Edited version of your written advice

Authorisation Number: 1051445988713

Date of advice: 25 October 2018

Ruling

Subject: Income tax – commercial debt forgiveness

Question 1

Did each assignment of the promissory notes constitute the forgiveness of a debt under Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question

If yes to Question 1, did each assignment of the promissory notes result in a net forgiven amount under Division 245 of the ITAA 1997?

Answer

No.

This ruling applies for the following period:

Year ended 31 December 2016

The scheme commences in:

Year beginning 1 January 2016

Relevant facts and circumstances

HeadCo is the head company of a consolidated group. HeadCo undertook a reorganisation.

The reorganisation involved a number of transactions and these included the following:

● AustCo, a subsidiary member of HeadCo, acquired all of the issued shares in ABC Co from FoeignCo. AustCo issued promissory notes to satisfy its obligation to pay for the ABC Co shares. The market value of each promissory note was equal its face value on the date of issue.

● ForeignCo assigned the promissory notes (initial assignments) to two new creditors and it received consideration for the assignments. The amount of consideration the new creditors gave and the market value of the promissory notes at the time of the initial assignment were both equal to the notes’ face value (plus accrued interest).

One of the promissory notes was subsequently assigned (subsequent assignment) by the new creditor of the note. The amount of consideration the new creditor gave in respect of the subsequently assigned promissory note and its market value at that time were both equal to the notes’ face value (plus accrued interest).

AustCo did not make a loss from the promissory notes by reference to, or by reason of, the interest on the promissory notes for the duration the promissory notes subsist.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 section 245-10

Income Tax Assessment Act 1997 section 245-20

Income Tax Assessment Act 1997 section 245-36

Income Tax Assessment Act 1997 Subdivision 245-C

Income Tax Assessment Act 1997 section 245-55

Income Tax Assessment Act 1997 section 245-65

Income Tax Assessment Act 1997 section 245-75

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

All legislative references are to the ITAA 1997 unless indicated otherwise.

Question 1

Did each assignment of the promissory notes constitute the forgiveness of a debt under Division 245 of the ITAA 1997?

Summary

Each assignment of the promissory notes constituted the forgiveness of a debt under Division 245.

Detailed reasoning

Division 245 applies to any commercial debt (or part of a commercial debt) that is forgiven.

For the commercial debt forgiveness rules to apply there must be a forgiveness of a commercial debt. The term ‘debt’ is not defined so the ordinary meaning of ‘debt’ applies to Division 245. The Explanatory Memorandum to the Tax Laws Amendment (Transfer of Provisions) Bill 2010 states that the ordinary meaning of “debt” requires an obligation to do something which is enforceable.

Debts which are subject to Division 245 include debts:

● where interest paid or payable on the debt was deducted, or can be deducted, by the debtor (paragraph 245-10(a)), and

● where interest is not payable by the debtor in respect of the debt but had interest been payable, the whole or any part of the interest could have been deducted by the debtor (paragraph 245-10(b)).

The promissory notes were issued by AustCo to ForeignCo to satisfy its obligation to pay for the ABC Co shares.

Having regard to the terms of the promissory notes, the interest on these promissory notes can be deducted or could have been deducted (apart from the operation of any provision of the taxation Act other than paragraphs 8-1(2)(a), (b) or (c) that has the effect of preventing a deduction (subsection 245-10(c)). Accordingly, the promissory notes are ‘commercial debts’ for the purposes of Division 245.

For each assignment of the promissory notes, to constitute the forgiveness of a debt under Division 245, the following conditions outlined in section 245-36 must be met:

A debt is forgiven if and when the creditor assigns the right to receive payment of the debt to another entity (the new creditor) and the following conditions are met:

(a) either the new creditor is the debtor's *associate or the assignment occurred under an *arrangement to which the new creditor and debtor were parties;

(b) the right to receive payment of the debt was not acquired by the new creditor in the ordinary course of *trading on a market, exchange or other place on which, or facility by means of which, offers to sell, buy or exchange securities (within the meaning of Division 16E of Part III of the Income Tax Assessment Act 1936) are made or accepted.

The parties to the assignments are associates as defined in section 318 of the Income Tax Assessment Act 1936 (ITAA 1936) and the assignment did not occur in the ordinary course of trading on a market, exchange or other place on which, or facility by means of which, offers to sell, buy or exchange securities (within the meaning of Division 16E of Part III of the ITAA 1936) are made or accepted.

Accordingly, each assignment constitutes the forgiveness of a commercial debt for the purposes of Division 245.

Question 2

If yes to Question 1, did each assignment of the promissory notes result in a net forgiven amount under Division 245 of the ITAA 1997?

Summary

Each assignment of the promissory notes did not result in a net forgiven amount under Division 245.

The commercial debt forgiveness provisions do not apply in circumstances where the value of the forgiven debts (represented by the assignments of the promissory notes) is equal to or less than the amount of offset to be applied. As a result there is no gross forgiven amount and Subdivisions 245-D to 245-F (about how to work out the net forgiven amount of a debt and how to treat it) do not apply. Subdivision 245-F does not apply as it contains special rules about partnerships.

Detailed reasoning

Under Division 245, where the forgiveness of a commercial debt results in a debtor having a positive ‘net forgiven amount’, the debtor will be required to reduce certain tax attributes that could otherwise reduce their taxable income (in the same or a later income year), to the extent of the net forgiven amount.

