Edited version of private advice

Authorisation Number: 1051964141030

Date of advice: 23 March 2022

Ruling

Subject: CGT - debt forgiveness

Question

Are you able to claim a CGT loss in relation to funds you lent to a company upon its wind up?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You traded in a company for a number of years.

The company was not profitable and incurred debts of $X.

The company ceased trading in June XXXX.

The funds were lent over a number of years for various amounts.

There was no loan agreement between the parties.

You forgave the loans on XXXXX.

The company is deregistered with ASIC and shares cancelled.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 108-5(2)

Income Tax Assessment Act 1997 subsection 102-25(1)

Income Tax Assessment Act 1997 subsection 104-25(1)

Income Tax Assessment Act 1997 subsection 104-25(3)

Income Tax Assessment Act 1997 subsection 116-20(1)

Income Tax Assessment Act 1997 subsection 116-30(1)

Income Tax Assessment Act 1997 subsection 116-30(2)

Income Tax Assessment Act 1997 subsection 116-30(3A)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997.

A capital gains tax (CGT) asset is defined as any kind of property, or a legal or equitable right that is not property - subsection 108-5(1). Examples of CGT assets include land and buildings; shares in a company and units in a unit trust; options; debts owed to you; a right to enforce a contractual obligation; and foreign currency.

A debt owed to a lender is a CGT asset for the purposes of section 108-5 - see CGT Determination Number 2 TD 2 which specifically states that a debt is an asset of the lender. The debt is disposed of when the lender waives or forgives the debt. As such a CGT event will happen to the lender.

Relevantly, subsection 104-25(1) provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset being released, discharged or satisfied. The time of the event is:

a)            when you enter into the contract that results in the asset ending; or

b)            if there is no contract - when the asset ends.

You make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base - subsection 104-25(3).

Whether the lender makes a capital gain or capital loss from the CGT event will depend on the consideration (capital proceeds) received for the forgiveness of debt and the appropriate cost base of the asset which is the debt.

Capital proceeds

The capital proceeds from a CGT event are the total of the money you have received, or are entitled to receive, in respect of the event happening; and the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event) - subsection 116-20(1).

The market value substitution rules will apply if no capital proceeds are received from a CGT event; and no consideration paid for the acquisition of a CGT asset - subsection 116-30(1).

Also, the capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if the capital proceeds are more or less than the market value of the asset and the event is CGT event C2 - subsection 116-30(2).

The market value of the debt at the time of the CGT event is worked out as though the forgiveness of debt had not happened and was never proposed to happen - subsection 116-30(3A).

Application to your circumstances

The loan you provided to the company is a CGT asset to you within the meaning of the term in section 108-5. CGT event C2 happened when you forgave the loan.

For your capital proceeds from CGT event C2, you are taken to have received an amount equal to the market value of the debt at the time of the event, ie when the debt is forgiven, because you received no consideration from the company for the forgiveness of the debt.

The market value of the debt at the time of the event is worked out as though the forgiveness of debt had not happened and was never proposed to happen.

Broadly, the cost base and reduced cost base of an asset is the money paid to acquire or create the asset plus any expenditure and/or incidental costs relating to the asset. For you as the lender, that will be the amount of your loan to the company.

If the market value of the debt is less than the amount owed to you (face value of the debt) then you will make a capital loss from the forgiveness of debt.

If the market value of the debt equals the face value of the debt, you make no capital gain or capital loss from the forgiveness of debt.

In your case, the value of the debt to be forgiven and the market value of the debt at the time of the forgiveness is the same.

Therefore, you make no capital gain or capital loss from the forgiveness of debt.