Edited version of private advice

Authorisation Number: 1052355158626

Date of advice: 17 April 2025

Ruling

Subject: Commercial debt forgiveness - exclusion

Question

Will the debt that Individual A and Individual B forgive be excluded from the application of the commercial debt forgiveness provisions in Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You are a discretionary trust established by deed (Deed).

Company A Pty Ltd (Company A or Trustee) has been your trustee since you were established.

Individual A and Individual B are the directors of Company A.

Individual A and Individual B each hold 50% of the shares on issue in Company A.

Individual A and Individual B, as directors of Company A, intend on keeping you in existence indefinitely, and have no intention of causing the Trustee to amend the Deed in the foreseeable future.

Individual A and Individual B have been the only Primary Beneficiaries of you under the Deed since you were established.

Beneficiary in the Deed is defined to mean:

(a)          any Primary Beneficiary

(b)          any Spouse of a person referred to or described in (a) above

(c)          any grandparent of a person referred to or described in (a) or (b) above

(d)          any Child or remoter issue, including a person born after the date of the Deed, of a person referred to or described in (a), (b), or (c) above

(e)          any Spouse, including a person born after the date of the Deed, of a person referred to or described in (d) above

(f)          any Specified Beneficiary

(g)          any person nominated by the Trustee (except the Settlor)

(h)          the Legal Personal Representative in that capacity for the estate of a deceased Beneficiary

(i)          any corporation formed in any country any shares in which are held by the Trustee of the Trust Fund; or by or for the benefit of a Beneficiary listed in the definition (including any trustee described in paragraph (j) below) or are the subject of an option in favour of such a Beneficiary

(j)          the trustees in their capacity as such of any trust established at any time and in any country:

•                    in which a Beneficiary listed in this definition is a beneficiary, and

•                    the inclusion of which does not infringe the rule against perpetuities, and

(k)          any body established wholly for charitable purposes.

The Deed has not been amended since you were established.

Individual A and Individual B jointly borrowed $X (Personal Loan).

Individual A and Individual B loaned the amount they borrowed under the Personal Loan to you (Investment Loan) under a loan agreement (Loan Agreement).

You used the proceeds of the Investment Loan to partly finance the purchase of a freehold interest in real property (Property).

Individual A and Individual B have subsequently repaid the Personal Loan from other funds available to them.

Individual A and Individual B are and were married to each other and not separated and enjoy and have enjoyed an ordinary loving husband-wife relationship.

Under the Deed the Trustee may:

•                     pay to, apply or set aside for the maintenance or benefit of a Beneficiary who is alive or in existence during the relevant accounting period any income of the Trust Fund for the Accounting Period or any part thereof and any capital of the Trust Fund, including, but not limited to, any money borrowed or raised by the Trustee, and

•                     execute a determination to play, apply or set aside any income or capital of the Trust Fund to or for the benefit of a Beneficiary in any manner and subject to any terms and conditions the Trustee thinks fit.

The Trustee may, therefore, in accordance with the Deed, distribute any or all of the net income of the Trust Fund for any Accounting Period and any capital of the Trust Fund to either or both of Individual A and Individual B and/or their children, although the Trustee may also or instead distribute any or all of the income or capital of the Trust Fund to a wider range of other persons if it thinks fit.

As Primary Beneficiaries Individual A and Individual B are entitled:

•                     to any net income of the Trust Fund which is undistributed immediately prior to midnight on the last day of any Accounting Period, and

•                     if alive at the Termination Date and if the Trustee has not made a determination (under clause X of the Deed which empowers the Trustee to distribute that income and capital to all or any of the Beneficiaries generally) to the income and capital of the Trust Fund at that date.

Individual B is your Appointor. The Deed provides that if Individual B dies, becomes incapable or resigns they shall be succeeded as Appointor by Individual A.

Your appointor has the power to remove and appoint your Trustee. Individual B has no intention of removing your Trustee for an indefinite period.

Company A as your Trustee has the power to amend the Deed. Individual A and Individual B, in their capacity as directors of your Trustee have no intention of causing your Trustee to exercise its power to amend the Deed for an indefinite period.

Individual A and Individual B have 3 children aged X, Y and Z. The children reside with Individual A and Individual B at their residence. Individual A and Individual B have enjoyed, and continue to enjoy, an ordinary loving parent-child relationship with each of their children.

You have only existed for 2 Accounting Periods. You did not make any distributions of income in either of those Accounting Periods as you had no net income to distribute.

Individual A and Individual B, as directors of your corporate trustee, intend that at some point in the medium term you will commence earning net income.

When you commence earning net income Individual A and Individual B will use their powers as directors to cause you to distribute all or substantially all of that income only to themselves and their children.

Individual A and Individual B also control another discretionary trust (M Trust) which does generate net income each financial year. Individual A and Individual B use their control of the M Trust to distribute the net income of that trust each financial year in the same general way as the way in which they propose that you will distribute any future net income which you earn.