To calculate the net forgiven amount of a debt, it is first necessary to calculate the ‘gross forgiven amount’ of a debt. The rules to calculate the gross forgiven amount of a debt that has been forgiven are set out in Subdivision 245-C.

Value of the debt at the forgiveness time

Initial assignments of the promissory notes

In accordance with the rules set out in Subdivision 245-C, the value of a forgiven debt needs to be worked out. Subsection 245-55(1) provides the primary rule for working out the value of a debt:

The value of your debt at the time (the forgiveness time) when it is *forgiven is the amount that would have been its *market value (considered as an asset of the creditor) at the forgiveness time, assuming that:

(a) when you incurred the debt, you were able to pay all your debts (including that one) as and when they fell due; and

(b) your capacity to pay the debt is the same at the forgiveness time as when you incurred it.

According to this rule, the value of a debt when it is forgiven is its market value when it is forgiven assuming that, at the time the debt is incurred and at the time it is forgiven, the debtor is solvent (solvency assumption). That is, the debtor is able to repay that debt and all debts as and when they fell due when the debt was incurred and has that same capacity when the debt is forgiven.

The market value of the debt is the amount that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length (Spencer v The Commonwealth (1906) 5 CLR 418).

The solvency assumption in paragraph 245-55(1)(a) does not apply if all of the conditions in subsection 245-55(3) are met. As not all the conditions in subsection 245-55(3) are met in this case, paragraph 245-55(1)(a) will apply when working out the value of the debt.

Accordingly, the value of each promissory note, being their market value at the time of each initial assignment, is equal to their face value (plus accrued interest).

Subsequent assignment

Section 245-61 sets out the special rule for working out the value of a previously assigned debt:

If your debt has been assigned as mentioned in section 245-36 and is later *forgiven by the new creditor, the value of that debt when it is later forgiven is:

(a) if the debt was not a *moneylending debt and the creditor and the new creditor were not dealing with each other at *arm's length in connection with the assignment - the *market value of the debt at the time of the assignment; or

(b) in any other case - the sum of:

(i) the amount or market value of the consideration (if any) you paid or gave, or are required to pay or give, to the creditor in respect of the assignment; and

(ii) the amount or market value of the consideration (if any) the new creditor paid or gave in respect of the assignment.

On the facts provided:

● the subsequently assigned promissory note was not a moneylending debt as defined in subsection 995-1(1), and

● the amount of the consideration the new creditor gave in respect of the initial assignment of the subsequently assigned promissory note and its market value at the time of the initial assignment were both equal to the note’s face value (plus accrued interest).

Accordingly, whether or not the parties to the assignment were dealing with each other at arm’s length in connection with the initial assignment of the subsequently assigned promissory note, the value of the promissory note when it was subsequently assigned as worked out under subsection 245-61 was equal to the face value of the promissory note (plus accrued interest).

Amount offset

The next step is to determine if an amount is to be offset against the value of the debt under section 245-65. Since the debts in question had been forgiven by way of assignment pursuant to section 245-36, the relevant items in the table in subsection 245-65 are items 4 and 5.

Item 4 of the table in subsection 245-65(1) will apply unless item 5 applies. Item 4 states that the amount which is offset against the value of a debt is the sum of the market value of any consideration paid or given (or required to be paid or given) by the debtor, in respect of the assignment, and the amount or market value of any consideration paid or given by the new creditor in respect of the assignment.

Item 5 of the table in subsection 245-65(1) states that where the debt is assigned under section 245-36 and the debt is not a moneylending debt and the creditor and the new creditor were not dealing with each other at arm’s length in connection with the assignment, the amount which is offset against the value of a debt is the market value of the debt at the time of the assignment.

On the facts provided:

● the promissory notes were not moneylending debts as defined in subsection 995-1(1), and

● the amount of the consideration the new creditors gave in respect of the initial assignment of the promissory notes and the market value of the promissory notes at the time of the initial assignments were both equal to the notes’ face value (plus accrued interest), and

● the amount of the consideration the new creditor gave in respect of the subsequently assigned promissory note and its market value at the time of the subsequent assignment were both equal to the note’s face value (plus accrued interest).

Accordingly, irrespective of which of items 4 or 5 of the table in subsection 245-65(1) applies, the amount offset against the value of the promissory notes was equal to the respective face value of the promissory notes (plus accrued interest).

Gross forgiven amount

The final step is to work out the gross forgiven amount.

On the basis section 245-65 applies:

● the gross forgiven amount is the amount by which the value of the debt (when it was forgiven) exceeds the amount offset under section 245-65 (paragraph 245-75(1)(b)); or

● if the value of the debt when it was forgiven is equal to or less than the amount offset there is no gross forgiven amount in respect of the debt and Subdivisions 245-D to 245-F do not apply in respect of the debt (subsection 245-75(2)).

Accordingly, having regard to subsection 245-75(2), the commercial debt forgiveness provisions do not apply to each assignment of the promissory notes because the value of each of the forgiven debts (worked out under subsection 245-55(1) or section 245-61 as the case may be) is equal to the amount of offset to be applied. As a result, there is no gross forgiven amount. It follows that there is no net forgiven amount and Subdivisions 245-D to 245-F (about how to work out the net forgiven amount of a debt and how to treat it) do not apply.