Edited version of private advice

Authorisation Number: 1052241331671

Date of advice: 12 April 2024

Ruling

Subject: CGT - debt forgiveness

Question 1

Will the forgiveness of a loan owed by the Trust to the Company give rise to a deemed dividend under section 109F of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes.

Question 2

Will the amount of the deemed dividend in Question 1 be reduced under section 109Y of the ITAA 1936?

Answer

Yes.

Question 3

Will the commercial debt forgiveness rules in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the forgiveness of a loan owed by the Trust to the Company?

Answer

No.

Question 4

Will the commercial debt forgiveness rules in Division 245 of the ITAA 1997 apply to the forgiveness of a loan owed by the Trust to a financial institution?

Answer

No.

Question 5

Will the commercial debt forgiveness rules in Division 245 of the ITAA 1997 apply to any future forgiveness of the tax debt owed by the Company to the Australian Taxation Office (ATO)?

Answer

No.

Question 6

Will a capital gains tax (CGT) event under Division 104 of the ITAA 1997 happen when the Trust forgives the loans owed to it by its beneficiaries?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20YY

Year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You are a private company registered on XXXX.

Your directors are Director A and Director B.

You previously operated a Business.

The Business was sold in the 20XX income year.

The director intends to wind up the company.

Your sole shareholder is a related entity, Trustee as Trustee for a Trust.

Directors of the Trustee are Director A and B who are also beneficiaries of the Trust.

You provided draft financial statements which have the following account balances for the year ended 30 June 2023 (2023 income year) after all transactions have been accounted for:

•         Assets

o   Division 7A loan to the Trust of $XX.

o   Cash on hand of $XX

•         Liabilities

o   Tax debt of $XX

•         Equity

o   Retained earnings of $XX

o   Paid up share capital of $XX

The Trust is also no longer trading and it is the intention of the Trustee to wind up the Trust.

The Trust provided draft financial statements which has the following account balances for the 2023 income year after all transactions have been accounted for:

•         Assets

o   Loan to Beneficiary A of $XX

o   Loan to Beneficiary B of $XX

•         Liabilities

o   Division 7A loan owed to you of $XX

o   Financial institution loan of $XX (that has been forgiven in full in the 2024 income year)

•         Trust Funds

o   $XX

The above balances are after all other transactions for the 20YY income year have been accounted for, including Division 7A interest, repayments and dividends declared.

Complying Division 7A loan agreements were in place for the loans between you and the Trust and minimum yearly repayments were made in income years prior to the 20YY income year by way of dividends declared by directors' resolution.

For the 20YY income year you had a tax loss of $XX.

For the 20YY income year the Trust had a distributable profit of $XX.

Interest on the Division 7A loan is not tax deductible to the Trust as the funds were not used for a taxable purpose.

The Trust Deed defines Net Income of the Trust as per section 95 of the ITAA 1936.

The financial institution loan to the Trust was made in the 20YY income year to assist in paying down Beneficiary A and Beneficiary B's personal credit card debts incurred after the sale of the Business.

Interest on the financial institution loan is reported in the financial statements but has not been claimed as a deduction in the Trust's tax return as it is not an expense incurred in earning taxable income.

Financial institution provided written confirmation of the Trust's debt write-off of $XX on XX.

Proceeds from the sale of the Business were lent by you to the Trust in the 20YY income year.

The loans from the Trust to Beneficiary A and Beneficiary B resulted from them withdrawing funds from the Trust exceeding their present entitlements.

The funds were used by Beneficiary A and Beneficiary B to purchase the family rural property.

It was intended that the Trust would operate the property as a rural business, however, this did not eventuate due to funding issues and family stress.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 section 109F

Income Tax Assessment Act 1936 section 109G

Income Tax Assessment Act 1936 section 109Y

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 108-20

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 section 245-1

Income Tax Assessment Act 1997 section 245-35

Income Tax Assessment Act 1997 section 245-37

Income Tax Assessment Act 1997 section 245-40

Taxation Administration Act 1953 section 250-10

Taxation Administration Act 1953 section 255-5

Reasons for decision

Question 1

Summary

The forgiveness of a loan owed by the Trust to you will give rise to a deemed dividend under section 109F of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

A private company that forgives a debt owed to it by an entity is taken to pay a dividend to the entity if they are a shareholder in the private company or an associate of the shareholder when the payment is made (paragraph 109F(1)(a) of the ITAA 1936).

The dividend is taken to be paid at the end of the private company's income year in which the debt is forgiven (subsection 109F(1) of the ITAA 1936). The dividend is taken to equal the amount of debt forgiven (subsection 109F(2) of the ITAA 1936), reduced by reference to the amount of the company's distributable surplus (section 109Y of the ITAA 1936).

