Only a natural person can forgive a debt for natural love and affection
Whether or not you have to be a natural person to forgive a debt by reason of natural love and affection has finally been settled, at least in the eyes of the ATO. With the recent release of a taxation determination, the ATO has made it clear that the natural love and affection exclusion under the commercial debt forgiveness provisions can only be exercised by a natural person. This means that businesses are no longer able to use the natural love and affection exclusion to forgive debts through their directors or other controllers.
Forgiving debts for reasons of natural love and affection
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 (i.e. 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, the 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 reasons of natural love and affection.
Old love
Prior to the release of the ATO’s draft views on the matter, the natural love and affection exclusion for 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 owed to the company for reasons of natural love and affection. This forgiveness would not have attracted the commercial debt forgiveness rules.
Finalised ATO view: No love
On 2 October 2019, the ATO released a draft determination which explicitly stated that the exclusion from the commercial debt forgiveness rules 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 could 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 under the commercial debt forgiveness rules might also apply in instances where a natural person forgives a debt owed to a trust or partnership and the natural person is acting as the trustee of a trust or as a partner in a partnership. The determination points out that cases where this could happen would be limited, given the limitations that arise under trust and partnership law principles, statute, and the terms of any trust deed or partnership agreement.
According to the ATO, whether a creditor’s decision to forgive a debt is motivated by natural love and affection for a person needs to be determined on a case by case basis.
In addition, although the Commissioner will not devote compliance resources in relation to debts forgiven by a company prior to 6 February 2019 for reasons of natural love and affection, if required to state a view in a private ruling or litigation, the Commissioner will do so consistently with the views set out in the recent determination.
Need help?
If you need help to determine whether a certain debt forgiveness meets the new criteria, we can help. We can also help you work out the impact of any commercial debt forgiveness on your tax position for the year. Contact us today.
Disclaimer: The information on this page is for general information purposes only and is not specific to any particular person or situation. There are many factors that may affect your particular circumstances. We advise that you contact Mathews Tax Lawyers before making any decisions.