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Edited version of your written advice
Authorisation Number: 1051380859233
Date of advice: 1 June 2018
Ruling
Subject: Trust – debt forgiveness
Question
Do the Commercial Debt Forgiveness provisions, under section 245-40 of the Income Tax Assessment Act 1997, apply when the Primary Beneficiary forgives a debt owed by the Trust out of love and affection?
Answer
No
This ruling applies for the following period:
Year ending 30 June 20XX
The scheme commenced on:
1 July 20XX
Relevant facts and circumstances
The Trust was established for the benefit of the Primary Beneficiary, and there were no specified beneficiaries.
There are no fixed beneficiaries.
Distributions of profit are made to the Primary Beneficiary and one other person.
The Trust holds the Primary Beneficiary’s investments separate from their personal and business activities.
Between mid 20XX and the present day, a loan account has been built up. The Primary Beneficiary has lent money to the trust either through direct payments for the trust or through distributions which have been declared in the Primary Beneficiary’s favour, but not fully withdrawn.
There is no formal loan agreement.
The loan was interest free, and as such no interest has been paid to the beneficiary.
If interest had have been charged it most likely would have been deductible for the Trust, as the borrowing was for the same purpose as the bank loan, income producing.
The Trust has used the loan funds primarily to reduce its borrowing from the bank.
This loan is an asset of the Primary Beneficiary and is potentially at risk in the event that the Primary Beneficiary is sued in relation to either personal actions or in relation to other actions or other business activities.
There are no current legal actions against the Primary Beneficiary and it is not anticipated that there will be any legal action in the future; however, reducing the assets now, owned by the Primary Beneficiary will leave fewer assets at risk in the future.
The Primary Beneficiary is considering forgiving some or all of the debt to the trust for love and affection for other potential beneficiaries of the trust, and in order to protect the assets.
The arrangement is being considered to remove the interest free loan and to tidy up the balance sheet. The Primary Beneficiary has no personal debt and has no need for the funds to be repaid. The assets in the Trust will be held for life, and as such no consideration is being given to selling them. Due to this there will be no opportunity to repay the loan in the foreseeable future.
Should the debt be forgiven, the amount of the forgiven debt would be allocated to a reserve in the accounts of the trust as part of the trust capital. This would be reflected in the accounts of the Trust via the journal debiting the loan account, and crediting a capital reserve account.
Any funds transferred to the capital reserve account will be equity, and will not be considered an asset of any beneficiary nor held on behalf of a beneficiary.
No debts have been forgiven to date.
It is proposed to forgive 100% of the debt.
The capital reserve account will not list or make reference to any beneficiary, and it is not intended to distribute any of the capital reserve if the arrangement proceeds.
However, in the event that the Primary Beneficiary or another beneficiary requires access to the funds, making up the forgiven loan, the amount of funds equal to the forgiven debt will be available for the use of the beneficiaries at some point in the future, if and when required, and the trustee would declare a capital distribution from the debt forgiveness reserve.
There are currently no plans to make any distributions from this debt forgiveness reserve in the near future, however you wish to ensure that distributions are possible if the need arises.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 245-10
Income Tax Assessment Act 1997 Section 245-40
Income Tax Assessment Act 1997 subsection 245-40(e)
Reasons for decision
Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997) is about forgiveness of commercial debts.
Section 245-10 of the ITAA 1997 provides a debt is a commercial debt if the whole or any part of interest, or of an amount in the nature of interest, paid or payable in respect of the debt is or would be allowable as a deduction to the debtor.
Section 245-40 of the ITAA 1997 lists specific circumstances where the forgiveness of a debt will not come within the operation of Division 245 of the ITAA 1997.
An exclusion to Division 245 applies under subsection 245-40(e) of the ITAA 1997 where a commercial debt is forgiven for reasons of natural love and affection.
Application to your circumstances
The Primary Beneficiary is considering forgiving some or all of the debt to the trust for love and affection.
As the Primary Beneficiary is considering forgiving the debt for love and affection the commercial debt forgiveness provisions under section 245-40 of the ITAA 1997 will not apply.
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