In your case, you have forgiven a debt of $XX owed to you by the Trust who is your shareholder when the debt is forgiven. Your forgiveness of that debt, therefore, will be taken to pay a dividend to your shareholder, the Trust, at the end of your 20YY income year if all or part of the debt the Trust owed you is forgiven in that year (section 109F of the ITAA 1936).

Additionally, the exclusions contained in section 109G of the ITAA 1936 do not apply to your circumstances.

Question 2

Summary

The amount of the deemed dividend in Question 1 will be reduced to $XX under section 109Y of the ITAA 1936.

Detailed reasoning

The amount of the deemed dividend you are taken to pay under Division 7A of the ITAA 1936 is limited to your distributable surplus for that income year (subsection 109Y(1) of the ITAA 1936).

Your distributable surplus for the 20YY income year is worked out using the following formula under subsection 109Y(2) of the ITAA 1936[1]:

Table 1: Distributable surplus.

Subsection 109Y(2) of the ITAA 1936 also defines "net assets" as the amount (if any), at the end of your year of income, by which your assets (according to your accounting records) exceed the sum of your present legal obligations to persons other than you. After the debt is written off, your assets will only consist of $XX cash on hand and your liabilities will be equal to your tax debt which as at 30 June 2023 was $XX.

Consequently, as your assets do not exceed your tax debt, your net assets for the 20YY income year would be nil.

If the total amount that would be treated as a dividend (if not for this limitation) is greater than your distributable surplus, the amount of the provisional dividend is reduced to reflect the lower amount of the distributable surplus under subsection 109Y(3) of the ITAA 1936 as follows:

Provisional dividend x Distributable surplus for the income year

Total of provisional dividends for the income year

In your case, you forgave a $XX debt owed to you by your shareholder, the Trust. The forgiveness of this debt is taken to be a Division 7A deemed dividend under section 109F of the ITAA 1936. In the 20YYincome year, you would have a distributable surplus of $XX. As the debt forgiven of $XX which would otherwise be treated as a dividend exceeds the distributable surplus of $XX, you are taken to have paid:

$XX x $XX = $XX

$XX

You are required to give the Trust a written statement as soon as possible after the end of the 2024 income year, which must set out:

•         your distributable surplus for the 2024 income year, and

•         the total amount you would otherwise be taken to pay under Division 7A as dividends for the 2023 income year (i.e., the total of provisional dividends) under subsections 109Y(4) and 109Y(5) of the ITAA 1936.

Question 3

Summary

The commercial debt forgiveness rules in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997) will not apply to the forgiveness of a loan owed by the Trust to you.

Detailed reasoning

The commercial debt forgiveness rules are set out in Division 245 of the ITAA 1997 and apply where a "commercial debt" owing by a taxpayer is forgiven. As per section 245-10 the commercial debt forgiveness rules apply to a debt where the whole or any part of interest, or an amount in the nature of interest, paid or payable in respect of the debt is allowable as a deduction to the debtor. Where interest, or an amount in the nature of interest is not payable, a debt is also a commercial debt, if, interest had been payable, it would have been deductible.

However, if the interest in respect of a debt is non-deductible because it is capital, private or domestic in nature, or related to exempt or non-assessable non-exempt income, Division 245 will not apply to such a debt.

Additionally, section 245-40 of the ITAA 1997 prescribes circumstances in which the forgiveness of a debt will not be caught by Division 245. One circumstance where Division 245 will not apply is to a debt that has been, or will be, included in the debtor's assessable income for any year of income (subsection 245-40(b)). Typically, such a position arises if a private company provides a loan to its shareholder (which is not a company) and the loan is deemed as a dividend and included in the shareholder's assessable income under Division 7A of the ITAA 1936.

In your case, the interest on the loan of $XX to the Trust which was forgiven is not tax deductible to the Trust, as the funds were not used for a taxable purpose. Furthermore, as the forgiveness of the loan is treated as a deemed dividend under section 109F of the ITAA 1936 and is to be included in the Trust's assessable income, the loan would not be treated as a debt to which Division 245 applies. As a result, your waiver of the Trust's obligation to repay the loan will not trigger the debt forgiveness provisions under Division 245.

Similarly, the $XX loan to the beneficiaries which was forgiven by the Trust, was also not used for a taxable purpose. Therefore, as the debts forgiven are private or domestic in nature, these debts are not commercial debts and Division 245 will not apply. Consequently, the Trust will not need to offset the forgiven amount against amounts that could otherwise reduce its taxable income under subdivision 245-E of the ITAA 1997.

