Fine-tuning the debt forgiveness rules for dormant group companies

Where a person forgives a debt owed by another person, there are adverse tax consequences for the person who owed the debt. These adverse tax consequences are provided for in section 19 of the ITA and paragraph 12A of the Eighth Schedule to the ITA.  

1 Mar 2023 2 min read Special Edition Budget Speech Alert Article

At a glance

  • When a person forgives a debt owed by another person, adverse tax consequences apply to the borrower.
  • The tax consequences depend on how the loan proceeds were used, and recoupment of allowances and reduction of the tax value of assets may be required.
  • There is uncertainty regarding the application of relief when the debt is forgiven before or after the transfer of assets under corporate rollover relief rules, and the legislation is proposed to be amended to clarify this.

The exact nature of these tax consequences for a particular borrower depends on how the borrower used the loan proceeds. For example, if the borrower used the loan to buy a business asset and a wear and tear allowance was claimed on the cost of the asset, the borrower must recoup the wear and tear allowance in the year the debt is forgiven, and the remaining tax value of the asset must be reduced to nil.

The legislation provides for specific circumstances where these adverse tax consequences do not apply. One of these circumstances is where the debt is owed by a company to another company which falls into the same group of companies, and the borrower company has not carried on trade for two years before the debt is forgiven.

However, this relief is denied where the borrower company used the loan to buy an asset, and the borrower transferred the asset to another company within the same group under the corporate rollover relief rules. These rules allow for tax-free transfers of assets within a group of companies.

There is some uncertainty on how to interpret this: Is the relief denied where the debt is forgiven after the asset was transferred under the corporate rollover relief rules, or is it denied where the debt is forgiven before the asset is transferred under the corporate rollover relief rules?

The policy intention was that the relief would be denied in both circumstances. The Minister has proposed that the legislation be amended to make this clear.     

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