Although your class of beneficiaries is wider than Individual A and Individual B and their children, they do not intend to exercise their powers as directors of your corporate Trustee to cause the company to distribute any substantial amount of your future net income, or your capital, to any person or entity other than themselves and their children, for an indefinite period.

Individual A and Individual B intend to forgive the Investment Loan.

You have the capacity to repay the Investment Loan if it is not forgiven.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 Subdivision 245-B

Income Tax Assessment Act 1997 paragraph 245-40(e)

Reasons for decision

The Commercial debt forgiveness provisions are found in Division 245 of the ITAA 1997.

A debt forgiven for reasons of natural love and affection is excluded from the application of the commercial debt forgiveness provisions (paragraph 245-40(e) of the ITAA 1997) (Paragraph 2 of Taxation Determination TD 2022/1 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 2022/1)).

The exclusion for debts forgiven for reasons of natural love and affection requires that the creditor is a natural person (Paragraph 1 of TD 2022/1).

The context of paragraph 245-40(e) of the ITAA 1997 requires a direct causal nexus between the forgiveness and the natural love and affection, and the natural love and affection must arise in consequence of ordinary human interaction. For this to occur, the creditor must be a natural person and the object of their love and affection must be one or more other natural persons. Where the conditions for the exclusion are otherwise satisfied, there is no requirement that the debtor must be a natural person (Paragraph 3 of TD 2022/1).

As the natural love and affection required for paragraph 245-40(e) of the ITAA 1997 to operate must arise in consequence of ordinary human interaction, the object of the creditor's natural love and affection that is the reason for the debt forgiveness must be another natural person (paragraph 16 of TD 2022/1).

However, paragraph 245-40(e) of the ITAA 1997 does not further require that the object of the creditor's natural love and affection is also the debtor (paragraph 17 of TD 2022/1).

Accordingly, paragraph 245-40(e) of the ITAA 1997 is capable of applying in circumstances where the debtor is not a natural person (for example, a company). It still remains necessary to establish that the creditor forgave the debt for reasons of natural love and affection, notwithstanding the debtor was not the object of that sentiment (for example, where a parent forgives a debt owed by a company that is 100% owned by their child) (Paragraph 18 of TD 2022/1).

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 (paragraph 7 of TD 2022/1).

The text in paragraph 245-40(e) of the ITAA 1997 comprises three elements, whose interaction is important:

•                     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 (paragraph 8 of TD 2022/1).

Element 1 - 'forgiveness of a debt' - the creditor

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 (paragraph 9 of TD 20221/1).

Element 2 - 'for reasons of'

The second element is comprised in the phrase 'for reasons of', which requires a causal nexus between the forgiveness and the natural love and affection. 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. The Commissioner takes the view that the causal nexus requires that the forgiveness be for the reason of the natural love and affection felt by the creditor for another natural person (paragraph 10 of TD 2022/1).

Element 3 - 'natural love and affection'

The third element in paragraph 245-40(e) of the ITAA 1997 is the phrase 'natural love and affection', which has both a legal meaning and an ordinary meaning. No contrary intention appears from the text or context of paragraph 245-40(e) to displace the presumption that the Commonwealth Parliament intended the term to have these ordinary and legal meanings (paragraph 11 of TD 2022/1).

The ordinary meaning of this phrase imports 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, particularly that of a parent to their children (paragraph 12 of TD 2022/1).

In testing the state of mind of a creditor to establish the presence of natural love and affection, a number of factors may be relevant including past dealings, existing relationships and future intentions. Whether natural love and affection is present in a relationship can only be determined on a case-by-case basis (paragraph 13 of TD 2022/1).

In the context of a conveyance, the phrase 'natural love and affection' ordinarily arises between family members where the making of a gift could constitute good consideration, although not valuable consideration. Ordinarily, it is considerations of moral obligation or emotional willingness, irrespective of self-interest, which are the catalyst for the relevant action, rather than a promise of something in return. (paragraph 14 of TD 2022/1).

This interpretation is further supported by considering the elements of paragraph 245-40(e) of the ITAA 1997 as a whole. The notion of forgiveness is confined by the use of 'natural love and affection'. That term serves to identify the motivation for the forgiveness. The requisite connection between that motivation and the forgiveness can only be satisfied when the creditor feels the natural love and affection for some other natural person. That is, an entity that is not a natural person cannot feel natural love and affection (paragraph 15 of TD 2022/1).

Application to your circumstances

Having regard to the past dealings, close family relationships and future intentions that exist between Individual A, Individual B and their children it is accepted that the Investment Loan will be forgiven for reasons of natural love and affection. As such, paragraph 245-40(e) of the ITAA 1997 will operate to exclude the forgiveness of the debt from the application of the commercial debt forgiveness provisions in Division 245 of the ITAA 1997.