Tax Implications when commercial debt is forgiven
During challenging economic times some businesses face a situation when they are unable to meet their financial obligations as they fall due. Whenever a debt is forgiven, assigned or otherwise dealt with the taxpayer should consider the application of the Commercial Debt Forgiveness (CDF) rules.
The CDF rules apply to debts forgiven after 27 June 1996. Also, the debt must be a “commercial debt”. A debt is a commercial debt if part or all of the interest payable on the debt is, or would be, an allowable deduction. A debt is forgiven if the taxpayer is freed from the obligation to pay it.
The creditor may be entitled to a tax deduction or a capital loss in connection with the forgiven debt. Whereas, the debtor generally would not include the amount of the forgiven debt in their assessable income and no capital gain will arise. However, the CDF rules limit tax benefits that the taxpayer receives because of the debt being forgiven. This is achieved by reducing or cancelling the debtor’s entitlements to tax benefits in relation to the forgiven debt.
Under the CDF rules, a forgiven amount would reduce (in the following order) the taxpayer’s:
- prior income year revenue losses
- net capital losses from earlier years
- deductible expenditure, and
- cost base and reduced cost base of assets.
The remaining net forgiven amount is not assessable and cannot be carried forward to future income years.
However, the CDF rules will not apply:
- to a debt forgiveness under bankruptcy law,
- if a debt is forgiven under a will,
- if a debt is forgiven for reasons of natural love and affection,
- to a debt that constitutes a fringe benefit ,
- if an amount of the debt is included in the debtor’s assessable income (eg. where a debt is treated as a deemed dividend)
If you require help or are unsure of the proper treatment, why not contact one of our tax accountants or tax lawyers on 02 9223 9166 or make an online enquiry here.