Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Forgiveness of commercial debts
Summary of the amendments
8.1 The amendments in Schedule 6 are technical in nature and will ensure that the provisions relating to the forgiveness of commercial debts operate as intended. They are contained in the Income Tax Assessment Act 1936 (the Act) as proposed to be amended by the Taxation Laws Amendment Bill (No. 2) 1996 .
8.2 The amendments are to have effect from 27 June 1996.
Explanation of the amendments
8.3 New subsection (4A) being inserted in new section 245-25 will make it clear that taxation debts due to the Commonwealth are not commercial debts. That will prevent the debt forgiveness measures from applying to a taxation debt due to the Commonwealth in the event that the debt is reduced or eliminated, eg by way of an amendment or withdrawal of an assessment. The amendment will apply to debts arising not only under the Act but also under other Commonwealth taxation laws eg Fringe Benefits Tax Assessment Act 1986 or the Sales Tax Assessment Act 1992 . [Items 1 to 3]
Notional value of 'foreign debts'
8.4 In valuing a debt, the basic rule is to assume the debtor was solvent when the debt was incurred and that the debtor's capacity to pay has not changed. Ordinarily, that means the debt is valued by reference to its arm's length terms.
8.5 New subsection 245-55(4) contains a special rule which provides for the purposes of valuing a forgiven debt that the assumption of initial debtor solvency does not apply where the debtor and the creditor were not dealing at arm's length in relation to a debt and the debt is not a moneylending debt. The reason is that for capital gains tax (CGT) purposes, subsection 160ZH(9) would treat the creditor in such circumstances as having given market value consideration for the debt when it was acquired as an asset of the creditor. A similar valuation rule therefore applies to the debtor for debt forgiveness purposes in that circumstance.
8.6. However, the special rule ought not apply to a foreign debt - that is, where the creditor is a non-resident and the debt is not a taxable Australian asset of the creditor for CGT purposes - because CGT applies only to Australian residents and taxable Australian assets of non-residents. There are no reasons, therefore, to depart from ordinary debt valuation rules for those kinds of assets.
8.7 Accordingly, new subsection 245-55(4) is being amended so that the special rule would apply in the circumstances described (ie where the debtor and creditor of a non money lending debt were not at arm's length) only where the creditor was a resident at the time of forgiveness or where the forgiveness of the debt constituted the disposal by the creditor of a taxable Australian asset (under section 160T of the Act). [Item 4]
Consideration in respect of forgiveness of 'foreign debts'
8.8 For reasons similar to the ones underlying new subsection 245-55(4) , new subsection 245-65(2) treats a debtor as having paid consideration equal to the market value of the debt for the purposes of working out the gross forgiven amount of a non moneylending debt. That is, consideration in respect of a debt is valued in a manner consistent with the way consideration would be valued from the perspective of the creditor under s160ZD(2) for CGT purposes.
8.9 However, new subsection 245-65(2A) will prevent the deeming rule from applying to the debtor where the creditor was a non-resident at the time of forgiveness except where the forgiveness of the debt constituted the disposal by the creditor of a taxable Australian asset (under section 160T of the Act). In those circumstances, the actual value of any consideration given by the debtor in respect of forgiveness (rather than the market value of the debt) is taken into account in working out the gross forgiven amount. [Items 5 and 6]
Debtors who are jointly and severally liable
8.10 The debt forgiveness provisions potentially could apply more than once in respect of a single debt in circumstances where there is more than one debtor and the debtors are jointly and/or severally liable for the debt. In these circumstances, each debtor would have a debt as defined in proposed section 245-15 because there is an enforceable obligation on each debtor to pay the whole amount of the debt. Therefore, a forgiveness of the debt could result in a forgiven amount equal to the whole amount of the debt for each of the debtors.
