Edited version of your written advice

Authorisation Number: 1012697075975

Ruling

Subject: Commercial debt forgiveness

Question

If the shares you acquired under an employee share scheme (ESS) are bought back from you, and the consideration applied in satisfaction of the loan balances at a time when the value of the shares is less than the amount of the loan balances, will there be a positive 'gross forgiven amount' and an adjustment to your tax attributes pursuant to Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period

Year ending 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

You were employed by an entity.

Whilst employed you participated in the Employee Share Scheme (ESS).

Through the ESS, shares in the entity were issued to you at market value and were funded by non-recourse loans from the entity.

The entity's rights for the repayment of the loans were limited to the shares issued to you under the ESS.

You received dividends and then paid the full amount of the dividend to cover the interest on each of the loans.

Your employment ceased.

The entity exercised its right as outlined under the ESS and issued a Repayment Demand Notice which demanded you make a payment in respect of the balance due for scheme loans which were made to you.

You were required to repay the outstanding balance of the scheme loans.

You advised the entity that you would not be making any repayment of the outstanding loans.

The entity exercised its right under the ESS and issued a Buyback Notice.

The Buyback Notice, pursuant to the ESS, from the entity to you showed:

• the price at which the entity would buyback your scheme shares

• the number of participant scheme shares being bought back; and

• the date for completion of the buyback.

The market value for the buyback was determined pursuant to the ESS.

The shares were sold by you pursuant to the buyback. The entity applied the consideration against the loan pursuant to the ESS.

There was a shortfall on the loans because the market price of shares on the ASX had fallen below the prices at which they were issued to you under the ESS.

Pursuant to the ESS, the entity had no further recourse and wrote off the balance of each of the loans.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 245-10

Income Tax Assessment Act 1997 Section 245-35

Income Tax Assessment Act 1997 Section 245-60

Income Tax Assessment Act 1997 Subsection 245-60(1)

Income Tax Assessment Act 1997 Subsection 245-60(2)

Income Tax Assessment Act 1997 Subsection 245-60(3)

Reasons for decision

Division 245 of the ITAA 1997 is about forgiveness of commercial debts.

The operative rules for Division 245 of the ITAA 1997 are contained in Subdivisions 245-C to 245-G. In summary, these operative rules provide, when a creditor forgives a commercial debt you (the debtor) owe, the forgiven amount is offset against amounts that could otherwise reduce your taxable income in the same or a later income year, namely:

(a) your tax losses and net capital losses;

(b) capital allowances and some similar deductions; and

(c) the cost bases of your CGT assets.

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.

In this case, you were provided with non-recourse loans by the entity pursuant to the ESS and interest was payable on the outstanding balance 'at a rate equal to the Dividend Rate', therefore a 'commercial debt' exists for the purposes of section 245-10 of the ITAA 1997.

Forgiven Debt

Section 245-35 of the ITAA 1997 provides that a debt is forgiven if and when the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full.

Where the non-recourse feature of the loans comes into effect and you are not required to pay any further loan payments at a time when the value of the shares is less than the outstanding loan balances, there will be a commercial debt forgiveness under section 245-35 of the ITAA 1936.

What is the net forgiven amount?

Under Division 245 of the ITAA 1997 where a forgiveness results in an investor having a positive 'net forgiven amount', the investor will be required to reduce certain tax attributes to the extent of the net forgiven amount.

Section 245-60 of the ITAA 1997 provides a special rule for working out the value of a non-recourse debt.

To constitute a non-recourse debt under that section the rights of the creditor in the event of default in the payment of the debt or the payment of interest must be limited in one or more ways listed in subparagraph 245-60(2)(b) of the ITAA 1997. In this case the rights of the creditor are limited in the requisite manner to be a non-recourse debt.

Furthermore, the definition requires that the debt was incurred directly in respect of the financing of the acquisition, construction or development of property.

In this case subsection 245-60(1) of the ITAA 1997 applies to you as you incurred the debt directly in respect of financing the acquisition of property (the shares in the entity).

To determine the net forgiven amount of a forgiven debt it is first necessary to determine the 'gross forgiven amount'. The gross forgiven amount is equal to the 'notional value' of the debt less any consideration paid or given in respect of the debt.

The value of the debt when it was forgiven was the lesser of:

• the amount of the outstanding debt, when it was forgiven, in this case it was the outstanding balances of the total of the non-recourse loans after the shares had been bought back; and

• the market value at that time of the creditor's rights including rights in respect of rights (including the right to money payable) in relation to all or any of the following matters:

• the property or the use of the property; or

• goods produced, supplied, carried, transmitted or delivered by means of the property; or

• services provided by the property; or

• the loss or disposal of the whole or a part of the property or of your interest in the property; or

• rights in respect of a mortgage or other security over the property; or

• rights arising out of any arrangement relating to the financial obligations, in relation to the property, of the end user of the property to you.

As the loans were non-recourse loans, the liability on you to repay the outstanding balance of the loans was limited to the proceeds arising from the buyback of the shares, therefore the value of the creditor's rights was nil.

As the market value of the creditor's rights was nil, it was less than the amount of the outstanding debt, when it was forgiven, consequently the value of the non-recourse debt is nil.

In these circumstances Division 245 of the ITAA 1997 will have no practical effect as the 'gross forgiven amount' in respect of the debt will be equal to zero.