The commercial debt forgiveness rules broadly apply where a creditor forgives a commercial debt owing by a debtor.
These special rules apply to remedy the effective duplication of tax deductions that would otherwise arise from the forgiveness of commercial debt. It is the general consensus of debt consolidation companies
that duplication could occur because, while a creditor may be entitled to a tax deduction or a capital loss when a debt is forgiven, the debtor, though relieved of the liability to repay the debt, is not assessed on any gain and could continue to claim deductions for accumulated revenue and capital losses and other undeducted expenditure.
Division 245 of ITAA97 treats the “net forgiven amount” of a commercial debt as having been used to generate the deductions that would otherwise be available to the debtor. Duplication of deductions is eliminated by applying the net forgiven amount to reduce the deductions in the following order:
- Deductible revenue losses
- Deductible net capital losses of the income years before the forgiveness year
- A wide range of deductible expenditure, such as expenditure relating to depreciating assets, R&D, Australian films and capital works.
- The cost bases of certain CGT assets
Within each of the above four classes of deductible amounts, the debtor can choose the relevant loss, item of expenditure or asset against which the net forgiven amount is to be applied and the amount to be applied, but the net forgiven amount must be applied to the maximum extent possible within each class.
Any part of the net forgiven amount which remains after being applied against all available deductible amounts is disregarded, except where the debtor is a partnership, in which case the residual amount is applied against the reducible amounts of the partners.
A debtor under Div 245 includes a person acting in the capacity of a trustee of a trust estate in respect of the trust estate’s debts. Division 245 applies to more than the conventional release or waiver type of forgiveness; it extends to a number of specific circumstances (such as debt parking and some debt-for-equity swaps) in which a forgiveness will be deemed to have occurred.
On the other hand, a forgiveness effected under a bankruptcy law, by will or for reasons of love and affection, is excluded. The payment of a debt by a guarantor does not constitute the forgiveness of the debt.
The waiver of a debt constituting a fringe benefit is disregarded as is a debt that is included in a taxpayer’s assessable income, for example as a deemed dividend.
A debt is commercial if the whole or any part of the interest payable on the debt is, was, or will be an allowable deduction to the debtor. It also includes debts in respect of which interest would have been deductible except for the operation of a special provision which prevents a deduction that would otherwise be allowable. Where interest is not payable on a debt, the debt will be subject to the rules where, had interest been charged, it would have been deductible.
Net forgiven amount
The amount that a debtor must apply against its deductible amounts is called the “net forgiven amount”. To determine this amount a debtor must:
- calculate the value of the debt.
- calculate what (if any) consideration was given for the forgiveness
- subtract the consideration from the value of the debt to arrive at the net forgiven amount of the debt.
Where there is a forgiveness of an intra-group debt, i.e. a debt owed by one company to another company under common ownership, the debtor company can avoid the reduction of its own reducible amounts if the creditor company agrees to forgo an equivalent amount of its entitlement to a capital loss or bad debt deduction.