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Edited version of private advice
Authorisation Number: 1051612114810
Date of advice: 22 November 2019
Ruling
Subject: Commercial debt forgiveness rules - exclusion for reasons of natural love and affection.
Question
If the trustee for X Family Trust writes off the loan to Y Trust, would the requirement in paragraph 245-40(e) of the Income Tax Assessment Act 1997 (ITAA 1997) be met, so that the commercial debt forgiveness rules do not apply to the debt forgiveness?
Answer
No
This ruling applies for the following periods:
Year ending 30 June 2020
Year ending 30 June 2021
Year ending 30 June 2022
The scheme commences on:
1 July 2019
Relevant facts and circumstances
The private ruling request concerns two taxpayers:
- X Pty Ltd as trustee for the X Family Trust (Creditor Trust) - a discretionary family trust, and
- Y Pty Ltd as trustee for the Y Trust (Debtor Trust) - a discretionary investment trust.
The owners of X Pty Ltd, the trustee of the Creditor Trust, are two siblings, owning 50% of the shares each. The same siblings are also the directors of the company.
The owners of Y Pty Ltd, the trustee of the Debtor Trust, are the same two siblings, owning 50% of the shares each. The same siblings are also the directors of the company.
Both siblings are elderly and have decided to separate their business interests to simplify their estate planning. As part of the separation of their business interests it has been proposed that the loan owed by the Debtor Trust to the Creditor trust be forgiven for reasons of natural love and affection.
The trustees' tax agent advises that the loan has come into existence as a result of the business restructure process, and that the loan meets the definition of a "commercial debt" for the purposes of section 245-10 of Income Tax Assessment Act 1997.
The Debtor Trust is currently holding and developing a parcel of land. According to the taxpayers' tax agent, the land previously belonged to a related entity and was acquired by the Debtor Trust as a result of a business restructure.
The Debtor Trust has not reported any income and has not made any distributions to beneficiaries prior to the date of this ruling.
Both the Creditor Trust and the Debtor trust are Australian resident trusts.
The Debtor trust is solvent and has sufficient assets to cover its liabilities.
Relevant legislative provisions
Section 8-1 of the Income Tax Assessment Act 1997
Division 245 of the Income Tax Assessment Act 1997
Section 245-10 of the Income Tax Assessment Act 1997
Paragraph 245-40(e) of the Income Tax Assessment Act 1997
Section 960-100 of the Income Tax Assessment Act 1997
Subsection 960-100(3) of the Income Tax Assessment Act 1997
Reasons for decision
Question 1
Summary
As the Creditor Trust is not a natural person, it has no capacity to feel natural love and affection, or to forgive a debt for that reason.
As such, paragraph 245(e) of the Income Tax Assessment Act 1997 (ITAA 1997) would not apply, and the write off of the loan would be subject to the commercial debt forgiveness rules in Division 245.
Detailed reasoning
Paragraph 245-40(e) of the ITAA 1997 provides that the commercial debt forgiveness provisions do not apply to a debt forgiven for reasons of natural love and affection.
Draft Taxation Determination TD 2019/D9 Income tax: commercial debt forgiveness - does the exclusion for debts forgiven for reasons of natural love and affection require that the creditor be a natural person? (TD 2019/D9) provides guidance on this issue.
Whether a debt has been forgiven for reasons of natural love and affection necessitates a careful examination of the reasons for forgiving the debt. This is a question of fact and includes taking into account the surrounding circumstances of the debt, and the nature of the relationship said to be the subject of the natural love and affection.
As discussed in paragraph 8 of TD 2019/D9, the text in paragraph 245-40(e) of the ITAA 1997 comprises three elements:
· The first element requires that there must be 'forgiveness of a debt'.
· The second element, 'for reasons of', requires a causal nexus between the first and third element.
· The third element, 'natural love and affection', can be characterised as a limitation on the first element.
The interaction of these elements is important.
Forgiveness of a debt
The use of the phrase 'forgiveness of a debt' in section 245-40 denotes creditors generally, and read in context, paragraph 245-40(e) indicates that the reasons of natural love and affection must be those of the creditor.
For reasons of
The phrase 'for reasons of' requires a connection that shows or implies that the love and affection caused the debt forgiveness. (paragraph 10 of TD 2019/D9).
It is not sufficient that there is forgiveness of the debt and there is natural love and affection, the forgiveness must be because of the natural love and affection.
This link requires that the natural love and affection is felt by the creditor.
Natural love and affection
The third element in paragraph 245-40(e) of the ITAA 1997 is the phrase 'natural love and affection'. The phrase has both a legal meaning and an ordinary meaning (paragraph 11 of TD 2019/D9).
The ordinary meaning of this phrase indicates strong emotions of caring, fondness and attachment that arise in consequence of ordinary human interaction. The term's legal meaning refers to goodwill towards, or emotional attachment to, another person (paragraph 12 of TD 2019/D9).
The phrase "natural love and affection" ordinarily arises between family members. Ordinarily, it is thoughts of moral obligation or emotional willingness, irrespective of personal interest, that motivates the relevant action (TD 2019/D9 paragraph 14).
Natural love and affection arises in consequence of ordinary human interaction. For this to occur, the creditor must be a natural person (TD 2019/D9 paragraph 3).
The second and third elements would not be satisfied in the case of an individual acting in their capacity as a trustee, or an individual acting in their capacity as a director of a corporate trustee, because the fiduciary relationship will govern the decisions taken by the trustee (paragraph 16 of TD 2019/D9).
Application to your circumstances
Although, the individual directors of both corporate trustees are family, under the proposed circumstances it is the Creditor Trust that is the creditor and would forgive the debt.
As the trust does not have the capacity to feel natural love and affection, the debt cannot be forgiven for that reason.
As both the trustee company, and its directors, are governed by the fiduciary relationship in relation to their decisions for and on behalf of the trust, the directors' feelings of natural love and affection to each other would not apply to the debt forgiven by the trust.
Conclusion
The forgiveness of the commercial debt by the Creditor Trust would not be for reasons of "natural love and affection", because there is no direct link between the forgiveness and the natural love and affection.
Therefore, paragraph 245(e) of the ITAA 1997 would not apply, and the proposed write off of the loan would be subject to the commercial debt forgiveness rules in Division 245.