Getting personal
Sonny Pty Limited (Sonny) has made a number of loans to an associated company, Cher Pty Limited (Cher), to assist the company in funding its business activities. Pressure from Cher’s trade creditors in recent months, however, has led Sonny to cancel or “forgive” the debts owed to it by Cher.
For capital gains purposes, the loan owing to Sonny by Cher is a capital asset of Sonny. Thus upon forgiveness of the debt Capital Gains Tax (CGT) event C2 occurs, giving rise to a capital loss in Sonny. However, Sonny is not entitled to a capital loss if this debt is characterised as a personal use asset.
The characterisation of the loan as a personal use asset is determined by whether the loan is held in the ordinary course of its business for income-producing purposes. Provided the loan was granted by Sonny for the purpose of deriving interest payments or other income producing purposes, the loan is not a personal use capital asset to Sonny.
By way of contrast, if no interest has been payable on the debt and the loan was made for no other reason than to provide assistance to Cher, the loan may be a personal use asset. On this basis, Sonny would not be entitled to a capital loss on forgiveness of the debt.
Should Cher have been a wholly-owned subsidiary of Sonny and there was an expectation of deriving dividend income, the loan may not be considered to be a personal use asset held by Sonny.
Forgiveness of debts
Where the debt is forgiven, you need to consider whether the forgiven amount is assessable as “ordinary income” to the debtor, and whether commercial debt forgiveness rules apply.
Ordinary income
In respect of forgiveness of any debt owing by a debtor, you need to consider if the forgiveness gives rise to ordinary income. This would be the case if the forgiveness was an ordinary incident of the business of the debtors. For example, if the debt arose in the course of buying trading stock and the supplier agreed to waive part of the debt (eg, by providing a rebate), it may be considered to be assessable income for the debtor.
