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Edited version of your written advice

Authorisation Number: 1051204879886

Date of advice: 26 April 2017

Ruling

Subject: Loan forgiveness

Question 1

Will the forgiveness of an intragroup loan constitute an amount that is transferred to the share capital account of Company M for the purposes of section 197-5 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will the forgiveness of an intragroup loan cause a franking debit to arise in the franking account of Company H in accordance with subsection 709-75(2) of the ITAA 1997?

Answer

No

Question 3

Will the forgiveness of an intragroup loan give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002?

Answer

No

Relevant facts and circumstances

Company H is the head company of an income tax consolidated group ('the group') with its wholly owned subsidiary entities, which include Company M and Company N.

As part of the group's operations, Company N provided a loan amount to Company M.

Company N will forgive the loan amount owed by Company M, and the following accounting entries will record this:

Company N

Company M

Company N accounting entries

The credit entry in the accounts of Company N recognises that it will cease to hold an asset. Company N will therefore reduce its assets being the loan receivable from Company M that will be forgiven.

This loss of value will be reflected as a debit to the retained earnings account of Company N. The debit entry will not be treated as an expense through the profit and loss, but rather it will affect the retained earnings balance at the end of the financial period in which Company N forgives the intragroup loan amount owing from Company M.

Company M accounting entries

The debit entry in the accounts of Company M recognises that it will cease to be liable for the loan amount payable to Company N that will be forgiven.

The decrease in liabilities will be reflected as a credit to the retained earnings account of Company M. The credit entry will not be treated as an income amount through the profit and loss account, but instead will affect the retained earnings balance at the end of the financial period in which Company N forgives the intragroup loan amount owing from Company M.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 Section 197-1

Income Tax Assessment Act 1997 Subsection 197-5(1)

Income Tax Assessment Act 1997 Subsection 197-5(2)

Income Tax Assessment Act 1997 Subsection 197-45(1)

Income Tax Assessment Act 1997 Subsection 709-75(1)

Income Tax Assessment Act 1997 Subsection 709-75(2)

Income Tax Assessment Act 1997 Subsection 709-75(3)

Income Tax Assessment Act 1997 Section 975-300

Income Tax Assessment Act 1997 Subsection 975-300(1)

Income Tax Assessment Act 1997 Subsection 975-300(2)

Income Tax (Transitional Provisions) Act 1997 Section 205-20

Income Tax (Transitional Provisions) Act 1997 Subsection 205-20(2)

Income Tax (Transitional Provisions) Act 1997 Section 205-25

New Business Tax System (Franking Deficits Tax) Act 2002 Section 3

New Business Tax System (Franking Deficits Tax) Act 2002 Section 4

New Business Tax System (Franking Deficits Tax) Act 2002 Section 5

Reasons for decision

In these reasons for decision, all legislation references are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless specified otherwise.

Question 1

The forgiveness of the loan by Company N will not constitute an amount that is transferred to the share capital account of Company M for the purposes of section 197-45.

Section 709-75 operates to debit the franking account of the head company of a consolidated group if a debit would otherwise arise in the franking account of a subsidiary member of the group. The consolidation single entity rule does not affect the operation of section 709-75.

Subsection 197-5(1) states:

Subsection 197-45(1) provides that where an amount is transferred to a company's share capital account, a franking debit arises in the company's franking account immediately before the end of the franking period in which the transfer happened.

The exclusions in subdivision 197-A (which are set out in sections 197-10 to 197-42) will not be relevant in the present circumstances.

Meaning of share capital account

Subsection 975-300(1) states that:

Subsection 975-300(2) provides that if a company has more than one account covered by subsection 975-300(1), the accounts are taken, for the purposes of the ITAA 1997, to be a single account.

Meaning of share capital

The term 'share capital' is not defined in Australian income tax legislation. However, the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 3) Bill 2006 which introduced section 975-300 into the ITAA 1997 states:

A company's share capital comprises amounts received by a company as consideration for the issue of shares.

The concept of share capital is discussed in paragraphs 32, 34 and 50 of Taxation Ruling TR 2012/1: Income tax: retail premiums paid to shareholders where share entitlements are not taken up or are not available which state:

Transfer to a share capital account

Under the current proposed arrangement, Company M will record the following accounting entries in its accounts to reflect Company N's forgiveness of the intragroup loan amount:

The debit entry in the accounts of Company M recognises that it will cease to be liable for the loan amount payable to Company N that will be forgiven.

The decrease in liabilities will be reflected as a credit to the retained earnings account of Company M. The credit entry will not be treated as an income amount through the profit and loss account, but instead will affect the retained earnings balance at the end of the financial period in which Company N forgives the loan amount owed by Company M.

Although retained earnings are recorded under shareholder's equity in the balance sheet of Company M, the account remains entirely separate from other shareholder's equity accounts such as the 'share capital account'.

Based on the above accounting entries, the Commissioner accepts that no part of the forgiveness of the loan amount by Company N will cause, or result in, the transfer of an amount to the share capital account of Company M from another of the company's shareholder's equity accounts, nor will the forgiveness cause, or result in, an increase in Company M's share capital account.

Question 2

The forgiveness of the loan by Company N will not cause a franking debit to arise in the franking account of Company H.

Section 709-75 operates to debit the franking account of the head company of a consolidated group if a debit would otherwise arise in the franking account of a subsidiary member of the group. The consolidation single entity rule does not affect the operation of section 709-75.

Subsection 197-45(1) provides that where an amount is transferred to a company's share capital account, a franking debit arises in the company's franking account immediately before the end of the franking period in which the transfer happened.

As set out in the Reasons for Decision for Question 1, the Commissioner accepts that there is no 'transferred amount' to the share capital account of Company M.

The Commissioner also notes that Company N will record the following accounting entries to reflect the forgiveness of the loan:

The Commissioner accordingly accepts that there is no 'transferred amount' to Company N's share capital account caused by, or as a result of Company N's forgiveness of the loan.

As the share capital account of Company M, or the share capital account of Company N, will not otherwise be tainted by Company N's forgiveness of the loan, the forgiveness will not cause, nor result in, a debit arising in the franking account of Company H under section 709-75.

Question 3

Summary

The forgiveness of the intragroup loan will not give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002.

Detailed reasoning

Franking deficit tax (FDT) is imposed by section 4 of the New Business Tax System (Franking Deficits Tax) Act 2002 (the FDT Act).

As set out in Section 3 of the FDT Act:

A liability to FDT arises where:

● An entity's franking account is in deficit at the end of the income year (Subsection 205-45(2))

● An entity's franking account is in deficit immediately before the entity ceases to be a franking entity (Subsection 205-45(3) of the ITAA 1997), or

● A late balancing company elects to have its FDT liability determined on 30 June under section 205-20 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997). The entity's liability is therefore determined under sections 205-25 and 205-30 of the ITTPA 1997 (Subsection 205-20(2) of the ITTPA 1997).

The Commissioner confirms that the forgiveness of the loan by Company N will not of itself give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002.

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