligation imposed by law on a person, to pay an amount to another person'.

Generally, a debt was a commercial debt for purposes of the former debt forgiveness provisions (see former section 245-25 of the ITAA 1936), if the whole or any part of the interest payable on the debt is or would be an allowable deduction to the debtor (in this case the company). This was the case for the company with regard to the loan it had from the financier.

The application states that in this instance there has been no release or extinguishment of the company's obligation to repay the loan that they formerly owed to the financier. In fact, their obligation to repay the loan remained subsequent to its assignment. The company continued to owe the group the full face value of the debt, in addition to existing loan balances.

Debt parking

The debt parking provisions contained in subsection 245-35(4) of Schedule 2C to the ITAA 1936 apply where a creditor assigns its rights under a debt to a third party without the debtor's obligations under the debt being forgiven. The debt forgiveness provisions apply as if the debtor had been forgiven instead of their debt being assigned.

245-35(4) Debt parking.  

If:

(a) the creditor, in relation to a debt, assigns the right to receive payment of the debt to another person (the new creditor); and

(b) either:

(i) the new creditor is an associate of the debtor; or

(ii) the assignment occurred under an agreement or arrangement to which the new creditor and the debtor were parties; and

(c) the right to receive payment of the debt was not acquired by the new creditor in the ordinary course of trading on a securities market;

this Division has effect as if:

(d) the debtor had, at the time of the assignment, been forgiven a debt (the notional debt) equal to the amount of the assigned debt; and

(e) the net forgiven amount of the notional debt were equal to the amount that would have been the net forgiven amount of the assigned debt if that debt had been forgiven instead of being assigned.

As set out in this provision (subsection 245-35(4) of the ITAA 1936) debt parking occurs when the creditor agrees to assign the right to receive the debt to a 'new creditor' who is also an associate of the debtor, or there is an agreement or arrangement between the 'new creditor' and the debtor. Also, the transaction cannot be in the ordinary course of trading on the securities market.

As the Relevant facts record, the applicant has stated that the company was not an active participant in the agreement to assign the debt, nor could the circumstances of the agreement be characterised as 'in the ordinary course of trading on the securities market'. This leaves the ascertainment of association as the other aspect that could establish an occurrence of debt parking.

In the context of this ruling application the 'new creditor' is the group and it is necessary to determine whether the latter is an associate of the company and can be regarded as providing debt parking to the company, pursuant to paragraph 318(2)(d) of the ITAA 1936 (as shown under the following subheading).

Associates of a company

Subsection 318(2) of the ITAA 1936 sets out the following regarding associates of companies:

For the purposes of this Part, the following are associates of a company (in this subsection called the "primary entity"):

(a) a partner of the primary entity or a partnership in which the primary entity is a partner;

(b) if a partner of the primary entity is a natural person otherwise than in the capacity of trustee - the spouse or a child of that partner;

(c) a trustee of a trust where the primary entity, or another entity that is an associate of the primary entity because of another paragraph of this subsection, benefits under the trust;

(d) another entity (in this paragraph called the "controlling entity") where:

(i) the primary entity is sufficiently influenced by:

(A) the controlling entity; or

(B) the controlling entity and another entity or entities; or

(ii) a majority voting interest in the primary entity is held by:

(A) the controlling entity; or

(B) the controlling entity and the entities that, if the controlling entity were the primary entity, would be associates of the controlling entity because of subsection (1), because of subparagraph (i) of this paragraph, because of another paragraph of this subsection or because of subsection (3);

In the context of this ruling the relevant provisions are those stating that an associate of a company will be a company which is sufficiently influenced by another company.

These terms are explained in paragraph 318(6)(b) and paragraph 318(6)(c) of the ITAA 1936, as follows:

(b) a company is sufficiently influenced by an entity or entities if the company, or its directors, are accustomed or under an obligation (whether formal or informal), or might reasonably be expected, to act in accordance with the directions, instructions or wishes of the entity or entities (whether those directions, instructions or wishes are, or might reasonably be expected to be, communicated directly or through interposed companies, partnerships or trusts); and

(c) an entity or entities hold a majority voting interest in a company if the entity or entities are in a position to cast, or control the casting of, more than 50% of the maximum number of votes that might be cast at a general meeting of the company.

Sufficiently influence

It is necessary to consider whether the group could sufficiently influence the company in the context of the prevailing circumstances of the subject income year.

Even though the Commissioner has not specifically expressed his view on what the term "sufficiently influence" means there are indicators, including Taxation Ruling TR 92/6, Income Tax: whether a non-resident convertible noteholder is a foreign controller for thin capitalisation purposes (TR 92/6). In TR 92/6 the Commissioner's view in relation to whether an entity can exert sufficient influence over the actions of a company or its director is given.

The Commissioner ruled in TR 92/6 at paragraph 26, that a holder of at least 15% of the voting rights or dividend or capital distribution entitlements of a company is generally able to exercise influence over the actions of the company or its directors.

Immediately after the assignment of the debt from the financier to the group, the company owed significantly more money to the group which indirectly had a more than 20% holding in the company. Furthermore, the group's influential role in the viability of the company's business is reflected in its marketing of the company's products. Under the marketing and off-take agreement the group has the exclusive right to market and sell the products of the company worldwide.

The sum of these interactions is that in regard to the company, by the end of the subject income year the group has:

· had an association from year one of operations

· had security over all the company's assets;

· had board representation;

· worked with the company to qualify it with customers;

· provided loans

· "rescued" the company when it breached its debt covenants

· In excess of 20% of the company's shares

· assisted the company to negotiate "advantageous" marketing agreements

· has an agreement to buy all the company's products; and

· the exclusive right to market and sell the company's products worldwide.

The sum of the group's influence as set out ensures it would be reasonably expected that the company would not disregard the wishes or views of the group. Also, it is reasonable to expect that the group could exert sufficient influence over the company and its directors to act in accordance with the directions, instructions or wishes of the group, whether they were formally or informally conveyed.

Accordingly, in the subject income year, it is considered that the group is an associate of the company, within the meaning of section 318 of the ITAA 1936.

Paragraph 245-35(4)(b) of Schedule 2C to the ITAA 1936 provides that where the new creditor is an associate of the debtor, then paragraph 245-35(4)(d) of Schedule 2C has affect as if:

(d) the debtor had, at the time of the assignment, been forgiven a debt (the notional debt) equal to the amount of the assigned debt … .

Further, paragraph 245-35(4)(d) of Schedule 2C to the ITAA 1936 provides that the debt is taken to be forgiven at the time the debt is assigned.

Paragraph 245-35(4)(e) of Schedule 2C to the ITAA 1936 provides that:

(e) the net forgiven amount of the notional debt were equal to the amount that would have been the net forgiven amount of the assigned debt if that debt had been forgiven instead of being assigned.

Accordingly, where a debt is assigned to a new creditor that is associated with the debtor, then the debtor will be taken to have had a debt forgiven as at the time of assignment.

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