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Edited version of your private ruling
Authorisation Number: 1012606035207
Ruling
Subject: Commercial debt forgiveness - CGT cost base reduction
Questions and Answers:
1. For the year ended 30 June 2012, should the debt forgiveness you received be included in your assessable income?
No.
2. For the year ended 30 June 2012, should the debt forgiveness you received be used to reduce your capital gains tax (CGT) losses?
Yes.
This ruling applies for the following period:
Year ended 30 June 2012
The scheme commences on:
1 July 2011
Relevant facts and circumstances
During the year ended 30 June 2012, you received a debt forgiveness amount, which was lodged in your tax return as assessable income.
Your tax return for that income year did not contain any tax losses, capital losses or other deductions from previous income years but did contain carried forward net CGT loss in relation to the disposal of a CGT asset during that income year.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 245-1
Income Tax Assessment Act 1997 Section 245-115
Income Tax Assessment Act 1997 Section 245-130
Income Tax Assessment Act 1997 Section 245-190
Income Tax Assessment Act 1997 Section 100-40
Income Tax Assessment Act 1997 Section 110-55
Reasons for decision
Section 245-1 of the ITAA 1997 summaries that the application of net forgiven amounts (of commercial debts) is to be done in the following order:
(a) to your tax losses from previous income years;
(b) to your net capital losses from previous income years;
(c) to the deductions you would otherwise get in the income year, or in a later income year, because of expenditure from a previous year (for example, the capital allowance deductions you would get for expenditure on acquiring a depreciating asset);
(d) to the cost bases of your CGT assets.
In respect to (a) and (b) above, sections 245-115 and 245-130 of the ITAA 1997 explain:
The total net forgiven amount is applied first…in reduction…of your tax losses (if any) for any income years, if the tax losses could…be deducted in: (a) the forgiveness income year; or (b) a later income year.
The total net forgiven amount (if any) remaining…is applied…in reduction…of your net capital losses (if any)…for income years before the forgiveness income year that you could apply in working out your net capital gain for the forgiveness income year if you had enough capital gains.
Section 245-190 of the ITAA 1997, in general, explains the reduction is last of all applied to the relevant cost bases of CGT assets owned by the debtor at the beginning of the forgiveness year of income.
The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 2) 1996 includes the following example:
Assume debtor A has applied residual forgiven amount of $1,000 to reduce the cost bases of an asset owned on 1 July 1997. The asset is disposed of subsequently for $10,000 at a time when its indexed cost base is $8,000. Under ordinary capital gains calculations, the capital gain is $2,000 ($10,000 - $8,000). However, the indexed cost base must be reduced by $1,000 in accordance with subsection 245-190(1). The capital gain becomes $3,000 ($10,000 - $7,000).
Section 100-40 of the ITAA 1997 explains, for the purpose of working out a capital loss, your total costs associated with the event are called the 'reduced cost base' of the asset.
Section 110-55 of the ITAA 1997 defines the reduced cost base of a CGT asset and does not allow interest expense in its third element. Therefore, interest expense incurred in relation to a CGT asset, which is subject to a CGT loss on disposal, will not form part of the reduced cost base.
In your case, for the year ended 30 June 2012, you did not have any tax losses, capital losses or other deductions from previous years. Therefore, your forgiven debt amount should not be used to increase your assessable income.
However, because you held a CGT asset at 1 July 2011 (that was disposed of for a loss during the same income year), the reduced cost base of that CGT is to be reduced by your forgiven debt amount.
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