Question 4

Summary

The commercial debt forgiveness rules in Division 245 of the ITAA 1997 will not apply to the forgiveness of a loan owed by the Trust to a financial institution.

Detailed reasoning

In your case, the financial institution provided a business loan to the Trust, and subsequently provided written confirmation of the Trust's debt write-off of $XX on XX.

As detailed in the reasoning at Question 3 earlier, Division 245 of the ITAA 1997 only applies where a "commercial debt" owing by a taxpayer is forgiven and where the whole or any part of interest, or an amount in the nature of interest, paid or payable in respect of the debt is allowable as a deduction to the debtor, or, had interest been payable, it would have been deductible.

In this instance, the loan to the Trust forgiven by the financial institution, was borrowed in 20XX to assist in paying down personal credit card debts incurred after the sale of the Business. Although the interest shows in the financial statements it has not been claimed as a deduction in the Trust's tax return as it is not an expense incurred in earning taxable income.

Therefore, because the interest in respect of the Trust's debt to the financial institution is non-deductible as it is private or domestic in nature, it is not a commercial debt and Division 245 will not apply.

Question 5

Summary

The commercial debt forgiveness rules in Division 245 of the ITAA 1997 will not apply to any future forgiveness of your tax debt owed to the Australian Taxation Office (ATO).

Detailed reasoning

Division 245 of the ITAA 1997 does not apply to a debt that is a tax-related liability or a civil penalty under Division 290 in Schedule 1 to the Taxation Administration Act 1953 (TAA 1953) (subsection 245-40(f) of the ITAA 1997).

A tax-related liability is defined in section 255-5 of the TAA 1953 as a debt owed to the Commonwealth, payable to the Commissioner under any of the laws as listed in section 250-10 of the TAA 1953. The list includes income tax and extends to fringe benefits tax, GST and superannuation guarantee charge, among other things. This measure eliminates the possibility of a reduction or elimination of a tax related liability as a result of an amended or withdrawn assessment triggering the debt forgiveness rules.

Question 6

Summary

A CGT event under Division 104 of the ITAA 1997 will happen when the Trust forgives the loans owed to it by its beneficiaries.

Detailed reasoning

A capital gains tax (CGT) asset is defined as any kind of property, or a legal or equitable right that is not property under subsection 108-5(1) of the ITAA 1997 and includes debts owed to you.

A debt owed to a lender is a CGT asset for the purposes of section 108-5, see CGT Determination Number 2 TD 2 Capital Gains: What are the CGT consequences for the lender (Creditor) when a debt is waived? 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) of the ITAA 1997 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.

The lender makes a capital gain if the capital proceeds from the ending are more than the asset's cost base. The lender makes a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-25(3) of the ITAA 1997).

Additionally, in working out the net capital gain or net capital loss for the income year, any capital loss made from a personal use asset is disregarded (subsection 108-20(1) of the ITAA 1997).

A personal use asset is:

•         a debt arising from a CGT event in which the CGT asset the subject of the event was one (except a collectible) that is used or kept mainly for your (or your associate's) personal use or enjoyment (paragraphs 108-20(2)(a) and (c) of the ITAA 1997), or

•         a debt arising other than:

o   in the course of gaining or producing your assessable income, or

o   from your carrying on a business (paragraph 108-20(2)(d) of the ITAA 1997).

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) of the ITAA 1997).

If no capital proceeds are received from a CGT event you are taken to have received the market value, at the time of the event, of the CGT asset (subsection 116-30(1) of the ITAA 1997).

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) of the ITAA 1997).

The loans the Trust provided to its beneficiaries, are CGT assets within the meaning of the term in section 108-5. CGT event C2 will happen when the Trust forgives the loans. The loans are also considered to be personal use assets in accordance with subsection 108-20(1) of the ITAA 1997.

For capital proceeds from CGT event C2, the Trust as the lender will be taken to have received an amount equal to the market value of the debts at the time of the event, i.e., when the debt is forgiven, because no consideration will be received from the beneficiaries 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 the Trust as the lender, that will be the amount of the loan to the beneficiaries.

If the market value of the debt is less than the amount owed to the Trust (face value of the debt) then the Trust will make a capital loss from the forgiveness of debt. However, as the loans are considered to be a personal use asset any capital loss would be disregarded.

If the market value of the debt equals the face value of the debt, the Trust will neither make a capital gain nor a capital loss from the forgiveness of debt.

[1] As you are no longer operating the Business and have no further sources of income or deductions, the assets and liabilities are assumed to be the same as they were as at 30 June 2023 for the purposes of this calculation under subsection 109Y(2) of the ITAA 1936.