8.11 Accordingly, new subsection 245-75(3) is being inserted to deal with joint debts which are not partnership debts. (Partnership debts are dealt with in Subdivision 245-F of Schedule 2C). The new provision will require a gross forgiven amount to be apportioned between the debtors in respect of whom the debt was a commercial debt ('commercial debtors') on the basis of the number of commercial debtors who are jointly and/or severally liable for the particular debt. [Items 7 to 9]
Table of deductible expenditure
8.12 To correct an oversight, the table of deductible expenditure contained in new subsection 245-140(1) will be amended to include expenditure incurred on research and development under section 73B of the Act and capital expenditure incurred in establishing horticultural plants under sections 124ZZF and 124ZZG, and subsection 124ZZM(2) (Division 10F of Part III of the Act). [Items 10 and 11]
8.13 New subsection 245-190(3) stipulates that the maximum amount by which the cost bases of each nominated asset may be reduced is the amount that would have been the reduced cost base of the asset calculated as if the asset had been disposed of on either of the following days:
- (a)
- the first day of the forgiveness year of income; or
- (b)
- if the specified described event occurred after the beginning of the forgiveness year of income - the day on which the event occurred.
8.14 Section 160ZK of the Act, however, requires any balancing adjustment arising from the disposal of an asset to be taken into account in working out its reduced cost base. Without knowing the consideration in respect of disposal, it would not be possible to determine the amount of any balancing adjustment arising from a notional disposal. However, new subsection 245-190(3) does not stipulate the amount to be treated as consideration in respect of a notional disposal of an asset.
8.15 Accordingly, new subsection 245-190(3) will be amended so that the reduced cost base of a nominated asset is calculated as if the asset had been disposed of at its market value. [Item 12]
8.16 Subdivision 245-G of Schedule 2C applies to apportion a net forgiven amount of a debtor company among companies under common ownership as the debtor company at the time a debt is forgiven and on the last day of the immediately preceding year of income before forgiveness. In circumstances outlined in new subsection 245-225(3) , however, a special rule applies to treat a previously commonly owned company that was not under common ownership with the debtor company at those times as though it were grouped with the debtor company for purposes of the apportionment.
8.17 The special rule applies where the other company and the debtor company were under common control immediately before and after they ceased to be under common ownership, and at the time when the debt was forgiven. It is doubtful whether the rule, as it stands, would include in the relevant company group a subsidiary of a widely held debtor company because, even though the debtor company would control the subsidiary, the common control test is expressed by reference to a taxpayer who is the controller of both companies. It can be argued that, because the debtor company is widely held, no shareholder would qualify as a controller of the company so that the subsidiary could not be said to be under common control with the debtor company according to the common control test as presently expressed. By the same argument, the rule would appear not to apply in the case of a widely held parent company of a debtor company even though the parent company would control the debtor company.
8.18 The special rule is meant to prevent previously commonly owned companies which remain effectively under the control of the relevant group from avoiding the debt forgiveness rules by ceasing technically to be under 'common ownership' (ie. 100% common ownership) before a group company is forgiven its debts.
8.19 Accordingly, new paragraph 245-225(3)(d) will ensure that the special rule applies to a company which at the relevant times, is either under common control with the debtor company or controls or is controlled by the debtor company. [Item 13]
Company's deductible revenue losses
8.20 Broadly, section 80G of the Act allows a resident company which incurs a revenue loss incurred in a year of income to transfer the loss to another resident company in the same group of companies. Where a loss is transferred in the year in which it was incurred by the transferor company ('current year loss'), paragraph 80G(6)(f) has the effect of deeming the transferee company to have incurred the loss in the preceding year of income.
8.21 New section 245-230 (the company grouping provisions) apportion a debt forgiveness amount to companies that constitute a group of related companies on the basis of each company's undeducted prior revenue losses, ie. losses incurred in a year of income before the forgiveness year of income that have not been deducted [new paragraph 245-110(b)] .
8.22 The technical effect of these provisions would be that a loss incurred by a debtor company in the forgiveness year of income that is transferred under section 80G to another group company will be treated as an undeducted prior revenue loss of that group company for the purposes of apportioning a debt forgiveness amount of the debtor company. That is inconsistent with the principle that losses incurred in the forgiveness year of income are not to be affected by the measures.
8.23 A new definition of 'deductible revenue losses' is being inserted in new subsection 245-230(4) to prevent a loss incurred by a debtor company in respect of the forgiveness year of income that is transferred to a group company from qualifying as a deductible revenue loss of the group company (by virtue of paragraph 80G(6)(f) of the Act) for the purposes of apportioning a net forgiven amount of the debtor company. [Item 14]