The ATO has recently finalised its stance on the issue of commercial debt forgiveness, in particular the natural love and affection exclusion. A commercial debt is any debt where interest payable is deductible, or would be deductible if interest were payable, but for certain statutory restrictions. Under this definition, investments that are securities and equity for debt swaps could be included.
Under the commercial debt forgiveness provisions, if a taxpayer’s obligation to pay the debt is released, waived, or otherwise extinguished (ie by agreement, parking of debt, repurchase, redemption etc), the amount forgiven will be deducted from the taxpayer’s current and future tax deductions. Specifically, the amount forgiven will reduce prior year revenue losses, prior year net capital losses, undeducted balances of other expenditure being carried forward for deduction, and the CGT cost base of other assets held, in that order.
Given that commercial debts forgiven may mean a business will have to pay more tax, it would be advantageous if debts forgiven are not captured under the commercial debt forgiveness provisions. These exclusions include the forgiveness of a debt that is effected under an Act relating to bankruptcy or by will, or if the debt is forgiven by a natural person for the reasons of natural love and affection.
Prior to 6 February 2019, the natural love and affection exclusion to commercial debt forgiveness did not require that the creditor be a natural person. This meant that a company, through their directors, was able to forgive the debts of an individual by the reason of natural love and affection and it would not have been considered a commercial debt forgiveness.
From 6 February 2019, the ATO released a new draft determination which explicitly stated that the exclusion for debts forgiven for reasons of natural love and affection requires that the creditor be a natural person. This view was confirmed in the finalised determination which was recently released.
Delving a little deeper into the final determination, while it states that 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 also be a natural person.
For example, the natural love and affection exclusion can apply in circumstances where the debtor is a company (such as where a parent forgives a debt owed by a company that is 100% owned by their child or children).
The natural love and affection exclusion to commercial debt forgiveness may also apply in instances where a natural person forgives a debt owed to the trust or partnership in their capacity as a trustee of a trust, or as a partner in a partnership, respectively. The determination points out that cases where this could happen would be limited, given limitations that arise under trust and partnership law principles, statute, and terms of any trust deed or partnership agreement.