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Edited version of your written advice
Authorisation Number: 1051178964465
Date of advice: 17 January 2017
Ruling
Subject: Whether a debt would be excepted from the commercial debt forgiveness rules
Question
If a commercial loan owed by entity A to entity B is forgiven by entity B because entity A does not have the funds to repay it, will paragraph 245-40(e) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to exclude the forgiveness of the debt from the commercial debt forgiveness rules contained in Division 245 of the ITAA 1997?
Answer
No.
This ruling applies for the following period
Year ending 30 June 2017
The scheme commences on
1 July 2016
Relevant facts and circumstances
Money was lent by entity B to entity A. The funds were used by entity A to pay for deductible and non-deductible expenses.
All the assets of entity A have now been realised and all available cash has been paid to entity B to repay as much of the debt as possible. There are no further assets of entity A available to enable the rest of the debt to be repaid.
Entity B intends to forgive the debt as entity A has no ability to repay the remainder of the debt.
Relevant legislative provisions
Income Tax Assessment Act 1997 Division 245
Reasons for decision
Division 245 of the ITAA 1997 covers forgiveness of commercial debts.
Section 245-10 of the ITAA 1997 provides that 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.
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.
There are a number of exclusions where the forgiveness provisions do not apply.
One of those provisions is under paragraph 245-40(e) of the ITAA 1997 where a commercial debt is forgiven for reasons of natural love and affection.
This paragraph does not specify that the creditor must be a natural person. It only requires that the debt was 'forgiven for reasons of natural love and affection'.
In a situation where a debtor has an outstanding debt and can only pay part of the debt to a creditor, the part which can be paid but is forgiven by the creditor can be excluded for reasons of natural love and affection under paragraph 245-40(e) of the ITAA 1997. However, the other part of the debt which is not able to be repaid cannot be excluded for reasons of natural love and affection. As the reason it cannot be paid back is the debtor does not have the funds to pay it back, the exclusion under paragraph 245-40(e) of the ITAA 1997 for forgiveness for natural love and affection does not apply.
In this case, entity A has realised all of its assets and all available cash has been paid to entity B to repay as much of the debt as possible. Entity B intends to forgive the remaining debt because entity A doesn't have the capacity to repay it.
If entity B forgave an amount owed by entity A that it could repay, then it may be that the forgiveness was for reasons of natural love and affection. However, entity A has repaid to entity B as much as it could and entity B only intends to forgive the balance that entity A is unable to repay. Therefore, the forgiveness will be due to an inability to repay rather than for reasons of natural love and affection. Therefore paragraph 245-40(e) of the ITAA 1997 will not exclude the forgiveness of the debt from the commercial debt forgiveness rules contained in Division 245 of the ITAA 1997.
Division 245 of the ITAA 1997 will only apply to the commercial part of the debt, that is, the part of the debt on which interest (whether charged or not) would have been an allowable deduction for entity A. Division 245 will not apply to the part of the debt on which no deduction would be allowable for the loan interest (whether it has been charged or not), that is, the commercial debt forgiveness rules will not apply to the part of the debt which was used by entity A to pay for non-deductible expenses.